Caught in the US Tax Trap: Part I How Does a Non-US citizen Become a US “Resident” – Taxed on WORLDWIDE Income?

US “residents” are subject to tax on income derived from all sources. That means they are subject to tax on their worldwide income regardless of the source of that income.  So, for example, dividends earned from a French company are taxable, as is gain on the sale of rental property located in Hong Kong; prize money won from entering a contest in Barbados, interest from a bank account in Switzerland and so on.

In addition, foreign nationals who are treated as US tax “residents” must comply with all of the various and complex information reporting requirements imposed by the US tax laws, in the same manner as US citizens. These include information reporting with regard to interests in foreign financial assets, and foreign entities and more.  Stiff penalties are assessed for noncompliance.

It usually comes as a shock for the US tax resident to learn of the numerous US tax problems associated with foreign investments (for example, a non-US mutual fund or foreign “life insurance” product which are treated as “PFICs”), or the duty to report foreign financial accounts on the notorious FBAR.  Pre-immigration tax planning is critical, yet many immigrants fail to take appropriate steps and find themselves in the IRS tax penalty box.

Two Ways You May Qualify as a US “Resident”

An individual becomes a “US resident” under either the so-called “green card” test or the “substantial presence” test.  Both tests are discussed in detail in a 2 part series. Today, the Green Card test!

Green Card

It’s very simple. Getting a green card (lawful admission to reside permanently in the US) subjects you to US tax on your worldwide income.  You need to be aware of the “residency starting date” or RSD (full info at my blog post here).  If you are considering getting a green card, have a listen to my tax podcasts with attorney John Richardson; links in my blog  “Getting a Green Card – Is it Really Worth It?“.

While we are on the green card topic, let’s bust a few green card myths.

  • The “Expired” Green Card

It comes as a rude awakening that even though the individual no longer has the right to live and work in the US from an immigration standpoint because the green card has “expired”, his US tax duties remain intact.  Yes, absent a proper relinquishment of the card , the individual stays on the hook for annual US income taxes and reporting obligations.

Make no mistake. Simply because a green card has “expired” has no impact on one’s status as a US tax subject. The tax law is very precise on this topic: once “resident” status is acquired, it is deemed to continue unless it is rescinded or administratively or judicially determined to have been abandoned. This requires precise actions! A full discussion can be found here and here.

  • “But, I Never Used my Green Card”

This is another favorite.

Some individuals remain abroad never using the green card.  This does not matter from a tax perspective.

In fact, some individuals obtain their green card by using a “care of” address of a US relative and having the relative later forward the green card overseas. It can happen that the individual changes his mind about leaving the home country and simply never enters the United States. Is this individual still on the hook for US income taxes on worldwide income?  If so, when?  Sadly under a literal reading of the Treasury Regulations, the answer to the first question is apparently “yes.”  Under a special rule “if an individual meets the green card test for the current year but is not physically present in the United States during the current year, then the individual’s residency starting date shall be the first day of the following year.”

While this rule may not impact many individuals, those who feel its impact will be blindsided. Apparently, they will become US tax residents on January 1 of the year following the year they got the green card even though they may never enter the USA as a green card holder.  Unless and until the green card is properly relinquished, the US tax impact will be ongoing each and every year.  US resident status under the green card test continues unless certain events take place, as mentioned above.

“I May as Well Keep the Card, Right?” — WRONG!  The “Expatriation” Regime

You’ve heard the expression “less is more”.  When it comes to the green card, this expression holds true. If you do not need the card, then by all means, plan your exit.  The tax problems only become worse if the green card is held for 8 “tax years”.  There’s a reason the words are in quotes. “Tax year” does not mean a full calendar year, a tax year can be a very short period within the calendar year. Having the green card for even one day during the calendar year will cause that entire year to be counted for purposes of computing the 8 year period since that one day in the calendar year counts as a “tax year”.  Once held for that time period, the entire expatriation regime will apply upon giving up the card.  In the best case, this regime causes nothing but angst …. but more often than not, in most cases it causes far bigger problems – not only for the individual giving up the card, but for any US members in his family or close circle.

Next week’s post will closely examine the “Substantial Presence” Test in all its detail.  Stay tuned.

Posted November 4, 2021

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