For a unique group of foreign individuals (i.e., non-US citizens referred to in the tax world as “aliens”), living in the U.S. does not trigger “resident” status for tax purposes. These so-called “exempt” individuals include foreign students, foreign scholars, and alien employees of foreign governments and of international organizations in the United States. U.S. tax law considers this lucky bunch to be exempt from counting days of presence in the United States for the purposes of determining whether they are resident aliens of the United States.
Avoiding resident status can be extremely beneficial for exempt individuals because, among other things, resident aliens are subject to tax on their worldwide income, while nonresident aliens are generally only subject to tax on income that is connected with the U.S. in certain ways, such as passive income (e.g., dividends and interest) that is sourced from the United States or active income that is connected with a U.S. trade or business.
Exempt aliens living in the U.S. are generally taxed in the same manner as nonresident aliens living outside the U.S. – that is except with respect to capital gains. In this blog, we dissect the so-called “183-day rule,” a unique rule applicable to capital gains, which widens the U.S. tax net to capture otherwise exempt aliens.
SOURCING OF CAPITAL GAINS
In order to understand the 183-day rule, we need to begin with the general rules relating to the sourcing of capital gains.
For U.S. citizens and resident aliens, capital gains are sourced within the United States only if the individual does not have a “tax home” in a foreign country. For nonresident aliens, capital gains are sourced outside the United States unless the individual has a “tax home” in the United States. As with all tax rules, there are a number of exceptions to these general rules including, importantly, U.S. real estate, the sale of which triggers gain that is automatically sourced within the United States.
For the avid followers of our blog, the concept of a “tax home” should be very familiar – it serves as one of the linchpin requirements for the foreign earned income exclusion, a key weapon against double taxation for U.S. expats. “Tax home” generally refers to one’s principal place of business or employment, but the concept is vague enough that is has been the subject of numerous court cases interpreting the term in various circumstances.
THE 183-DAY RULE
Now back to the subject at hand – the 183-day rule, which reads like this:
“In the case of a nonresident alien individual present in the United States for a period or periods aggregating 183 days or more during the taxable year, there is hereby imposed for such year a tax of 30 percent of the amount by which his gains, derived from sources within the United States, from the sale or exchange at any time during such year of capital assets exceed his losses, allocable to sources within the United States, from the sale or exchange at any time during such year of capital assets.” IRC Section 871(a)(2).
So, for example, a foreign student or diplomat or nonresident alien employee of an international organization, who is visiting the United States on a visa for a period longer than 183 days during the year would be subject to the 30 percent tax on his or her U.S. source capital gains – even if he or she continues to be a nonresident alien as an exempt individual.
The 183-day rule, however, requires that the gains be “from sources within the United States,” which takes us back to the capital gains sourcing rules and the linchpin concept of “tax home.” So, if an exempt nonresident alien’s tax home is considered not to be in the United States, the individual’s capital gains should be sourced outside the United States and the 30 percent withholding tax under the 183-day rule should not apply. But if the individual’s tax home is considered to be in the United States, the 30 percent tax should apply to the capital gains.
In the end, the devil is in the details, and a taxpayer’s circumstances need to be carefully analyzed in order to determine both tax residency status and income sourcing. The 183-day rule is one of a number of rules that can sneak up on an unsuspecting taxpayer who isn’t familiar with the intricacies of the U.S. tax system.
Have a question? Contact Ephraim Moss. Your comments are always welcome!