Too Many Days in America?  The “Closer Connection Exception” May Save the Day (& the Tax Hit)

Most people have heard of it, but not many truly understand it.  I will hear a foreign individual proudly state he cannot be taxed by the US since he has no income from US sources and has not spent 183 days or more in the US in any calendar year. Therein lies the “misunderstanding” and it can have serious consequences.

Under US tax laws, any individual with a “substantial presence” in the United States runs the risk of being classified as a US person for tax purposes.  What this means is taxation on worldwide income, along with the duty not only to file tax returns and pay tax, but to report foreign holdings and financial accounts (I think everyone has heard of Mr. FBAR and the penalties for missing out). Those who are physically present in the United States for a long enough time may find themselves owing taxes on their worldwide income to the Internal Revenue Service (IRS) even if they are neither a US citizen nor a green card holder, and even if they earn no income from US sources.

Here’s the deal:

The Substantial Presence Test

Too many people naively believe that meeting the “substantial presence test” simply means residing in the US for more than 182 days in a given calendar year.  This is misleading, since the actual calculation under the tax laws is more complicated. Physical presence is examined over a three-year period.  The day of arrival and departure counts as 2 full days even if the individual was physically present in the US for only 10 minutes on a particular day.  Here is how the formula works.

An individual has a “substantial presence” in the US for a particular calendar year (e.g., the “current” calendar year) if the sum of the following equals 183 days or more:

1) The number of days they were present in the US during the current calendar year;

2) One-third the number of days they were present in the US during the previous calendar year;

3) One-sixth the number of days they were present in the US during the second previous calendar year;

In addition, the individual must have spent at least 31 days in the United States in the current calendar year.

One Possible Escape Hatch: The “Closer Connection” Exception

An individual who has overstayed his welcome from a tax perspective may still find relief. He may be treated as a nonresident alien after meeting the substantial presence test, provided it can be determined that the individual has a so-called “closer connection” to a foreign country than to the US.  This is one possible escape hatch. Another possibility will be discussed in a future post.

The initial criteria for establishing this connection is that the individual maintains a “tax home” in the foreign country, and has not resided in the US for 183 or more days during the current calendar year alone.  Count those days very carefully – if they total 183 or more, do not pass go.

What is a “Tax Home”?

Under the tax rules, one’s tax home” is defined generally as the main place of business, employment, or post of duty, regardless of where the individual maintains his family home. The tax home focuses on the place of one’s vocation or employment. It is the place where the person is permanently or indefinitely engaged to work as an employee or self-employed individual.  If there is no regular or main place of business because of the nature of the work, the tax home may be the place where the individual regularly lives. If they do not have either a regular or main place of business or a place where they regularly live, the individual is considered an “itinerant”.  In that case, the tax home is wherever they work.

Immigration Status

The individual must not have applied to become a lawful permanent resident of the US during that same year, or applied for adjustment of status to lawful permanent resident.  If documents have been filed with the US immigration authorities, this can possibly mean a loss of eligibility for the exception.

If any of the forms listed below were filed during or before the year in question, the filing indicates the individual’s intent to become a Lawful Permanent Resident of the United States.  This will result in the individual being ineligible for the Closer Connection Exception.

• Form I-508, Waiver of Rights, Privileges, Exemptions and Immunities
• Form I-485, Application to Register Permanent Residence or Adjust Status
• Form I-130, Petition for Alien Relative
• Form I-140, Immigrant Petition for Alien Worker
• Form ETA-750, Application for Alien Employment Certification
• Form OF-230, Application for Immigrant Visa and Alien Registration

Other Facts and Circumstances

The IRS will examine the facts and circumstances of each case to determine whether the individual has closer ties with the foreign country than with the United States.  Some of the factors considered include the location of a person’s permanent home (which may be rented rather than owned, but must be available for use at all times), where their family members reside, where they keep their personal belongings, where they conduct their business, the location of social, cultural and religious ties, the jurisdiction in which the individual votes and in which he has a valid driver’s license.

Claiming a closer connection with a foreign country requires filing Form 8840 – Closer Connection Exception Statement for Aliens.  This form must be filed by the 15th of June the year after a given tax year in order to be valid for that tax year.  If the form is not timely filed, the individual cannot claim the closer connection exception, unless a difficult burden is met. It must be shown by clear and convincing evidence that the individual took reasonable actions to become aware of the filing requirements and significant steps to comply with those requirements.  Trust me – this is not so easy to do!

Those who successfully claim the Closer Connection Exception will remain classified as nonresident aliens, and can avoid facing tax obligations on their worldwide income for that particular tax year.

 

Posted Dec. 28, 2023

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