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Substantial Presence Test: A Trap for the Unwary

Hand reaches out from crumpled papers

Thousands of foreign individuals enter the US on a daily basis. Some for tourism, but many others on non-immigrant student or working visas, such as the F1, J1, H1B, L1 or E2. While these individuals are usually aware that if they work in the US the income received must be reported (and taxes paid) to the IRS, most do not know they might also need to report income received in their home country (or any other country).

The Substantial Presence Test Explained

The US has one of the most unique tax systems in the world. It taxes its citizens and residents on their worldwide income, no matter where they reside or where the income is being generated. What many do not know is that a resident, for US tax purposes, is not only an individual that is a legal permanent resident (green card holder), but also the one that satisfies the Substantial Presence Test.

To put it simply, the Substantial Presence Test is a test used by the Government to determine if a foreign individual in a non-immigrant visa can be considered a resident for tax purposes.

The Substantial Presence Test essentially counts up the number of days that a person has been in the United States during the current year and the two preceding years. It sets a threshold (currently 183 days) for the amount of time that it takes to go from being a nonresident tax alien to a resident tax alien. The formula is simple: if a person is in the US for 31 days or more in the current year, then you must count:

  • All of the days spent in the US in the current year;
  • 1/3 of the days spent in the US in the preceding year;
  • 1/6 of the days spent in the US in the second preceding year.

If the sum of the days is over 183, then the individual is considered a tax resident for US purposes, even if his/her immigration status is of a non-immigrant.

Being a US tax resident means that the individual is treated as a US person for tax purposes and must report his/her worldwide income to Uncle Sam. All other international tax rules, such as those relating to a Controlled Foreign Corporation (CFC) and Passive Foreign Investment Company (PFIC) also apply. The individual will also have FBAR reporting obligations, Form 3520 obligations, and so on.

Note that, days in which the individual is i) commuting from a residence in Mexico or Canada, ii) in the US for less than 24h, iii) unable to leave the US due to a medical condition, iv) an exempt individual, or v) a member of a crew of a foreign vessel in transit in the US do not count towards the Substantial Presence Test calculation.

Exempt Individuals

Certain foreign individuals are exempt from counting the days spent in the US towards the Substantial Presence Test. These individuals are:

  1. Foreign Government Employees under the A or G visa
  2. Teacher, Professors, Trainees, Researchers or other individuals on a J or Q visa, such as physicians, au pairs, summer camp workers, etc.

Caveat: these individuals are only exempt for the first 2 calendar years before counting the 183 days.

  1. Students on a F, J, M or Q visa.

Caveat: these individuals are only exempt for the first 5 calendar years before counting the 183 days. Moreover, the 5 years do not need to be consecutive.

  1. Professional athletes temporarily present in the US to compete in a charitable sports event.

The aforementioned individuals are exempt, not only from the Substantial Presence test, but also from paying social security and Medicate taxes.

Tax Return Reporting Obligation

Foreign individuals working in the US must file Form 1040-NR if they are considered nonresident tax aliens. Those considered to be a resident for tax purposes under the Substantial Presence Test, must file Form 1040, just as if he/she were a US citizen or legal permanent resident.

For those individuals who have satisfied the Substantial Presence Test but have not reported their worldwide income or foreign financial assets, the US has amnesty programs to allow the person to come forward and voluntarily disclose the foreign income and/or financial assets. The Programs in existence offer reduced penalties and peace of mind for many non-immigrants that would like to comply with the US tax laws.

If you are foreign individual present in the US with a non-immigrant visa and has questions regarding your tax filing obligations, do not hesitate to contact Brunoro Law, APC for a 1h free consultation.






Posted in: Tax Planning, Uncategorized

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