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Physical Presence As A Necessary Condition For Being A US “Resident” Under The Internal Revenue Code



John Richardson

Introduction

Every country in the world with the exceptions of Eritrea and the United States claim tax jurisdiction based on “residence”. Although the tests for “residence” may differ, “residence based taxation” means that it is possible to sever your tax connection to a country by severing residence.

The nations of Eritrea and the United States impose taxation based on citizenship. U.S. citizens (primarily those “Born In The USA”) can NEVER sever their tax connection to the United States as long as they remain citizens. When it comes to U.S. citizenship-based taxation it is possible to NEVER have lived in the United States and still be subject to taxation!

Citizenship-based AKA “Place of Birth” Taxation is NOT based on any kind of physical presence or actual residence …

Q.Why is it that:

(from an email message I received)

“The British are called “subjects” but they are citizens; and the Americans are called “citizens” but they are “subjects”?

A.How about, as a proposed answer? (from an email message I received), because (CBT = “citizenship-based taxation”):

“CBT is a servitude (apparently some minds still can’t accept the abolition of slavery and racial segregation, so they have to reintroduce servitude). You, like any American “citizen” are in truth property of the IRS, and you will remain so unless you give up your citizenship (which means, like all serfs that you wold have to buy back your freedom from your master). If you don’t like the word “serf”, you may say that you are indentured. But that’s basically the same idea; you’re not free. CBT is a problem of the rest of the world, because it is vile and despicable: “No one shall be held in slavery or servitude; slavery and the slave trade shall be prohibited in all their forms.

Why? CBT means that an American is bound by birth to pay taxes to the US, even if they have never lived there. The truth is, all Americans (including you, including all people in Congress) live in serfdom. Those considering that CBT (i.e. being a serf) is a problem only for expats, are not really concerned by their liberty. They are cattle in a pen, they don’t know what freedom means. CBT has made the word “freedom” meaningless.”

Strong language indeed! Offensive to some? Yes. But what about the concept itself? Is “citizenship-taxation” morally offensive? It depends on who you ask. Is it better to call U.S. citizens “prisoners”? There have been many references to the “prison of citizenship-based taxation“.

The simple fact of the matter is that:

1. The United States claims the right to impose world-wide taxation on people who do NOT live in the United States and on income earned outside the United States.

2.The United States requires all those who it defines as its citizens to comply with expensive, penalty laden reporting requirements that enforce the principle that: “U.S. citizens abroad are required to live as a U.S. resident lives”. This is the“When In Rome, Live as a Homelander” principle.The United States claims the right to impose world-wide taxation on people who do NOT live in the United States and on income earned outside the United States.

What this post is about

This post is NOT about “U.S. citizenship-based taxation” per se. This post is about the connection between “presence” in a country and taxation. U.S. citizens are ALWAYS U.S. tax subjects as long as they are citizens WHETHER THEY HAVE ANY PHYSICAL PRESENCE IN THE UNITED STATES OR NOT!

That said, CBT is a problem ONLY for those U.S. citizens who decide to live outside the United States. From the perspective of U.S. citizens living in the United States (“Homelanders”), the U.S. tax system is based on residence. Let them try to leave the United States of America!

The ONLY advantages to being a U.S. citizen are that you have the right to live, work and carry on business in the United States.

For U.S. citizens, “residence” is not a necessary condition for U.S. taxation.

Rather for those born in the United States, “citizenship” is a “sufficient condition” for U.S. taxation.

But, I have digressed …

This post is about “non-resident aliens” and the circumstances that may cause them to be converted from “non-resident aliens” to “resident aliens”. Once they have been converted from “non-resident aliens” to “resident aliens”, they are subject to the full force of the Internal Revenue Code.

Until they are converted to “residents”, non-resident aliens are subject to their specific and far narrower rules. These rules are found primarily in Internal Revenue Code S. 871. The mode of “taxation of non-resident aliens” combined with FATCA and the refusal of the United States to embrace the OECD Common Reporting Standard, reinforces the role of the United States as a Tax Haven.

Different kinds of visas = Different kinds of “physical presence” to the United States

From a U.S. perspective, if you are NOT a U.S. citizen, you are an alien. Aliens will enter the United States under different kinds of Visas or (in some cases) with NO visa.

The “Green Card” (permanent residence Visa) vs. Other Kinds of Visas (not for permanent residence)

How are “non-U.S. citizens” AKA “aliens” taxed under the Internal Revenue Code? At what point does an “alien” become a “resident” of the United States?

