The United States (and California in particular) is an international hub where travelers from around the globe come to vacation and do business. As a result, many people who are not American citizens or legal permanent residents of the United States will be earning income on American soil…and the IRS does NOT let that go unnoticed! The Substantial Presence Test is part of how the IRS determines whether an international traveler is subject to taxation as a “resident alien” or as a “nonresident” in the United States. This is a critical test to understand for individual tax planning purposes.
How Does the Substantial Presence Test Work?
The Substantial Presence Test essentially counts up the number of days that a person has spent in the United States, and sets a threshold (currently 183 days) for the amount of time that it takes to go from being a nonresident to a resident alien. Days the person spent in America more than a year ago are only counted as one-third of a day, and days the person spent in America more than two years ago are counted as only one-sixth of a day. Time spent in the United States more than three years ago is not counted. Additionally, the Substantial Presence Tests only applies to people who have spent at least 30 days in the United States in the current calendar year.
For example, suppose a person has been coming to Los Angeles for 90 days each summer for the past ten years. Because she has spent at least 30 days in America this year, she is potentially a resident alien subject to a different set of tax rules; this will be determined by applying the Substantial Presence Test. The 90 days she has spent in California this year will be added to one-third of the 90 days she spent in California last year, and one-sixth of the 90 days she spent in California the year before. Time in the United States before that is not counted. Therefore, her calculation will look like this:
90 + (90/3) + (90/6) =
90 + 30 + 15 = 135
Because the Substantial Presence Test shows she has been in the United States for a total of 135 days, she has not surpassed the threshold to become a resident alien and will be taxed as a nonresident instead.
Days That Are Not Counted
Not every day a person spends on American soil is counted towards the person’s total. For example, people who live in either Mexico or Canada and regularly commute to work in the United States do not need to count the days they travel to work. Similarly, crew members of foreign vessels do not need to count the days their ship was in United States waters. Travelers who are simply passing through the US for less than 24 hours on their way to a destination outside the United States also do not need to count their time in America. Finally, international travelers who become unable to leave the United States due to a medical condition need not count the time they remain in America for treatment purposes.
Globalization makes the world a little smaller every day, resulting in more and more people earning income on both sides of international borders. Unfortunately globalization does nothing to simplify the American tax scheme, meaning more and more world citizens are being confronted with the complexities of the United States Internal Revenue Code. And since there are few places less pleasant to be than the bad side of the IRS, today’s international businessmen need legal advice they can rely upon. Our firm’s attorneys have been representing international clients in American tax issues for years, and are available to share their expertise with you! If you have questions about international tax issues, please contact us today to schedule a consultation.
Posted in: Tax Planning