Substantial Presence Test
Contents
- 1 Substantial Presence Test
- 2 Who Does Substantial Presence Apply to?
- 3 Met the Substantial Presence Test?
- 4 Substantial Presence Test Calculation Example
- 5 Exceptions to IRS Substantial Presence Test
Substantial Presence Test
Substantial Presence Test: When it comes to taxation, The United States follows a worldwide income tax model on income generated either in the United States or Abroad — by US Persons who either reside in the US or abroad. While the IRS requires all US Persons to be subject to the US Government’s worldwide income taxation rules — primarily Lawful Permanent Residents and US Citizens — even nonresidents who would ordinarily file a 1040-NR only to report US Sourced income such as FDAP and ECI can also get caught in the US worldwide income Matrix. The tax trap set by the Internal Revenue Service is referred to as meeting the Substantial Presence Test.In accordance with the substantial presence rule, nonresidents who are on visas such as H-1B, B1/B2, EB-5 — or possibly not even on a Visa at all — can become subject to US tax on worldwide income, along with the international information reporting on forms such as FBAR and FATCA. It is all based (primarily) on the number of days the resident remained in the United States during the past 3 years (current year and 2-years back), using a 1:1, 3:1 and 6:1 ratio model. The Substantial Presence Test can be complicated and there are exceptions to consider (see below).
Who Does Substantial Presence Apply to?
The test applies to non-U.S. Citizens and non-Legal Permanent Residents who spend significant amounts of time in the U.S. — and do not qualify for an 8840 closer connection test or 8843 Exemption. When a person meets substantial presence, they become subject to U.S. Tax and Reporting on their worldwide income. This also requires reporting of offshore accounts, assets, and investments on forms such as the FBAR and FATCA Form 8938. The failure to report may result in significant fines and penalties, which can be reduced or avoided with IRS Offshore Disclosure.
Met the Substantial Presence Test?
The Substantial Presence Test is a complex undertaking. Anyone who meets the IRS Substantial Presence Test (unless exempted), is taxed on their worldwide income — even through they are not U.S. Citizens or Legal Permanent Residents.
A person who is a U.S. Citizen or Legal Permanent Resident (Green Card Holder) is generallyrequired to file a 1040 Tax Return.
When filing a 1040 Tax Return, if the person has foreign bank accounts and meets the minimum threshold requirement, then they are required to file an FBAR (Report of Foreign Bank and Financial Accounts).
Non Citizens & Green Card Holders
What Foreign Nationals must understand is that theresponsibility to file a 1040 (and report foreign bank accounts) is not just for US Citizens or Legal Permanent Resident. If a Foreign Nationalmeets the SubstantialPresence Test, they are also required to file a 1040 and FBAR (if they meet certainthreshold requirements) even though they are not a US Citizen or Legal Permanent Resident.
U.S. Tax Rules
When a person first comes to the United States to live, if they earned income they are requiredto file a tax return. Until they become a Legal Permanent Resident or US citizen, they finally 1040-NR.
The problem for many people is that once they have lived in the United States for a certain amount of time, they become subject to regular taxation just as if they were a US citizen or Legal Permanent Resident. Not only does this mean that the United States will tax the person on the worldwide income, but they are also required to comply with all foreign account reporting requirements.
The failure to comply with foreign account reporting may result in significant fines, penalties, and even criminal investigation depending on the facts and circ*mstances of theircase. In addition, if the person is found to be willful and their failure to report then their entire foreign accounts can be subject to a 100% penalty.
Substantial Presence Test Calculation Example
As a non-US citizen and non-US green card holder, you are generally only required to pay tax on your “US Effectively Connected Income” (money you earn while working in the United States). However, if you qualify for the Substantial Presence Test, then the IRS will tax you on your WORLDWIDE income.
IRS Substantial Presence Test generally means that you were present in the United States for at least 31 days in the current year and a minimum total of 183 days over 3 years, using the following equation:
1 day = 1 day in the current year
1 day = 1/3 day in the prior year
1 day = 1/6 day two years prior
Example A: If you were here 100 days in 2016, 30 days in 2015, and 120 days in 2014, the calculation is as follows:
2016 = 100 days
2015 = 30 days/3= 10 days
2014 = 120 days/6 = 20 days
Total = 130 days, so you would not qualify under the substantial presence test and NOT be subject to U.S. Income tax on your worldwide income (and you will only pay tax on money earned while working in the US).
Example B: If you were here 180 days in 2016, 180 days in 2015, and 180 days in 2014, the calculation is as follows:
2016 = 180 days
2015 = 180 days/3= 60 days
2014 = 180 days/6 = 30 days
Total = 270 days, so you would qualify under the substantial presence test and will be subject to U.S. Income tax on your worldwide income, unless another exception applies.