S. 7701(a)(30) tells us that “U.S. Person” includes a “resident”. When does an “alien” become a “resident”?

S. 7701(b)(1)(A) defines when and ONLY when an “alien” becomes a “resident”.

The circumstances INCLUDE:

The Green Card Test – lawfully admitted as a “permanent resident”

Note that a Green Card gives the right of “permanent residence”. Therefore the (rebuttable) presumption is that Green Card Holders have an actual physical presence in the United States.

Q. Is it possible for a Green Card Holder to rebutt the presumption that he is a U.S. “resident”?

A. Yes, the Green Card Holder may be able to make use of a “Treaty Election” (normally Article IV) of a Tax Treaty. Does the availability of the Treaty Election presume that one should NOT be at tax resident of more than one country? Does the presume that a person should be subject ONLY to taxation where he actually resides? Does this assume a presumption of “residency based taxation”? It’s interesting to read the criteria to determine “tax residency” under the “Canada U.S. Tax Treaty“.

Article IV of the Canada U.S. Tax Treaty reads:

Article IV
Residence

2. Where by reason of the provisions of paragraph 1 an individual is a resident of both Contracting States, then his status shall be determined as follows:

(a) he shall be deemed to be a resident of the Contracting State in which he has a permanent home available to him; if he has a permanent home available to him in both States or in neither State, he shall be deemed to be a resident of the Contracting State with which his personal and economic relations are closer (centre of vital interests);

(b) if the Contracting State in which he has his centre of vital interests cannot be determined, he shall be deemed to be a resident of the Contracting State in which he has an habitual abode;

(c) if he has an habitual abode in both States or in neither State, he shall be deemed to be a resident of the Contracting State of which he is a citizen; and

(d) if he is a citizen of both States or of neither of them, the competent authorities of the Contracting States shall settle the question by mutual agreement

The “tie breaker” provision of the treaty seems to assume that:

1. People should NOT be tax residents of more than one nation; and

2. They should be treated as “tax residents” of the country where they actually reside.

Meets the “substantial presence” test

Note that “substantial presence test” is found in S. 7701(b)(3) and needs to be read very carefully.

A. Defending yourself against having actually met the “substantial presence test”

Note that S. 7701(b)(3)(B) provides a “defense” to meeting the “substantial presence” test. This defense is generally referred to as the “closer connection” exemption. It is NOT available to U.S. citizens (they are not aliens) or to Green Card Holders (they are already “residents”).

It is generally claimed by filing IRS Form 8840.

By filing Form 8840, one is taking the position that:

Yes, I have met the “substantial presence test”. But, I have a closer connection to another country.

The “defense” is based on S. 7701(b)(3)(B) of the Internal Revenue Code. This “defense” is NOT based on Article IV of the Tax Treaty. Notice that the defense is based on being a tax resident of being another nation. Can one infer that the Internal Revenue Code assumes that people should NOT be considered to be “tax residents” of two countries?

The “closer connection test” seems to assume that:

1. People should NOT be tax residents of more than one nation; and

2. They should be treated as “tax residents” of the country where they actually reside.

B. Defending the allegation that you have met the “substantial presence test” in the first place

To meet the “substantial presence test” you are required to have spent a certain number of days in the United States. S. 7701(b)(5) specifies days of ACTUAL physical presence in the United States that are NOT to be counted as “physical presence”.

Significantly, this section of the Internal Revenue Code specifically references S. 101(15) of the Immigration and Nationality Act to clarify exactly which kind of visa holder is entitled to this exemption. In other words, the focus is on the specific kind of visa that the person used to enter the United States.

The “exemption” is generally claimed by filing IRS From 8843.

By filing Form 8843, one is taking the position that certain days that you were actually present in the United States should NOT be counted as a day toward meeting the “substantial presence” requirement. Notice how the basis for the “exemption” is tied to very specific kinds of visas and specific reasons for actually being present in the United States. A practical description of
– who must file Form 8843
– why Form 8843 must be filed
– how Form 8843 defends one against meeting the “substantial presence” test may be foundhere.


The “exemption from days toward the “substantial presence test” seems to assume that:

1. People should NOT be tax residents of more than one nation; and

2. They should be treated as “tax residents” of the country where they actually reside.

One might think that the United States has a system of “residence based taxation” …

Notice that the obvious purpose of the S. 7701(b) and Article IV of the Tax Treaty are to ensure that, for non-citizens”, a “physical presence” in the United States is met before one is treated as a “tax resident”?

In the case of “aliens” it appears that “residence” is a necessary but NOT a sufficient condition for U.S. taxation.

What is it about a “U.S. place of birth” that makes U.S. citizens exceptional?

