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Determining Tax Residency In The United States



John Richardson

The advent of the OECD Common Reporting Standard (CRS) has illuminated the issue of tax residency and the desire of people to become tax residents of more tax favorable jurisdictions. It has become critically important for people to understand what is meant by tax residency. It is important that people understand how tax residency is determined and the questions that must be asked in determining tax residence. Tax residency is NOT necessarily determined by physical presence.

What is meant by tax residence? Different rules for different countries

All countries have rules for determining who is a tax resident of their country. Some countries have rules that deem people to be tax residents. Other countries have rules that base tax residency on facts and circumstances. Canada is a country that bases tax residency on either deemed tax residency OR tax residency based on factual circumstances.

What if a person qualifies as tax resident of two countries?

When an individual (who is NOT a U.S. citizen) is a tax resident of two countries, it is common to consider any tax treaty between those two countries. Often the tax treaty will contain a treaty tie breaker provision which will allocate tax residence to one of the two countries. (Note that the savings clause which is found in standard U.S. tax treaties prevents U.S. citizens from having most tax treaty benefits. Note treaty tie breaker provisions are available to Green Card Holders.)

In summary: for the purposes of the CRS, tax residence is determined by BOTH a country’s domestic laws AND tax treaty provisions that assign tax residence to one country.

Even though the United States has chosen to NOT participate in the OECD Common Reporting Standard and is NOT a reportable jurisdiction, the OECD reminds us of the rules for determining U.S. tax residency.

Determining Tax Residency in the U.S.

The IRS discussion of “U.S. Tax Residency” includes:

Introduction to Residency Under U.S. Tax Law

The taxation of aliens by the United States is significantly affected by the residency status of such aliens.

Although the immigration laws of the United States refer to aliens as immigrants, nonimmigrants, and undocumented (illegal) aliens, the tax laws of the United States refer only to RESIDENT and NONRESIDENT ALIENS.

In general, the controlling principle is that resident aliens are taxed in the same manner as U.S. citizens on their worldwide income, and nonresident aliens are taxed according to special rules contained in certain parts of the Internal Revenue Code (hereinafter referred to as I.R.C. or the Code). A major distinguishing feature of this special tax regime concerns the source of income: a nonresident alien (with certain narrowly defined exceptions) is subject to federal income tax only on income which is derived from sources within the United States and/or income that is effectively connected with a U.S. trade or business.

The residency rules for tax purposes are found in I.R.C. § 7701(b). Although the tax residency rules are based on the immigration laws concerning immigrants and nonimmigrants, the rules define residency for tax purposes in a way that is very different from the immigration laws. If you are an alien (not a U.S. citizen), you are considered a nonresident alien, unless you meet one of two tests for the calendar year (January 1 – December 31).

You are admitted to the United States as, or change your status to, a Lawful Permanent Resident under the immigration laws (the Green Card Test);

You pass the Substantial Presence Test (which is a numerical formula which measures days of presence in the United States);

Deemed U.S. tax residency based on characteristics one chooses – spending time in the USA

Note that the United States has a similar deemed residence provision based on the number of days spent in the United States. It is called the substantial presence and is based on a three year formula and is discussed here.

Deemed U.S. tax residency based on “immigration status” – Green Card

See Internal Revenue Code 7701(b)(1)(A)(i) and the associated regulations.

(b) Definition of resident alien and nonresident alien
(1) In general For purposes of this title (other than subtitle B)—
(A) Resident alienAn alien individual shall be treated as a resident of the United States with respect to any calendar year if (and only if) such individual meets the requirements of clause (i), (ii), or (iii):
(i) Lawfully admitted for permanent residence
Such individual is a lawful permanent resident of the United States at any time during such calendar year.

A person is a lawful permanent resident of the United States if that person has been issued a Green Card—commonly known as an Immigrant Visa—under the Immigration and Nationality Act.

Note that simply moving from the United States will NOT change one’s status as lawfully admitted for permanent residence. Internal Revenue Code 7701(b) is very specific. For a Green Card Holder to end his status as a U.S. tax resident the person must (in the language of the regulations):

(b)Lawful permanent resident –

(1)Green card test. An alien is a resident alien with respect to a calendar year if the individual is a lawful permanent resident at any time during the calendar year. A lawful permanent resident is an individual who has been lawfully granted the privilege of residing permanently in the United States as an immigrant in accordance with the immigration laws. Resident status is deemed to continue unless it is rescinded or administratively or judicially determined to have been abandoned.

(2)Rescission of resident status. Resident status is considered to be rescinded if a final administrative or judicial order of exclusion or deportation is issued regarding the alien individual. For purposes of this paragraph, the term “final judicial order” means an order that is no longer subject to appeal to a higher court of competent jurisdiction.

