Mechanics of the Substantial Presence Test and Exemptions: Foreign Teacher, Student, Trainee, Government Employee in the US

Once a non-US individual is classified for income tax purposes as a “resident” he is subject to income tax in the same manner as a US citizen: i.e., taxed on his worldwide income (meaning income from all sources whether from within or outside the US) at a maximum rate of 37 percent (this top rate is effective for the tax year 2018 and was put in place by the Tax Cuts and Jobs Act, also known as “TCJA”). This worldwide income tax covers the period from commencement of the residency period until its conclusion (determination of which is also tricky under the tax laws). Income that is taxed includes but is not limited to wages, interest, dividends, rents, capital gains, royalties, gambling winnings etc. regardless of whether these items arose from outside the US.

The person also becomes responsible for filing tax returns and various information returns (such as foreign bank account reports also known as “FBAR”). Often, foreigners do not understand these rules and do not realize they have a duty to file even if they are only earning wages from an employer in a foreign country. Filing is required even if the salary and / or housing allowance is below the foreign earned income (and / or housing) exclusion amount thresholds permitted for US taxpayers working overseas. Failure to file could result in loss of the ability to claim these exclusions.

Once an individual qualifies as a “resident”, a series of complicated tax rules come into play if that person is a beneficiary of a non-US trust or if he owns stock in a closely held non-US corporation. For example, an individual US resident shareholder can be currently taxed on certain income earned by the corporation, even if no actual corporate distribution has been made to him. See my earlier blog posts here and here.  The taxation of trust distributions also becomes complex and results in harsh consequences.

“Residency” Determination for US Income Tax Rules

The determination of residency for income tax purposes is very precise. A foreigner is considered a US “resident” for a particular calendar year if he meets the requirements of either the “green card” test or the “substantial presence” test for that year.  Simply holding a green card is enough to subject you to US income taxation on your worldwide income – even if the terms of the card have long ago expired under the immigration rules. This posting will focus on the “substantial presence” test, a numerical test that involves counting each day of physical presence in the US.

Exempt Individuals

As a general matter (subject of course to exceptions), days of physical presence do not count in certain cases for a so-called “exempt individual”. The term “exempt individual” does not refer to someone exempt from US tax, but to anyone in the following categories who is exempt from counting days of physical presence in the US:

  • An individual temporarily present in the United States as a foreign government-related individual;
  • A teacher or trainee temporarily present in the United States under a “J ” or “Q ” visa, who substantially complies with the requirements of the visa;
  • A student temporarily present in the United States under an “F, ” “J, ” “M, ” or “Q ” visa, who substantially complies with the requirements of the visa;
  • A professional athlete temporarily in the United States to compete in a charitable sports event.

If you exclude days of presence in the United States because you fall into a special category, you must file a fully-completed Form 8843, Statement for Exempt Individuals and Individuals with a Medical Condition (PDF).   You must also make sure that no exception applies to your particular case that would prevent you from being able to exclude days of physical presence (for example, even if you meet the aforementioned requirements, you cannot exclude days of presence in the current tax year as a student if you were exempt as a teacher, trainee, or student for any part of more than 5 calendar years unless you establish that you do not intend to reside permanently in the United States).  Professional advice should be taken in any such instance.

Mechanics of the “Substantial Presence” Test

For all others who must count days of physical presence, an individual will qualify under the substantial presence test if either he is physically present: (1) in the US for 183 days or more during the current calendar year or, (2) for at least 31 days during the current calendar year and the sum of the days present in the US during the current calendar year, plus one-third of the days he was present in the US during the immediately preceding calendar year, plus one-sixth of the days he was present in the second preceding calendar year, is 183 days or more.

To illustrate the operation of the “look-back” period rules, assume that in 2012 a foreign person spends 15 days investigating business opportunities in the US and 20 days on holiday there. Later that year, he spends 30 days meeting with his employer’s customers. In 2011, the individual spent 120 days in the US for treatment of a pre-existing medical condition. In 2010, he spent 60 days purchasing property and seeking investments and 60 days on business for his employer.

The number of days counted for purposes of the substantial presence test for 2012 are 125: 2012 = 65 days + 2011 = 40 (one-third of 120) + 2010 = 20 days (one-sixth of 120). In this example, the individual would not be considered a US resident for the 2012 calendar year. He was neither in the US during 2012 for at least 183 days, nor was the weighted average over the three-year “look-back” period equal to or more than 183 days.

Posted January 28, 2019

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