Why should this be different for citizens? Why shouldn’t citizens also be required to have a “physical presence” in the United States before becoming a “resident” for tax purposes? Why should ONLY U.S. citizens be “tax residents” of the United States even if they reside outside the United States?

The usual answer to this question is:

It’s Cook v. Tait! By God in 1924, the Supreme Court of the United States (per Justice McKenna) ruled that the United States could impose taxation on its citizens abroad.

I am not certain that Cook v. Tait can be interpreted to mean that the United States can impose taxation on ALL of its citizens abroad. As I noted in a previous post about “Cook v. Tait”:

“Citizenship taxation” is a relic of the post that probably was NOT justifiable in 1921. If it was justifiable as a general principle, note that even in 1921, the definition of “citizen” in Article 4 of Regulation 62:

4. A citizen is defined as follows: “An individual born in the United States subject to its jurisdiction, of either citizen or alien parents, who has long since moved to a different country and established a domicile there, but who has neither been naturalized in or taken an oath of allegiance to that or any other foreign country, is still a citizen of the United States.”

This appears to mean that if Cook HAD become a naturalized citizen of Mexico OR taken an oath of allegiance to Mexico, that he would NOT have been considered to be a U.S. “citizen” for tax purposes. It also means that all those “so called Americans abroad” who emigrated to other countries and became citizens of those countries would NOT have been considered U.S. citizens for tax purposes! This suggests that “citizenship taxation” does NOT have the rich history that it’s advocates claim. It also means that the new U.S. concept of the “Tax Citizen” which began in 2004 is NOT the entrenchment of an old principle but the establishment of a new principle.

Interesting, assuming that Cook had become a citizen of Mexico and was residing in Mexico, perhaps Justice McKenna should have ruled that:

The definition of “U.S. citizen” for tax purposes seemed to assume that:

1. People should NOT be tax residents of more than one nation; and

2. They should be treated as “tax residents” of the country where they actually reside.

Conclusion …

Those born in the United States are NOT exceptional. In order for the United States to participate in the global world:

As Jackie Bugnion so persuasively argues, Residence should be a “necessary condition” for U.S. taxation for ALL people!

Avatar

The Reality of U.S. Citizenship Abroad

My name is John Richardson. I am a dual citizen. I am a 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.”

I am also a member of the American Citizens Abroad Professional Tax Advisory Council (PTAC). This is an advisory panel focused on assisting American Citizens Abroad in an FBAR and FATCA world.

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.

3 thoughts on “Physical Presence As A Necessary Condition For Being A US “Resident” Under The Internal Revenue Code

  1. Avatar Jack Henry says:

    The article doesn’t fully reject the conspiracy theory that US citizens are “serfs” and bound in servitude because they must pay US taxes.

    The article doesn’t clarify that one doesn’t need to be born in the US to be a citizen. A naturalized foreigner or a child of a US citizen born anywhere, are also citizens.

    The article speaks of world-wide taxation as if citizens must pay tax to every country in the world. The actual tax law says that if you are a US citizen or resident alien, the rules for filing income, estate, and gift tax returns and paying estimated tax are generally the same whether you are in the US or abroad. Your “worldwide income” is subject to US income tax, regardless of where you reside. (Not “world-wide taxation”.)

    The article doesn’t mention the tax relief provided for expats working abroad. There is a foreign earned income exclusion which allows up to $101,000 to be nontaxed on the US tax return.

    For expats retired and not working abroad, there are foreign tax credits available if their country of residence also requires tax filing.

    For expats worried about international postage and shipping, their US tax returns can be electronically filed.

  2. Jack:

    Thanks very much for your comment. Actually, (as the title of the post
    states) the post is about the kind of physical connection to the United States that would convert a “non-resident alien” to a “resident alien” for U.S. tax purposes.

    With respect to your comments about “citizenship-taxation”, you are
    certainly correct that:

    – there is a foreign tax credit that provides some relief against double taxation on specified kinds of income;
    – there is a foreign earned income exclusion that operates to
    exclude very limited forms of income
    – Americans abroad can file their taxes without incurring
    postage.

    That said, the acknowledgement of those specific rules, is no guarantee against double taxation, and in no way describes the reality of “citizenship-based taxation” for those who live it. This is because “citizenship-based taxation” is NOT principally about taxation at all. It is about penalizing investment and business opportunities that are normal in the new country of residence.

    The “anti-deferral” and other U.S. rules (PFIC and CFC for example)
    impose significant limitations on the ability of American citizens to
    leave the United States and integrate into the countries where they are citizens and residents. In fact it is very difficult for Americans abroad to be both U.S. tax compliant and engage in necessary financial planning.