(3)Administrative or judicial determination of abandonment of resident status. An administrative or judicial determination of abandonment of resident status may be initiated by the alien individual, the Immigration and Naturalization Service (INS), or a consular officer. If the alien initiates this determination, resident status is considered to be abandoned when the individual’s application for abandonment (INS Form I-407) or a letter stating the alien’s intent to abandon his or her resident status, with the Alien Registration Receipt Card (INS Form I-151 or Form I-551) enclosed, is filed with the INS or a consular officer. If INS replaces any of the form numbers referred to in this paragraph or § 301.7701(b)-2(f), refer to the comparable INS replacement form number. For purposes of this paragraph, an alien individual shall be considered to have filed a letter stating the intent to abandon resident status with the INS or a consular office if such letter is sent by certified mail, return receipt requested (or a foreign country’s equivalent thereof). A copy of the letter, along with proof that the letter was mailed and received, should be retained by the alien individual. If the INS or a consular officer initiates this determination, resident status will be considered to be abandoned upon the issuance of a final administrative order of abandonment. If an individual is granted an appeal to a federal court of competent jurisdiction, a final judicial order is required.

Deemed U.S. residency based on immutable characteristics – a U.S. place of birth

The United States is the ONLY country that BOTH confers citizenship based on having been born in the country AND imposes worldwide taxation based on citizenship.

Therefore, the United States is the ONLY country in the world that imposes taxation based on the immutable characteristic of place of birth.

“It’s unjust. it’s inhumane. I didn’t choose where I was born!”

Imagine having been born in the United States. Having left the United States as a young child. Being a citizen and tax paying resident of another nation. Imagine then receiving a FATCA letter! Such is the plight of the Accidental American!

The trade off: Deemed residency (certainty) vs. Fact based residency (fairness)

Although deemed tax residency provides certainty, it often leads to VERY harsh results. These harsh results are compounded when the rule for deemed tax residency are different from the immigration rules that determine the right to factual residency. At the present time under U.S. law, it is possible:

A. To NOT have the legal right to reside in the United States under the Immigration and Nationality Act, but be taxed as a U.S. resident under the Internal Revenue Code; or

B. To NOT be a U.S. citizen under the rules in the Immigration and Nationality Act, but be still be treated as a U.S. citizen under the Internal Revenue Code.

YOU CAN’T MAKE THIS UP!

-John Richardson

The Reality of U.S. Citizenship Abroad

My name is John Richardson. I am a Toronto based lawyer – member of the Bar of Ontario. This means that, any counselling session you have with me will be governed by the rules of “lawyer client” privilege. This means that:

“What’s said in my office, stays in my office.”

The U.S. imposes complex rules and life restrictions on its citizens wherever they live. These restrictions are becoming more and more difficult for those U.S. citizens who choose to live outside the United States.

FATCA is the mechanism to enforce those “complex rules and life restrictions” on Americans abroad. As a result, many U.S. citizens abroad are renouncing their U.S. citizenship. Although this is very sad. It is also the reality.

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3 thoughts on “Determining Tax Residency In The United States

  1. Patrick says:

    “The United States is the ONLY country that BOTH confers citizenship based on having been born in the country AND imposes worldwide taxation based on citizenship.” I understand Eritrea has similar tax laws.

  2. @Patrick

    Being born in Eritrea does NOT automatically confer citizenship. But, with respect to your main point which I interpret to be that Eritrea also has “citizenship-based taxation”:

    Eritrea does require its citizens living outside Eritrea to pay something that is similar to an “excise tax” to the Government of Eritrea. It is a one page form and is easy to administer. Unlike the U.S. rules, Eritrea does NOT include penalty laden reporting requirements and punitive taxation when its citizens invest in the retirement planning products of other nations (example mutual funds, small businesses, etc.) The Eritrean laws do NOT provide incentives for people to to avoid having business relationships (or marriage) with citizens of Eritrea.

    It is for those reasons that I did NOT include Eritrea in the discussion.

    Frankly, to compare way that Eritrea imposes taxation on Eritrean citizens abroad to the way the USA imposes taxation on Americans abroad, is an insult to Eritrea.

    Interestingly the United Nations has condemned Eritrea for its tax policies. Yet, if the USA had the same policies as Eritrea, I suspect that fewer Americans abroad would be renouncing U.S. citizenship.

  3. Those interested in the issue of how Eritrea imposes taxation on its citizens abroad should google: “Eritrea condemned for taxing citizens abroad”.

    You will see that the USA and Eritrea have few similarities.

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