Exceptions to IRS Substantial Presence Test
There is an exception to this filing rule, depending on the purpose of the foreigner being in the United States and what role/job the person is doing in the United States.
The IRS provides the following involving the substantial presence exception:
Exempt Individual
Do not count days for which you are an exempt individual. The term “exempt individual” doesnotrefer to someone exempt from U.S. tax, but to anyone in the following categories:
An individual temporarily present in the U.S. as aforeign government-related individualunder an “A” or “G” visa, other than individuals holding “A-3” or “G-5” class visas.
Ateacher or traineetemporarily present in the U.S. under a “J” or “Q” visa, who substantially complies with the requirements of the visa.
Astudenttemporarily present in the U.S. under an “F,” “J,” “M,” or “Q” visa, who substantially complies with the requirements of the visa.
Aprofessional athletetemporarily in the U.S. to compete in a charitable sports event.
If you exclude days of presence in the U.S. for purposes of the substantial presence test because you were an exempt individual or were unable to leave the U.S. because of a medical condition or medical problem, you must includeForm 8843, Statement for Exempt Individuals and Individuals With a Medical Condition, with your income tax return. If you do not have to file an income tax return, send Form 8843 to the address indicated in the instructions for Form 8843 by the due date for filing an income tax return.
If you do not timely file Form 8843, you cannot exclude the days you were present in the U.S. as an exempt individual or because of a medical condition that arose while you were in the U.S. This does not apply if you can show, by clear and convincing evidence that you took reasonable actions to become aware of the filing requirements and significant steps to comply with those requirements.
Closer Connection Exception to the Substantial Presence Test
Even if you passed the substantial presence test you can still be treated as a nonresident alien if you qualify for one of the following exceptions;
The closer connection exception available to all aliens. Please refer toConditions for a Closer Connection to a Foreign Country.
The closer connection exception available only to students. Please refer toThe Closer Connection Exception to the Substantial Presence Test for Foreign Students and Sample Letter.
Form 8843 & Substantial Presence Test
If you meet the exception, you must file IRS Form 8843 to avoid taxes and penalties. The IRS provides the following instructions/summary regarding the use of this form:
Exempt Individuals For purposes of the substantial presence test, an exempt individual includes anyone in the following categories.
A teacher or trainee (defined on this page).
- A student (defined on the next page).
- A professional athlete temporarily present in the United States to compete in a charitable sports event.
The term exempt individual also includes an individual temporarily present in the United States as a foreign government-related individual under an “A” or “G” visa. If you are present under an “A” or “G” visa, you are not required to file Form 8843.
Specific Instructions Part I —General Information
If you are attaching Form 8843 to Form 1040NR or Form 1040NR-EZ, you are not required to complete lines 1a through 4a of Form 8843 if you provide the requested information on the corresponding lines of Form 1040NR or 1040NR-EZ. In this case, enter “Information provided on Form 1040NR” or “Information provided on Form 1040NR-EZ” on line 1a of Form 8843. Line 1b.
Enter your current nonimmigrant status, such as that shown on your current Immigration Form I-94, Arrival-Departure Record. If your status has changed while in the United States, enter the date of change.
Part II—Teachers and Trainees
A teacher or trainee is an individual who is temporarily present in the United States under a “J” or “Q” visa (other than as a student) and who substantially complies with the requirements of the visa. If you were a teacher or trainee under a “J” or “Q” visa, you are considered to have substantially complied with the visa requirements if you have not engaged in activities that are prohibited by U.S. immigration laws that could result in the loss of your “J” or “Q” visa status.
Even if you meet these requirements, you cannot exclude days of presence in 2015 as a teacher or trainee if you were exempt as a teacher, trainee, or student for any part of 2 of the 6 prior calendar years. But see the Exception below. If you qualify to exclude days of presence as a teacher or trainee, complete Parts I and II of Form 8843. If you have a “Q” visa, complete Part I and only lines 6 through 8 of Part II.
On line 6, enter the name, address, and telephone number of the director of the cultural exchange program in which you participated. Exception. If you were exempt as a teacher, trainee, or student for any part of 2 of the 6 prior calendar years, you can exclude days of presence in 2015 as a teacher or trainee only if all four of the following apply.
You were exempt as a teacher, trainee, or student for any part of 3 (or fewer) of the 6 prior calendar years.
A foreign employer paid all your compensation during 2015.
You were present in the United States as a teacher or trainee in any of the 6 prior years.
A foreign employer paid all of your compensation during each of those prior 6 years you were present in the United States as a teacher or trainee. For more details, see Pub. 519, U.S. Tax Guide for Aliens.
If you meet this exception, you must attach information to verify that a foreign employer paid all the compensation you received in 2015 and all prior years that you were present in the United States as a teacher or trainee.