    If you are truly interested in this topic, I suggest you read an
    earlier post on Tax Connections:

    https://www.taxconnections.com/taxblog/how-to-live-outside-the-united-states-in-an-fbar-and-fatca-world/

    I look forward to your comments on that post.

    Thanks again,

    John

  3. @Jack Henry

    I am not sure what you mean by “the article doesn’t fully reject the conspiracy theory that US citizens are “serfs” and bound in servitude because they must pay US taxes.” I don’t see this as a “conspiracy theory” at all but a mere description of fact when applied to non-resident Americans. The FEIE & FTC form a very small part of the picture; by no means should either be seen as fully off-setting what Americans abroad endure due to citizenship-based taxation. It is a misnomer, to put it mildly, that US tax policy is applied to expats in exactly the same way as it does to Homeland Americans. It is these differences that form the bulk of the idea that Americans (abroad) are serfs. For example, the proportion of Homelanders that need to file FBAR, 8938, 5471, 8621, 3520A 3520, etc could not possibly approach what expats file. Add to that the expense of having it done by professionals. The risk of non-filing and accuracy penalties. Then add the cost of even a simple 1040 which is easily $1,000 in Canada. There is nothing to offset the 3.8% Net Investment Income Tax. There is an inherent unfairness with regard to the AMT since a majority of expats file MFS where the thresholds are lower. And let’s not forget the absurdity of 8965, which must be filed to show an exemption for something unavailable to expats. Failure to file this form is a $600 penalty.That one “takes the cake.” There is also a problem when one must claim income that grows tax-free in the country of residence but which is not recognized by the U.S. (even though there are close equivalents which are regulated by, in Canada’s case, a first-world government). In Canada, there are two types, RESP (sim to 529 plans) and RDSP (sim to the Able Act) where matching grants by the Canadian government are taxable by the U.S. This amounts to nothing less than a direct tax on the people of Canada. Other things unavailable to anyone with a connection to the US: non-US mutual funds, Tax-Free Savings accounts and incorporation of small businesses. Most people use their principal residence as a primary source of retirement funds; in Canada, this is a capital-gains free disposition. Unlike the U.S., Canada does not allow for the deduction of mortgage interest etc over the years, thus the gain-free sale. The U.S. claims anything over $250k is taxable. More money just sucked right out of the country to whom it rightfully belongs.

    And should one dare to decide that they no longer wished to comply with all this, they must pay $2350 (per person) and possibly an Exit Tax in order to leave the country. The Exit Tax, when applied outside of who it was intended for, is perverse in the extreme. Expats who have been gone for decades and who have earned all their income/gained all their assets outside of the country are in no way similar to wealthy homeland Americans who HAVE earned all their income/assets inside the US who wish to leave to avoid tax (and for whom the Exit Tax was conceived). Try expatriating with a foreign pension for example. The entire pension is claimed as if paid out the day before renouncing and taxed in its entirety at that time.

    There are of course, other dimensions such as marriages ending, people suffering from more stress due to extreme fear of the U.S.’s stated position on penalizing, etc. No one seems to care about that at all. It doesn’t matter that one is a tax-compliant, law-abiding citizen where he/she is resident. Equating those people with wealthy, U.S. resident tax evaders is just fine with the U.S. government as well as most in the compliance industry. We just love being called “tax cheats” and “scofflaws.”

    The extension of/misapplication of all these policies does indeed, make those outside the country feel like nothing more than chattel to the U.S. Don’t forget, we don’t receive any benefits from the U.S, government for all this. Anyone who has paid the necessary number of quarters can draw Social Security because they have earned it. That’s about it and in fact, was directly earned by anyone claiming it.

    But the crowning glory is FATCA. It is bad enough to be presumed to have foreign accounts for illegitimate purposes. It is irresponsible of the US to have failed to enforce its tax policy for decades and to have done virtually no due diligence whatsoever to inform people of their obligations. But to come after us with OVDP, OVDI and now FATCA, is the final nail in the coffin for most. As with the oversimplified explanations of what tax is for Americans abroad, FATCA is NOT about tax evasion. It is a hunt for whoever the U.S. thinks it can claim and use in order to take capital out of the countries “U.S. Persons” are located in. There is no similarity here, to the OECDs CRS in spite of the pitch the U.S. uses to justify it. To claim other countries signed on as proof of its relevance, without mentioning the 30% economic sanction that was used to enforce it, is simply dishonest.

    It may not be slavery with the extreme forms of physical abuse the world has seen in the past but it still amounts to having to buy one’s way out. It doesn’t even really matter if anyone else sees it. We do. And just wait until they decide to start treating all of you like this…………..

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