The tax code in the United States categorizes taxpayers as U.S. persons and foreign persons. They can also be referred to as U.S. tax residents and nonresident aliens. It is important to known which type of person you are as the law treats them very differently.
Please note that the term person does not strictly refer to individuals only. It also applies to entities such as corporations, partnerships, estates, and trusts. With that said, I will focus only on individual taxpayers.
So, how do you determine what kind of person you are?
U.S. Person Definition According to the IRS
According to the IRS, you are a U.S. person for tax purposes if you:
- Are a U.S. citizen; or
- Meet the Green Card Test; or
- Meet the Substantial Presence Test.
If any of the above apply to you, you are a U.S. person for tax purposes. Otherwise, you are a foreign person for tax purposes.
As a general rule, if you were born in the United States, you are automatically a U.S. citizen. This is true regardless of whether your parents are citizens themselves, permanent residents, temporary workers, or even illegal immigrants. If you were born in this country, you have the same rights, and obligations, as every other citizen.
If you were born outside of the United States, you may be a U.S. citizen if at least one of your parents is a U.S. citizen and lived in the U.S. for a determined period of time. For more information on this specific situation, consult the U.S. Department of State website.
You can also become a U.S. citizen is through naturalization. One of the requirements is being a permanent resident for the past three or five years, depending on the category.
The Green Card Test
The Green Card Test states that you are a U.S. person for tax purposes if you are a lawful permanent resident of the United States at any time during the calendar year. In other words, if you have a green card during the year, you have met the test.
You become a tax resident on the day the USCIS officially approves your petition, If you are physically present in the U.S. Otherwise you become a tax resident on the first day you physically enter the U.S. after receiving your green card.
Expired Green Card Holders
Once you become a U.S. person under the Green Card Test, you will continue to have this status until:
- You voluntarily surrender your green card to the authorities; or
- Your status is terminated by either the USCIS or a U.S. federal court.
In other words, you are still a U.S. person even if your green card expired long ago and you moved out of the U.S. You still have to file a U.S. tax return every year and comply with all other regulations.
The Substantial Presence Test
Another way you can become a U.S. person is through the Substantial Presence Test. You meet this test if:
- You were physically present in the U.S. for at least 31 days during the current year; and
- You were physically present in the U.S. for at least 183 days during the 3 year period that includes the current year and the prior 2 years.
There’s a rule you have to follow when calculating the total number of days you were physically present in the U.S. You must count:
- All days you were present during the current year;
- 1/3 of the days in the first year before the current year;
- 1/6 of the days in the second year before the current year.
If you meet the substantial presence test, you generally become a tax resident on the first day you were physically present during the calendar year. For more detailed information, consult the official Residency Starting and Ending Dates page.
To better explain how to calculate the number of days of physical presence, I’ll use my own information. I moved to the U.S in 2012 and met the substantial presence test the same year. Below is a table listing all my U.S. visits for the years of 2010, 2011, and 2012:
|Year||Date of Entry||Date of Departure||Number of Days|
According to the rules, this is how the number of days should be calculated:
(11 / 6) + ((34+26) / 3) + (175 + 23 + 53) = 272.83
I had over 31 days of presence in 2012. I also had a total of 272.83 days of presence during the three-year period. Therefore, I met the test and I became a tax resident effective February 5th, 2012.
You do not count any day in which you were considered an exempt individual. You are an exempt individual if you are present in the U.S. under one of the following statuses:
- Foreign government individual under A or G visas, other than A-3 or G-5;
- Teacher or trainee under J or Q visas, as long as you comply with the visa requirements;
- Student under F, J, M, or Q visas, as long as you comply with the visa requirements;
- Professional athlete temporarily competing in a charitable event.
You also do not count certain days depending on the circumstances in which you were present in the U.S. Consult the official Substantial Presence Test page for more details.
It is important to note that, as a student, you will not be considered an exempt individual after being exempt for more than five calendar years. As a teacher or trainee, you will not be considered an exempt individual after being exempt for more than two or three years out of the past six years, depending on your situation.
Closer Connection Exemption
You can still be treated as a foreign resident for tax purposes even if you meet the substantial presence test. For this, you have to qualify for the Closer Connection Exemption. This is a complex topic that deserves its own post, but I encourage you to check the following official pages:
- If you are a foreign student: The Closer Connection Exception to the Substantial Presence Test for Foreign Students
- Everyone else: Closer Connection Exemption to the Substantial Presence Test
It Does Not Matter Where You Live
Do you think that just because you don’t live in the U.S., none of this applies to you? Think again! If you meet the definition of a U.S. person according to the IRS, you are a U.S. person. You have the exact same tax and reporting obligations whether you live in the U.S. or abroad. This is particularly true for U.S. citizens and green card holders.
If you are a U.S. citizen, your tax resident status will follow you everywhere in the world, for as long as you are a citizen. The only way to drop this status is by renouncing your citizenship. As a green card holder, you can only drop the status by voluntarily surrendering your green card. Simply moving to a different country is not enough.
Taxpayers that only meet the substantial presence test have an easier way out. As a general rule, if you move out of the U.S. your tax residency status will terminate on the last day of physical presence, or on December 31st, depending on your situation. This is only valid as long as you don’t meet the substantial presence test again during the following calendar year.
Please note that terminating your tax residency status can have many unpleasant tax consequences, especially if you still have assets in the U.S. Please consult with a licensed tax professional before taking any steps in this direction.
Consequences of Being a U.S. Person
You must follow all the tax laws and regulations if you are a U.S. person for tax purposes. This rule applies regardless of whether you live in the U.S. or not.
Depending on your specific circumstances, you must file a U.S. federal, and potentially state, tax return every year. You also have to pay taxes on the income you earn worldwide. If you live and work outside of the U.S., you still have to file a federal U.S. tax return even if you end up not owing any taxes.
In addition, you must also disclose any foreign financial assets you own or owned during the calendar year. This requirement applies if the aggregate value of such assets exceeds certain thresholds. You do this by filing the Report of Foreign Bank and Financial Accounts (FBAR) and/or the Statement of Specified Foreign Financial Assets (Form 8938).
Failing to comply with any of the laws or regulations can expose you to severe penalties and even imprisonment. Therefore, it is very important to understand the rules. Consult with a licensed tax professional, especially if you have any international ties.