Overview
For additional guidance, please refer to Steptoe's COVID-19 Resource Center.
The UK recently gave guidance that foreign employees, directors, and their associated companies forced to work in the UK due to coronavirus-related travel restrictions, would not be considered UK tax residents. Her Majesty's Revenue and Customs (HMRC) noted that it "wouldn't consider nonresident companies with employees conducting business from the UK to have created a taxable presence right away, as a 'degree of permanence is required.'" However, many other nations, including the United States, have not yet taken similar actions.
With many foreigners who are currently waiting out the pandemic here in the US, unintended US tax residency, and the potential tax liability it can bring, may make this bad situation even worse. The unprecedented spread of the pandemic caught many non-US citizens by surprise. Those who were in the US for work or vacation when the federal government and other countries restricted travelers from China and enacted other travel restrictions were faced with going back to their own countries, which were also fighting the virus with limited success, or staying in the US. Others may have been required to stay due to their own illnesses or the illnesses of a loved one. Regardless of the reason, the fact that the "shelter in place” orders would impact their standing as US residents for tax purposes was likely not considered.
Tax Implications
If an individual is deemed a US income tax resident, he or she is subject to US income taxes in the same manner as a US citizen. That means he or she would be required to report and pay US federal income tax on all of his or her worldwide income regardless of source, including wages, capital gains, and dividends.
These could include:
- His or her share of the earnings of non-US companies in which he or she owns stock, whether or not the earnings are distributed to the individual; and
- Earnings in retirement and savings accounts that are tax free in his or her home country.
While one might be entitled to offset his or her US tax liability by certain income taxes paid to a foreign government, the complex US foreign tax credit rules often only result in a partial credit.
US residency can also trigger federal estate and gift tax issues. As this is a separate and unique area of US tax laws, this article will not delve into that topic, as the underlying rules for determining US residency for US estate and gift tax purposes (which are based on the domicile of the taxpayer) differ from those for US income tax and financial reporting purposes.
Reporting Implications
US tax residents are required to report the details of many foreign assets to the IRS and the US Treasury Department. For example, if an individual owns non-US bank or financial accounts or shares of non-US companies, he or she may be required to file information forms that report both his or her non-US assets and financial information about such foreign companies.
The US reporting rules are highly complex, with issues that depend on the value and nature of the foreign assets, how the ownership is structured, and even the impact of ownership by other shareholders. This reporting may be necessary even if your US tax burden is small.
Determination of US Income Tax Residency
A person who is neither a US citizen nor a permanent resident (i.e., a green card holder) can be deemed a tax resident for US federal income tax purposes in different ways, but if he or she is stuck in the US, what is most relevant is that he or she can be treated as a US tax resident if he or she physically spends a substantial amount of time present in the US. This “substantial presence test” considers the effective number of days one has been in the US over the last three years, including the current year. It has two steps, as follows:
- Determine if you have been in the US for at least 31 days in the current calendar year; and
- Determine if the time in the US in the current year plus the two preceding years equals or exceeds 183 effective days, calculated by:
a. Counting the days of US presence in the current year,
b. Plus 1/3 of the days of US presence from the preceding year,
c. Plus 1/6 of the days of US presence from the second preceding year.
If you meet both Steps #1 and #2, you are a US tax resident for the current year. Keep in mind that even a brief visit during a portion of one day in the US counts as one day for purposes of the substantial presence test.
Example: Mr. Smith is visiting the US from Ireland and is stuck in New York due to complications arising from the coronavirus—resulting in him spending 150 days in the US in 2020. Mr. Smith also spent 100 days in the US in 2019, but visited for zero days in 2018. Under the substantial presence test, Mr. Smith is considered having spent effectively 183.33 days (150 + [100 x 1/3] + [0 x 1/6]) in the US over the past three years. Therefore, Mr. Smith would be a US income tax resident for 2020, subject to certain possible exceptions.
Residency Exceptions
Importantly, for some people currently in the US due to the coronavirus, there are some limited exceptions to the substantial presence test that may exclude certain days from the US presence calculation. For example, an individual will not be treated as being present in the US on any day that he or she is unable to leave the US because of a medical condition that arose while he or she was in the US. This would apply if one came here to visit, contracted the coronavirus while in the US, and is now unable to travel while recovering. However, this exception is very limited and is applied on a strict, individual basis, detailed below:
- The medical condition must have arisen while in the US – that excludes pre-existing conditions.
- Additionally, this exception does not exclude days that were part of original travel plans. For example, if a person is in the US now, but his or her originally planned return flight home is not until May 31, he or she may not exclude his or her days of presence even for medical reasons because he or she always intended to be here during this period.
- One cannot exclude days after which he or she is no longer prevented from leaving the US due to the medical condition.
- A physician is required to sign a specific IRS form to confirm the facts that support the medical exception.
- Days caring for the medical condition of a relative, even if he or she is your spouse and was traveling with you, cannot be excluded.
Regardless of health issues, foreign government officials, ambassadors, and certain foreign students and professors are considered “exempt” from the substantial presence test.
For individuals who do not qualify for any of the exemptions above, there are two other ways to avoid US residency:
- Under the “closer connection” exception, one will not be treated as meeting the substantial presence test for a year if he or she (i) is present in the US for fewer than 183 days in the current year, (ii) has a “tax home” in a foreign country, and (iii) has a closer connection to that foreign country than to the US (e.g., location of family members, residences, belongings, business activities).
- If an individual is a resident of a country that has an income tax treaty with the US, he or she may claim under that treaty residency in the foreign country (instead of the US), even if he or she exceeded 183 days of US presence in the current year.
To claim either of these exceptions, one must file a US federal income tax return and a specific IRS form noting the claim.
State and Local Tax Residency
Though the prospect of US federal income tax residency is daunting enough, many US states and local governments (including New York City) have their own income tax residency rules, and they impose their income taxes independently and separately from the US federal government. They are not required to follow the federal substantial presence test, and their own rules may determine one’s length of presence for different periods or consider other factors.
For example, New York State will consider an individual to be a tax resident if he or she is (i) domiciled in New York or (ii) in the state for 184 days or more in an individual year and has a “permanent place of abode” in New York for the year – i.e., if one rents or owns a residence in New York that could be used year-round.
New York State residency is typically determined on a year-by-year basis, but it does exempt days of presence if seeking treatment at a New York medical facility.
If one is deemed a tax resident of a US state, he or she may owe income taxes to that state. Many states use the amount of income one reports on his or her US federal tax return as the starting point for determining state income tax liability. Therefore, if an individual is a state tax resident, he or she could end up paying state tax on his or her worldwide income like as described above for federal tax liability.
Actions to Take
Determine if your days of presence in the US for recent years, including the current year, trigger US tax residency under the substantial presence test. Other than searching your personal travel and passport records, the US Customs and Border Protection agency's website allows individuals to retrieve the dates you entered the US. If they do not exceed the substantial presence test day count threshold, then you do not need to worry about claiming any exceptions.
If you meet or expect to meet the substantial presence test, you should seek professional advice for claiming one of the exceptions discussed above (e.g., the medical exception or closer connection exception). However, it is important to note that to qualify for an exception, one will likely be required to submit filings to the IRS that substantiate the claim.
