IRS Closer Connection Exception to Substantial Presence
Closer Connection to the Substantial Presence Test: When a foreign person resides in United States, they risk becoming subject to US tax on their worldwide income as a “U.S. Person.” Generally, individuals who may become subject to U.S. tax as a U.S. Person are limited to U.S. citizens and Legal Permanent Residents. But, there is a third category of individual who may be subject to U.S. tax on their worldwide income, which are individuals who meet the IRS substantial presence test. Even if a person meets the substantial presence test, they may still escape U.S. tax on their worldwide income if they can show they meet the Closer Connection Exception to the substantial presence test.
If a person meets the exception, they may be able to avoid us tax on the worldwide income and may be able to sidestep International Information Reporting on form such a FBAR & FATCA.
We will summarize the 8840 Closer Connection Exception to the IRS Substantial Presence Test.
IRS Substantial Presence Test
The IRS Substantial Presence Test involves the counting of days spent in the U.S., in order to determine if the person has been in the U.S. long enough for the IRS to required worldwide income and reporting.
For example, David is a foreign national who travels to the U.S on a visa for consulting. Over the past 3 years, David has averaged around 135 days in the U.S. (non-consecutive).
As a non-US citizen and non-US green card holder, you are only required to pay tax on “US Effectively Connected Income” (money you earn while working in the United States).
However, if you qualify for the Substantial Presence Test, then the IRS will tax you on your WORLDWIDE income.
IRS Substantial Presence Test generally means that you were present in the United States for at least 30 days in the current year and a minimum total of 183 days over 3 years, using the following equation:
- 1 day = 1 day in the current year
- 1 day = 1/3 day in the prior year
- 1 day = 1/6 day two years prior
Example A: If you were here 100 days in 2016, 30 days in 2015, and 120 days in 2014, the calculation is as follows:
- 2016 = 100 days
- 2015 = 30 days/3= 10 days
- 2014 = 120 days/6 = 20 days
- Total = 130 days, so you would not qualify under the substantial presence test and NOT be subject to U.S. Income tax on your worldwide income (and you will only pay tax on money earned while working in the US).
Example B: If you were here 180 days in 2016, 180 days in 2015, and 180 days in 2014, the calculation is as follows:
- 2016 = 180 days
- 2015 = 180 days/3= 60 days
- 2014 = 180 days/6 = 30 days
- Total = 270 days, so you would qualify under the substantial presence test and will be subject to U.S. Income tax on your worldwide income, unless another exception applies.
Since no exceptions apply, David meets the substantial present test.
Therefore, David is subject to U.S. tax on his worldwide income, and U.S. reporting on global assets and accounts.
Closer Connection Exception Requirements
Even if David meets Substantial Presence, he may be able to avoid the tax impact of worldwide income, if he can show he has a closer connection to another country(s).
As provided by the IRS:
Even though you would otherwise meet the substantial presence test, you will not be treated as a U.S. resident for 2019 if:
- You were present in the United States for fewer than 183 days during 2019;
- You establish that, during 2019, you had a tax home in a foreign country; and
- You establish that, during 2019, you had a closer connection to one foreign country in which you had a tax home than to the United States, unless you had a closer connection to two foreign countries.
If you are an alien individual and you meet the closer connection exception to the substantial presence test, you must file Form 8840 with the IRS to establish your claim that you are a nonresident of the United States by reason of that exception.
Each alien individual must file a separate Form 8840 to claim the closer connection exception. For more details on the substantial presence test and the closer connection exception, see Pub. 519.
Who Does NOT Qualify?
As provided by the IRS, these are individuals who do not qualify for the closer connection exception
- You were present in the United States 183 days or more in calendar year 2019.
- You are a lawful permanent resident of the United States (that is, you are a green card holder).
- You have applied for, or taken other affirmative steps to apply for, a green card; or have an application pending to change your status to that of a lawful permanent resident of the United States.
Steps to change your status to that of a permanent resident include, but are not limited to, the filing of the following forms.
- Form I-508, Waiver of Rights, Privileges, Exemptions and Immunities.
- Form I-485, Application to Register Permanent Residence or Adjust Status.
- Form I-130, Petition for Alien Relative, on your behalf.
- Form I-140, Immigrant Petition for Alien Worker, on your behalf.
- Form ETA-750, Application for Alien Employment Certification, on your behalf.
- Form DS-230, Application for Immigrant Visa and Alien Registration.
Even if you are not eligible for the closer connection exception, you may qualify for nonresident status by reason of a treaty.
The key ingredient in a successful Closer Connection Exception application is to show that the person has a tax home outside of the U.S. – and thus a Closer Connection to another country for tax purposes.
As provided by the IRS:
Your tax home is the general area of your main place of business, employment, or post of duty, regardless of where you maintain your family home.
Your tax home is the place where you permanently or indefinitely work as an employee or a self-employed individual.
If you do not have a regular or main place of business because of the nature of your work, then your tax home is the place where you regularly live.
If you have neither a regular or main place of business nor a place where you regularly live, you are considered an itinerant and Form 8840 (2019) Page 4 your tax home is wherever you work.
For determining whether you have a closer connection to a foreign country, your tax home must also be in existence for the entire year, and must be located in the foreign country (or countries) in which you are claiming to have a closer connection.
As further provided by the IRS:
You will be considered to have a closer connection to a foreign country than to the United States if you or the IRS establishes that you have maintained more significant contacts with the foreign country than with the United States.
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