The International Tax Corner: Edition 4
The Basic Principles of Residency
Residency is a critically important factor in international tax, not just for the US. Why is that? Residency typically determines who can impose tax on worldwide income. We’re going to stick first with the Internal Revenue Code and regulations and at some point, later discuss the interplay with tax treaties. To be clear, the US taxes US residents on worldwide income. We’ll first focus on individuals and then move to entities.
This portion is rather heavy with code sections as we want you to know where to look for specific guidance.
Internal Revenue Code Section (“§”) 7701, Definitions, needs to be bookmarked in every tax advisor’s notes. §7701(a)(9), United States, provides, The term “United States” when used in a geographical sense includes only the States and the District of Columbia. So, we’re not talking about US Protectorates: Puerto Rico, US Virgin Islands, US Minor Outlying Islands, Guam, American Samoa, and Northern Mariana Islands.
7701(a)(30), United States Person, states The term “United States person” means—
7701(a)(30)(A) — a citizen or resident of the United States,
7701(a)(30)(B) — a domestic partnership,
7701(a)(30)(C) — a domestic corporation,
7701(a)(30)(D) — any estate (other than a foreign estate, within the meaning of paragraph (31)), and
7701(a)(30)(E) — any trust if—
7701(a)(30)(E)(i) — a court within the United States is able to exercise primary supervision over the administration of the trust, and
7701(a)(30)(E)(ii) — one or more United States persons have the authority to control all substantial decisions of the trust.
A US citizen is, well, a US citizen. How about a resident of the United States. §7701(b), Definition of Resident Alien and Nonresident Alien, provides guidance. There are three (3) general ways a non-citizen could be a US resident: lawful permanent residency (“Green Card”), number of days in the US, and an election.
§7701(b)(1), In General — For purposes of this title (other than subtitle B)—
7701(b)(1)(A) Resident Alien — An 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):
7701(b)(1)(A)(i) Lawfully Admitted For Permanent Residence — Such individual is a lawful permanent resident of the United States at any time during such calendar year. This means you have a Green Card. Note: The Green Card doesn’t have to be in good standing. For instance, many people leave the US without formally abandoning their Green Card. While their time outside the US may impact whether they may enter again without a hassle, that’s an immigration issue. They may still be considered US tax resident. We’ll discuss that another day.
7701(b)(1)(A)(ii) Substantial Presence Test, sends us to 7701(b)(3). In that test, if one has “substantial presence”, that person is a US resident. This is the rule people commonly refer to as the 183-day rule, meaning that if one is in the US more than 183 days in a calendar year, that person is a resident. We’ve had potential clients tell us how smart they are by being in the US fewer than 183 days for many, many years. However, that’s only part of the story. There’s a portion of this test we like to call the 122-day test. How does that work?
It’s mechanical and applies if one is in the US for at least 31 days in the current year. The person must then sum the days in the US in the current year, plus each of the two (2) preceding years. Here’s where those mathematically challenged may need their abacus. A day in the current year counts as a full day, thus a multiplier of one (1). A day in the preceding years counts as one-third (1/3) of a day. A day in the second preceding year counts as one-sixth (1/6) of a day. If someone is in the US for 120 days three (3) years in a row from 2022-2024, the day count is cutting it too closely for our taste – 180 days (120-2024; 40-2023; 20-2022). Were the person in the US 122 days or more, the 183 days come into play, and you will have issues, even if a treaty allows residency in another jurisdiction. For people desiring NOT to become US residents, we recommend fewer than 122 days per year in the US. There’s more to it than that – but don’t play with fire here unless you’re a glutton for headaches.
Under §7701(b)(3)(B), there’s an exception to the substantial presence test for any year where the person is in the US fewer than 183 days during the current year and has a tax home in a foreign country and has a closer connection to such foreign country than to the US. There’s an exception as well, but we’re not going into that level of detail here.
7701(b)(3)(D) has an interesting rule – a day does not count toward the residency test if present in the US but unable to leave because of a medical condition which arose while such individual was present in the United States. [Emphasis added.] We once had a client who came to the US to seek medical assistance. His condition worsened and he was unable to leave until well after 183 days. Because the condition did not arise while present, those days in the US counted. Whether intentional, US policy discourages medical tourism and only gives a break if one becomes ill / incapacitated while here. To us, non-residents seeking US medical care might have disposable assets to help the US economy. We’re unsure why that wouldn’t be encouraged. Again, this could simply be one of the many examples in US law where those voting on legislation didn’t really think things through.
There’s also a first-year election one can make to be a US resident. We’re not going into that right now – not because that person should have her/his head examined but because we don’t feel like it. Actually, it’s just much less common in our experience. If you’d like further bedtime reading on the subject, see §7701(b)(4).
Ultimately, it’s not possible to have a comprehensive, accurate tax analysis without knowing where the taxpayer is resident. Overlook this part at your own risk.
Bonus Section – We found these items in §7701 interesting and thought we’d share.
7701(a)(11) – Secretary Of The Treasury And Secretary
7701(a)(11)(A), Secretary Of The Treasury — The term “Secretary of the Treasury” means the Secretary of the Treasury, personally, and shall not include any delegate of his.
7701(a)(11)(B), Secretary — The term “Secretary” means the Secretary of the Treasury or his delegate.
Forgetting about the gender issues, we’ve been practicing for several decades between us and haven’t run into this. So, it’s maybe more of a curiosity than anything else.
7701(a)(39), Persons Residing Outside United States— If any citizen or resident of the United States does not reside in (and is not found in) any United States judicial district, such citizen or resident shall be treated as residing in the District of Columbia for purposes of any provision of this title relating to—
7701(a)(39)(A) — jurisdiction of courts, or
7701(a)(39)(B) — enforcement of summons.
This is another interesting one for those of us not focusing on courts or summonses. A related item is US citizens who move to a foreign country and are no longer resident in a state yet desire to vote in federal elections.
About Schwartz International
The International Tax Nerds at Schwartz International team with individuals, companies of all sizes and other accounting and law firms to provide practical international tax, compliance, and legal advice.
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