U.S. Taxation of Resident Aliens and Non-Resident Aliens
Citizens of other countries who travel or visit the United States should be aware that the U.S. tax laws may cause unintended tax effects for them. The manner in which a non-US person is taxed by the U.S. generally will depend upon whether that person is considered a “resident alien” or a “nonresident alien.” Due to the different tax treatment for resident aliens and nonresident aliens, it is important for a non-US person to know the difference.
Resident aliens are generally taxed in the same manner as U.S. citizens, which means that their worldwide income is subject to U.S. taxation and must be reported to the U.S. tax authorities. Nonresident aliens are generally taxed only on their income which has a U.S. source. The tax rate will depend upon whether or not the income is effectively connected with a U.S. trade or business. In general, income which is effectively connected with a U.S. trade or business is taxed at rates which increase as the amount of income increases. Other income is taxed at the rate of 30%, unless there is an applicable tax treaty which provides for a lower tax rate.
Any non-US person who spends a significant amount of time in the U.S. should understand how the U.S. determines whether a person is a resident alien or a nonresident alien. There are two methods for a non-U.S. citizen to become a resident alien for U.S. income tax purposes. The first method is known as the “green card” test. Essentially, this refers to any person who has been given the privilege, according to U.S. immigration law, to reside permanently in the U.S. This method does not cause any unintentional problems, since the person will be aware of whether he has a green card.
The other method is known as the “substantial presence” test, and is much more likely to cause problems. A non-U.S. citizen will be considered a resident alien for U.S. income tax purposes for a particular calendar year if he is physically present in the U.S. on at least 31 days during the current year, and for at least 183 days during the three year period that includes the current year and the preceding two years. However, the computation of the 183 days is based upon a formula, which counts all of the days of U.S. presence of the current year, one-third of the days of the first preceding year and one-sixth of the days of the second preceding year. As a general rule, a non-U.S. citizen can avoid being treated as a resident alien under the substantial presence test by not being present in the U.S. for more than 121 days during any year. This general rule is based upon the mathematical effect of the formula, and should be used only as a rough guide. An example of the use of the formula is attached.
Even if a person would otherwise be treated as a resident alien because of the substantial presence test, he is not a resident alien if he meets what is known as the “closer connection” test. That test is met if the person (1) is present in the U.S. less than 183 days in the current year, (2) has a tax home in another country, and a closer connection to that other country than to the U.S. and (3) complies with certain reporting requirements. A person’s “tax home” is generally considered to be located at that person’s regular or principal place of business. Whether a person will be able to establish that he has a closer connection to another country will depend upon whether he can establish that he has maintained more significant contacts with another country than with the U.S. In order to claim the benefit of the closer connection exception, a statement must be filed with the U.S. tax authorities.
There are special rules for determining whether a person is present in the U.S. and for the method of counting the days of presence. For example, under certain circumstances, a person prevented from leaving the U.S. due to medical problems suffered while in the U.S. will not be treated as present in the U.S. for those days. It is important to retain documents to prove the amount of time spent in the U.S. While visa and passport documents will provide some information about U.S. entries and exits, they generally are not sufficient to prove the number of days present in the U.S., since departures are not always stamped in the passport.
The above explanation describes some of the general rules for determining residency in the U.S. However, bilateral tax treaties, such as the U.S.- Mexico Income Tax Treaty, provide additional and sometimes conflicting obligations, since each country applies its own standards with regard to residency and tax jurisdiction. This makes it possible for a person to be treated as a resident of both countries. Fortunately, the bilateral treaties will usually provide rules to choose between the two countries. In most cases, the country of residence will be determined based upon rules similar to those for the closer connection exception described above.
The tax laws of the U.S. are very complicated, and can sometimes cause unintended results. The purpose of this short article is to simply alert non-US persons to the possibility that they may be inadvertently subjected to U.S. taxation on their worldwide income unless they are aware of the issues discussed in this article. Although the U.S. has entered into bilateral tax treaties with many countries, the treaties are not all the same. In addition, the only tax treaties between the U.S. and other countries in the Americas are those with Mexico, Canada and Venezuela. Anyone who frequently travels to the U.S., or who spends several months a year in the U.S. should consult with a U.S. lawyer who is knowledgeable regarding these important and quite complicated tax matters.
Example: If the number of days of presence under the weighted average formula equals 183 days or more, the person will be a resident alien for the computation year, unless an exception applies. In this example, assume the person is in the U.S. for 120 days in 2005, 90 days in 2004 and 180 days in 2003. The computation to determine whether the person is a resident alien for 2005 would be as follows:
| | 2003 | 2004 | 2005 | Total |
| Days in US | 180 | 90 | 120 | |
| Portion Counted | 1/6 | 1/3 | all | |
| Days Counted | 30 | 30 | 120 | 180 |
Since the weighted average number of days is less than 183 days, then the person would not be a resident alien for 2005.
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