For U.S. income tax purposes, individuals are classified as either residents or nonresidents. There are very specific tax laws that determine an individual’s tax status for U.S. income tax purposes.
An individual can be classified as a resident for U.S. income tax purposes under several different circumstances. Unlike most other countries of the world, the U.S. taxes its citizens as residents, no matter where they live. A U.S. citizen living outside the U.S. is subject to the same reporting and disclosures as U.S. citizens living in the U.S. Persons holding permanent resident cards (commonly referred to as green cards) are also classified, in most cases, as U.S. tax residents, even though they are not U.S. citizens. In addition, individuals who spend 183 days or more in the U.S. in a calendar year will also be classified as U.S. income tax residents. The exception to the green card rule and the 183 day rule is if the individual qualifies for benefits under an income tax treaty between the U.S. and their home country.
A nonresident for U.S. income tax purposes is someone who is not a resident, i.e., isn’t a U.S. citizen, doesn’t have a green card and isn’t physically present in the U.S. for 183 days or more in a calendar year. However, an individual who is present in the U.S. for a substantial amount of time (defined as 183 days or more under a 3-year test) who is not a tax resident of any other country, could be classified as a U.S. tax resident.
Why does an individual’s U.S. income tax status matter?
The tax reporting and disclosure requirements are very different for each category of tax status. U.S. income tax residents must report their worldwide income on their U.S. income tax return. In addition, U.S. income tax residents are subject to many disclosures regarding foreign assets that are owned by the resident. For example, residents are required to disclose the details of any bank accounts or financial assets held outside the U.S. In addition, there could be disclosure requirements regarding ownership of shares of foreign corporations, an interest in a foreign partnership or the grantor or beneficiary of a foreign trust.
Alternatively, nonresidents are subject to income tax reporting on their U.S. source income only. They are not required to report their worldwide income on their U.S. income tax return. The most common types of income reported on a nonresident income tax return are the rental or sale of U.S. real estate. Nonresidents are not subject to the offshore disclosures that apply to residents.
However, as stated above, an individual could possess a green card or be physically present in the U.S. for 183 days or more in a calendar year, but still be classified for U.S. income tax purposes as a nonresident. For example, if he is a tax resident and has a centre of vital interest in his home country with which the U.S. has an income tax treaty that includes the residence provision, then the individual reports for U.S. income tax purposes as a nonresident, (i.e., reporting U.S. source income only), but is still subject to the same offshore disclosures required of U.S. tax residents.
Whether reporting as a resident or as a nonresident, the penalties for not properly disclosing the required offshore information can be quite significant.
There are other tax laws that may apply depending on the individual’s U.S. income tax status. For example, the withholding on the sale of U.S. real estate (i.e., FIRPTA withholding), only applies to sellers who are classified as “foreign.” Therefore, the seller’s U.S. income tax status must be determined in order to know if the FIRPTA withholding applies. U.S. partnerships and LLCs taxed as partnerships must withhold on the distributive share of income applicable to foreign partners, so the U.S. tax status of each of the partners must be determined in order to know if the partnership withholding rules apply. The sale of an interest in a U.S. partnership is subject to withholding if the seller is “foreign.”
In most cases, the classification of the U.S. tax status of the individual as a resident or as a nonresident is clear and straightforward. However, there are instances where the classification is not quite as certain. An individual who possesses a green card is most likely to be a U.S. income tax resident, but, depending on the specific circumstances, could be a nonresident for U.S. income tax purposes under the provisions of an income tax treaty.
It is important for individuals who are not clear on their U.S. income tax status to consult with a U.S. tax professional who is familiar with all the applicable tax laws in order to advise them on their appropriate income tax status so that the individual can comply with the laws that apply in their specific circumstances.