Coronavirus has been disruptive in many ways, and is having an ongoing, meaningful impact on both businesses and individuals. The global nature of the pandemic and the swift resulting responses undertaken by many governments has left many individuals dislocated, including non-US-citizens stricken with the disease while in the United States or unable or unwilling to return to their home countries.
When faced with the travel restrictions enacted to address the pandemic, US tax consequences are likely far from the non-citizen’s mind. Still, non-citizens whose stays in the United States are extended due to the pandemic can raise potential, unintended US tax residency issues for such foreign visitors, including the specter of taxation and reporting of their worldwide income, as well as the risk of a potential US tax bill for the earnings of their employer or controlled foreign, non-US companies, creating a tax bill whose impact could last well past the pandemic itself.
For these individuals temporarily stuck in the United States, these unintended but meaningful consequence can potentially be avoided by promptly evaluating their risk of US tax residency and undertaking appropriate, current planning.
Why does US tax residence matter?
If someone is deemed a US tax resident, this status can be important for a number of reasons:
- US tax residence exposes an individual’s worldwide income to US federal taxation and reporting.
- US estate tax implications can also potentially arise, subjecting the individual to a 40% tax on the value of their worldwide estate at death.
- The number of days a foreign taxpayer is able to spend in the United States during the next year might be impacted, even if they are not deemed a US tax resident for the current year.
- The risk may be increased for income taxation by one of the individual states (e.g., California with its maximum income tax rate of 13.3%).
Key Tests for Residency
Thus, individuals who can no longer travel, due to the illness or quarantine of themselves or loved ones, or due to legal or practical travel restrictions, could unwittingly trip over the residence rules and find themselves fully enmeshed in the US tax system. The principle tests for US tax residency are contained in Internal Revenue Code (“IRC”) section 7701(b). This section was enacted in 1984 and obviously did not contemplate how an alien’s classification as a “resident” or “nonresident” might be impacted by the coronavirus or another global pandemic. Thus, the code provision and related regulations contain little guidance as to how their words should be interpreted to address current realities.
Section 7701(b) provides that an individual will be treated as a resident alien for federal income tax purposes with respect to any calendar year only if such individual meets one of two tests. (Note that there is a separate test of US tax residency for federal estate, gift and other transfer tax purposes.) The first income tax residency test, often referred to informally as the “green card” test, causes an individual who has been admitted as a lawful permanent resident to be a US resident for federal tax purposes. These individuals are US tax residents, absent an overriding determination of foreign tax residency pursuant to a tax treaty that the alien’s home country has with the United States.
The second of the two tests, referred to as the “substantial presence test,” is more relevant to the foreigner whose US departure is delayed due to Covid-19. The substantial presence test is relevant only to alien individuals who are not lawful permanent residents. It is the foreigner’s status under this test that generally must be carefully monitored to avoid undesired US income tax resident status.
Under the substantial presence test, an alien individual is a US tax resident for a calendar year if the individual is present in the United States on at least 31 days during the calendar year and the sum of (1) the number of days of presence in the calendar year, (2) one-third of the number of days of presence in the preceding calendar year, and (3) one-sixth of the number of days of presence in the second preceding calendar year (the “formula”) totals 183 or more.
Nevertheless, an alien, who has not been present in the United States for at least 183 days in the current calendar year, is not treated as meeting the test, if, under the so-called “closer connections exception” to the application of the substantial presence test’s regular formula, it is established that the individual has a so-called “tax home” in a foreign country and has a closer connection to such country than to the United States. This exception is not available, however, if the individual has taken steps to apply for status as a lawful permanent resident (i.e., to obtain a “green card”). Still, even if the foreigner has met the formula for tax residency under the substantial presence test and cannot take advantage of the closer connections exception (e.g., because they are present in the United States a total of 183 days or more in the current calendar year), if the foreigner’s home country has a tax treaty with the United States, they may be able to avoid US tax residency under the determination of residency pursuant to the treaty’s separate residence article.
The US tax code does allow for some exceptions to a strict day counting for residency purposes under the substantial presence test. Individuals are not treated as being in the United States on any day that (a) the individual is an “exempt individual” (e.g., a full-time student, certain teachers, certain diplomats and other foreign-government related individuals, and certain professional athletes while competing in defined charitable sports events), (b) the individual is in limited transit between two foreign countries, © the individual is a regular commuter residing in Canada or Mexico who commutes to and from employment in the United States, or (d) the individual meets the medical condition exception described below.
It is the medical condition exception that may be the most fruitful to the alien experiencing an unintended extended stay in the United States due to the pandemic. The plain language of the provision clearly addresses an individual diagnosed with coronavirus while in the United States, but is susceptible to a broader reading to apply to an alien with a family member struck with the disease and possibly to an alien who has not developed the disease, but whose ability to leave the United States due to the pandemic is restricted as a legal or practical matter.
Still, it is ambiguous whether the medical condition provision will apply to allow an alien to exclude from their US day count days in the United States due to a loved one being stricken with the disease or where the alien and his family members have not been diagnosed with the disease but face legal or practical difficulties returning to their home country from the United States. Moreover, as a general rule, an alien relying on the medical condition exception to exclude days of US presence must leave the United States as soon as practical once their medical condition permits their departure and must file certain information reports with the IRS regarding their reliance on the medical condition exception. Efforts are being mounted by US professionals in seeking IRS guidance to resolve these ambiguities.
In the absence of such governmental guidance, the prudent course of action for an alien stranded in the United States due to the coronavirus pandemic would be for the alien to assess carefully their risk of US tax residency under the substantial presence test, without undue reliance upon the applicability of an expansive reading of the medical condition exception.
We can assist you by calculating the number of days you have spent in the United States for purposes of the substantial presence test, including evaluating your prospects for successfully relying upon the medical condition exception in calculating days in the United States, and advising you on the compliance steps you should take to claim the medical condition exception if it can be claimed.
If you need advice on any of the areas covered by this article, please contact us immediately. For taxpayers whose residence position is nuanced or who have become trapped in the United States, it will be important to react quickly while more options may be available, in order to avoid prejudicing their nonresident tax status.
In accordance with our business continuity planning, our fee earners are working flexibly in a number of locations to support our clients at this uncertain time.
For a discussion of recent IRS changes to international tax reporting deadlines in response to the coronavirus pandemic, see Coronavirus impact on US international tax compliance.
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