As a general rule, all U.S. citizens are U.S. residents for tax purposes. Foreign citizens who meet either the Green Card Test or the Substantial Presence Test are also residents for tax purposes. Under the internal revenue laws, all residents are subject to tax on worldwide income. Nonresidents are all foreign citizens who are not residents for tax purposes. Nonresidents are taxed only on U.S. source income.
Foreign citizens who are physically present in the United States become residents once they pass the Substantial Presence Test. The test employs a formulary approach, counting the days an individual is physically present in the United States during the current (test) tax year and the previous two tax years. The day of entry to or departure from the USA is counted as a full day of presence. The test is applied separately to each test year and the days of presence in the USA are calculated as follows:
- Count all days of presence in the current tax year (the test year)
- Add one-third of the days in the previous tax year (if any)
- Add one-sixth of the days in the year immediately before the previous year (if any)
If the combined amount of all days of presence calculated under the above rules is 183 or more, the individual is presumed resident for tax purposes.
The Substantial Presence Test does not apply to Green Card holders, exempt individuals, or to individuals with "de minimis" presence of 30 days or less during the test year. The Substantial Presence Test may be rebutted if the person proves to the satisfaction of the IRS that a closer connection to a foreign country is established. The provisions of Article 4 "Residency" of an income tax treaty to which the USA is a party may also revoke the resident status determined under the Test rules. Finally, special considerations also apply to the first and last years of residency.
Under the provisions of the Green Card Test, foreign citizens who are lawfully admitted into the United States as Permanent Residents (USCIS Form I-551 or Green Card) are treated as residents for tax purposes effective the first day of physical presence in the United States.
Special considerations apply to the first and last year of residency, which is often a dual-status tax year. In a dual-status year, the Green Card holder should file a dual-status return; a nonresident return for the period before the first day of entry or after the residency termination date, and a resident return for the remaining part of the year.
Non-U.S. citizens with U.S. filing obligations must first determine tax residency. Individuals who are residents for tax purposes file the same tax return as U.S. citizens, namely a resident return on Form 1040. On the contrary, nonresidents are required to use Form 1040-NR. A foreign citizen becomes a U.S. resident for tax purposes once the Substantial Presence Test or the Green Card Test is met. Nonresidents may also elect to be taxed as residents if they are married to a U.S. citizen or resident and a joint return is filed.
Fixed, Determinable, Annual, or Periodical (FDAP) Income refers to items of income that are not effectively connected with a US trade or business. Income is fixed when the amount is known ahead of time. It is also determinable when the amount can be ascertained with a reasonable accuracy. The income is annual or periodic when it is paid either in a lump sum or two or more installments. Most FDAP Income is taxed at a 30 % or lower tax treaty rate, and no deductions are allowed. The most common types of FDAP Income include interest, dividends, capital gains, royalties, rents, wages, pensions, annuities, scholarships, grants, and the like.
When applied to individuals the definition of Effectively Connected Income (ECI) includes all income derived from or attributable to, the performance of personal services or the active conduct of a trade or business within the USA. The stress is on where the services were performed, not on the location of the payor. For example, wages paid to individuals who work in the USA are effectively connected income regardless of whether the employer is based in or outside the USA. Income from self-employment in the USA is also ECI. Deductions are allowed against ECI, and the tax is computed at the graduated rates or lesser rate under a tax treaty.
Students and exchange visitors on J, F, M, or Q visa are considered "exempt" individuals under the Substantial Presence Test. The exemption grants nonresident treatment for two or five years, depending on visa type and purpose of stay. Because of the nonresident status F, J, M, and Q visa holders are subject to tax only on US source income.
Maybe. US citizens and residents are required to file income tax return regardless of whether they live in the United States or overseas. The filing status of the individual and the worldwide gross income are the major factors that trigger a tax return filing requirement. Consequently, if your gross income exceeds the combined amount of the standard deduction and personal exemptions for your filing status, you must file a tax return, even if you have been residing abroad for many years. A filing requirement also applies to self-employed individuals with $400.00 or more of net income from self-employment.
The ITIN is a unique nine-digit tax number assigned directly by the IRS to foreign individuals who do not qualify for a Social Security Number. The ITIN always starts with the digit 9 and follows the format of the Social Security Number (9XX-XX-XXXX). However, unlike the Social Security Number, the ITIN has no practical application outside the tax system. Therefore, the ITIN is issued solely to qualifying individuals who need to file tax returns, claim tax treaty benefits, or have specific income reporting requirements. In itself, the ITIN does not grant the right to work or stay in the United States.
The Foreign Earned Income Exclusion is a provision in Section 911 of the Tax Code that allows U.S. citizens and permanent residents to exclude from U.S. federal tax, the income earned abroad. The exclusion covers only compensation attributable to services performed in a foreign country. It offsets foreign earned income up to a statutory threshold increased annually for inflation. To avail of the exclusion U.S. citizens must pass either the Bona-Fide Resident Test or the Physical Presence Test. Green Card holders must qualify under the Physical Presence Test unless they do also qualify as residents of the host country under the provisions of an income tax treaty.
The Foreign Housing Exclusion is available to U.S. citizens and residents who are residing overseas. It is computed in addition to the Foreign Earned Income Exclusion as a trade-off for excessive housing expenses paid in a foreign country. Effective for tax years after January 1st, 2006, the housing exclusion is capped at 30 percent of the Foreign Earned Income Exclusion for the relevant year, over a base amount. The base amount has been set at 16 percent of the Foreign Earned Income Exclusion. Individuals residing in high-cost locations may avail of a higher housing exclusion limit. The foreign housing exclusion is available only if the Foreign Earned Income Exclusion is insufficient to offset all foreign earned income. Housing expenses are defined in Treas. Reg. 1.911-4(b) to include:
- Fair value rental of housing provided in kind by the employer,
- Real and personal property insurance,
- Occupancy fees and taxes;
- Nonrefundable fees paid to secure a lease (deposits that will be refunded are not excludable);
- Rental of furniture, fittings, and accessories, and
- Residential parking.
Taxpayers may elect to claim a non-refundable Foreign Tax Credit or take an itemized deduction for the taxes paid to a foreign country. Generally, it is more advantageous to claim the credit rather than the deduction as the Foreign Tax Credit results in a dollar-for-dollar reduction of your income tax obligations. The election to claim the credit is made on an annual basis by filing Form 1116. The Foreign Tax Credit is available to earned and passive category income. A proration of the taxes attributable to excluded or non-taxable income is required to accurately account for the credit.
The first attempt to lay taxes on American citizens who give up citizenship was introduced by Section 103(f) of the Foreign Investors Tax Act of 1966 (P.L. 89-809). Effective January 1st, 1967 a new Section 877 was added to the Internal Revenue Code. At that time Section 877 covered only U.S. citizens who renounce citizenship if one of the principal purposes for the expatriation is avoidance of U.S. income, gift, or estate taxes. The Taxpayer Relief Act of 1997 (P.L. 105-34), amended Section 877 to specify that the expatriation tax provisions shall also apply to a lawful permanent resident (Green Card holder) who is also a "long-term resident."
Section 877(e)(2) defines a long-term resident as any individual who is a lawful permanent resident (Green Card holder) of the United States in at least 8 taxable years during the period of 15 taxable years ending with the taxable year during which the expatriation occurs. Further, a Green Card holder shall not be treated as a lawful permanent resident for any taxable year if such individual is treated as a resident of a foreign country for the taxable year under the provisions of a tax treaty between the United States and the foreign country and does not waive the benefits of such treaty applicable to residents of the foreign country.