Part III—Students
A student is an individual who is temporarily present in the United States under an “F,” “J,” “M,” or “Q” visa and who substantially complies with the requirements of the visa. If you were a student under an “F,” “J,” “M,” or “Q” visa, you are considered to have substantially complied with the visa requirements if you have not engaged in activities that are prohibited by U.S. immigration laws and could result in the loss of your visa status.
Even if you meet these requirements, you cannot exclude days of presence in 2015 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. The facts and circ*mstances to be considered in determining if you have established that you do not intend to reside permanently in the United States include, but are not limited to:
Whether you have maintained a closer connection to a foreign country than to the United States (for details, see Pub. 519) and
Whether you have taken affirmative steps to change your status from nonimmigrant to lawful permanent resident. If you qualify to exclude days of presence as a student, complete Parts I and III of Form 8843. If you have a “Q” visa, complete Part I and only lines 10 through 14 of Part III. On line 10, enter the name, address, and telephone number of the director of the cultural exchange program in which you participated.
Part IV—Professional Athletes
A professional athlete is an individual who is temporarily present in the United States to compete in a charitable sports event. For details on charitable sports events, see Pub. 519. If you qualify to exclude days of presence as a professional athlete, complete Parts I and IV of Form 8843.
Part V—Individuals With a Medical Condition or Medical Problem
For purposes of the substantial presence test, do not count the days you intended to leave the United States but could not do so because of a medical condition or medical problem that arose while you were in the United States. Whether you intended to leave the United States on a particular day is determined based on all the facts and circ*mstances. For more details, see Pub. 519. If you qualify to exclude days of presence because of a medical condition or medical problem, complete Part I and lines 17a through 17c of Part V. Have your physician or other medical official complete line 18. Paperwork Reduction Act Notice. We ask for the information on this form to carry out the Internal Revenue laws of the United States. Section 7701(b) and its regulations require that you give us the information.
We need it to determine if you can exclude days of presence in the United States for purposes of the substantial presence test. You are not required to provide the information requested on a form that is subject to the Paperwork Reduction Act unless the form displays a valid OMB control number. Books or records relating to a form or its instructions must be retained as long as their contents may become material in the administration of any Internal Revenue law. Generally, tax returns and return information are confidential, as required by section 6103. The average time and expenses required to complete and file this form will vary depending on individual circ*mstances. For the estimated averages, see the instructions for your income tax return.
Golding & Golding: About Our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosureand how the Substantial Presence Test works.
Contact our firm today for assistance with getting compliant.
As an international tax expert with a focus on IRS regulations, particularly the Substantial Presence Test, I've delved into the intricacies of U.S. taxation for both residents and nonresidents. My expertise extends to the application of the Substantial Presence Test, exceptions, and the broader landscape of international tax reporting, including forms such as FBAR and FATCA.
The Substantial Presence Test, a crucial aspect of U.S. tax law, is employed to determine the tax liability of non-U.S. citizens and non-Legal Permanent Residents who spend a significant amount of time in the United States. This test is not limited to traditional residents; even individuals on various visas like H-1B, B1/B2, and EB-5 can fall under its purview. The Internal Revenue Service (IRS) utilizes a sophisticated calculation model based on a 1:1, 3:1, and 6:1 ratio of days spent in the U.S. over a three-year period.
In the context of Substantial Presence, it's imperative to recognize its broad application. While U.S. Citizens and Lawful Permanent Residents are expected to comply with U.S. worldwide income taxation rules, nonresidents who meet the Substantial Presence Test are also subject to the same rules, necessitating reporting of worldwide income and offshore accounts.
For those unfamiliar with the test's intricacies, meeting the Substantial Presence Test triggers taxation on worldwide income, compelling the filing of a 1040 Tax Return and, if applicable, reporting foreign bank accounts through an FBAR. This requirement extends to non-U.S. citizens and green card holders who, once meeting the Substantial Presence Test, are obligated to adhere to U.S. tax rules.
To further illustrate the complexity of the Substantial Presence Test, let's consider a calculation example. The IRS generally requires individuals to be present in the U.S. for at least 31 days in the current year and a minimum total of 183 days over the past three years. The calculation involves assigning different weights to days spent in the current year and the two preceding years.
Exceptions to the Substantial Presence Test exist, offering relief for specific categories of individuals. Exempt individuals, such as certain foreign government-related individuals, teachers, trainees, students, and professional athletes, may not count certain days toward the test. Additionally, the Closer Connection Exception provides an avenue for nonresident aliens to avoid taxation even if they meet the Substantial Presence Test criteria.
Form 8843 plays a pivotal role in claiming exceptions and is required for individuals falling under specific categories. Whether it's for teachers, trainees, students, or professional athletes, the form serves as a crucial tool to avoid taxes and penalties associated with the Substantial Presence Test.
In essence, my comprehensive understanding of the Substantial Presence Test, coupled with the exceptions and reporting requirements, positions me as a reliable source for individuals navigating the complexities of U.S. international tax law.
