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Last Updated on September 23, 2024 by Rashad Bolbol
Determining Your U.S. Tax Residency Status
In a previous post, we briefly touched on the concept of tax residency in the United States; however, in this blog, we will explain it in more detail. Understanding your tax residency status is crucial because it determines how much tax you owe while in the U.S. and what kind of income must be reported. Whether you’re a temporary visitor, student, or someone moving to the U.S. for work, knowing your tax residency status can prevent costly mistakes and ensure compliance with U.S. tax laws.
For many individuals new to the U.S., the country’s tax system can be complicated, especially when it comes to the rules surrounding worldwide income. Failing to understand these rules can lead to overpaying taxes or, worse, penalties for underreporting income. In this guide, we’ll break down everything you need to know about your U.S. tax residency status and the implications it has for both your U.S. and foreign-sourced income.
What Is Residency for Tax Purposes?
Your tax residency status determines how much of your income will be taxed in the U.S. Typically, a resident alien is taxed on their worldwide income, just like U.S. citizens. They must report all income earned both inside and outside the U.S.
On the other hand, nonresident aliens are taxed only on income earned in the U.S. or income connected to U.S. trade or business. Nonresidents are required to file a U.S. tax return for every year they earn income in the U.S. Even if you didn’t earn income as a nonresident, you are still required to file Form 8843 before the tax deadline to comply with U.S. tax laws.
Types of Residency
- Resident for Tax Purposes: To be considered a resident for tax purposes, you must pass the substantial presence test or the green card test for the calendar year.
- Nonresident for Tax Purposes: You are considered a nonresident for tax purposes if you have not passed the green card or substantial presence tests and are not a U.S. citizen or national.
- Dual Residency: A dual-status alien is someone who is treated as a nonresident for part of the year and a resident for the other part. This usually occurs during the first or last year of residency.
How Is Residency Determined?
There are two main ways to be considered a resident alien for tax purposes: the Green Card Test and the Substantial Presence Test.
- Green Card Test: If you have been granted lawful permanent residency (a green card), you are automatically considered a U.S. resident for tax purposes.
- Substantial Presence Test: This test is based on the number of days you have been physically present in the U.S. To qualify as a resident, you must meet both of these requirements:
- You were physically present in the U.S. for at least 31 days during the current year.
- You were present in the U.S. for at least 183 days over a 3-year period, which includes:
- All the days you were present in the current year,
- 1/3 of the days from the previous year, and
- 1/6 of the days from two years ago.
Tax Residency Exceptions
There are some exceptions to both the Green Card Test and the Substantial Presence Test.
Closer Connection Exception
Even if you pass the Substantial Presence Test, you may still be treated as a nonresident if you meet all of the following conditions:
- You were in the U.S. for less than 183 days in the year.
- You had a closer connection to a foreign country where you maintained a tax home for the entire year.
- You did not apply for a green card during the year.
A closer connection means that your ties to a foreign country (such as family, home, and business interests) are stronger than your ties to the U.S.
Special Cases
Nonresident Alien Spouse
If one spouse is a U.S. citizen or resident, and the other spouse is a nonresident, you can choose to treat the nonresident spouse as a resident for tax purposes. If you make this choice, you must file a joint tax return for the first year.
Tax Treaties
The U.S. has tax treaties with many countries. These treaties may allow residents of foreign countries to be taxed at lower rates or exempt from certain U.S. taxes. If you qualify for a treaty benefit, you still need to file a U.S. tax return and disclose your treaty position. Failing to do so could result in penalties.
Exceptions for Students and Trainees
The IRS applies different rules to nonresident aliens under F, J, M, or Q visas. For example:
- Students on these visas are considered nonresidents for their first five years in the U.S.
- Teachers, trainees, and scholars on J or Q visas are nonresidents for the first two years. After these periods, they start counting days for the Substantial Presence Test.
Are International Students Residents or Nonresidents?
International students on F, J, M, or Q visas are generally considered nonresident aliens for their first five years in the U.S. After five years, they must begin counting their days of presence in the U.S. If they pass the Substantial Presence Test, their status changes to resident for tax purposes.
For scholars, interns, trainees, professors, and researchers on J or Q visas, they are nonresidents for their first two years and must start counting days in their third year.
Common Mistakes Nonresidents Make
One of the most frequent mistakes nonresidents make is filing their taxes as a U.S. resident. Filing as a resident when you are actually a nonresident can result in claiming benefits or receiving refunds that you’re not entitled to. This not only breaks U.S. tax rules but can also lead to penalties, fines, and complications with future visa or green card applications. Filing correctly as a nonresident is essential to staying in compliance with both tax laws and your visa conditions.
Plan Ahead Before Moving to the U.S.
Once you become a tax resident in the U.S., you will be taxed on your worldwide income. This is why it’s essential to plan ahead before moving to the U.S. It’s often advantageous to adjust the timing of certain transactions, like selling foreign assets or receiving large sums of income, before becoming a U.S. tax resident. Once you are a resident, these transactions may be subject to U.S. tax rates, which could be higher than the tax rates in your home country. Proper tax planning can help you avoid unexpected tax liabilities.
Final Note
Remember that your federal and state tax residency statuses might differ. Always check both when determining your tax obligations.
Enrolled Agent, US/Canada Tax advisor.
Expert in US and Canada’s cross-border taxation. I assist individuals and businesses that earn income on either side of the border to plan ahead and save on their tax bills.