Happy 4th of July to all! I sincerely hope everyone had a great weekend of enjoying all of the things that make this country great…which I suppose is another way of saying that I trust everyone was thinking about things other than taxes over the holiday!
Dennis and I had a great weekend, enjoying some of our favorite American pastimes. We played tennis on a beautiful sunny day here in Denver and then headed downtown for a Rockies’ baseball game and fireworks.
We have remained busy at Lanphier Accounting through the summer months and are thankful to all our clients for the opportunity to serve them! And now for…
In honor of America’s birthday, I wanted to provide some advice for all of our nation’s international visitors. Uncle Sam is thrilled to have you here, and – oh by the way – would like to make sure you are aware of your tax obligations while he’s at it.
For non-US citizens, there are two classifications that may trigger U.S. tax liability and reporting requirements: Resident Alien and Non-Resident Alien.
Any individual who earns income that is “U.S. source” is required to pay U.S. tax on that income. However, unless they actually reside in the U.S., their foreign source income is subject to U.S. tax only under limited circumstances. Therefore, if an U.K. citizen/resident owns property in the U.S., they must pay U.S. tax on the income generated by that property even though they do not live here. If this individual is employed and receives wages in the U.K., those wages will not be subject to U.S. tax because it is not U.S. source income.
This individual would be considered a non-resident alien, because they are not a U.S. citizen and they did not meet any of the residency tests described below.
In contrast, if you are either a US citizen or a resident alien of the US, you are taxed on your worldwide income, meaning income earned in the U.S. and abroad. While the foreign tax credit is available to reduce double taxation between the U.S. and foreign governments, it is important to know that all income of individuals residing in the U.S. is required to be reported to the IRS, regardless of where it is derived.
Resident Alien Status
An individual is considered a resident alien if they meet one of the following tests:
- Green Card Test – If the individual is a legal permanent resident of the U.S. for immigration purposes (i.e. has a green card) then they are automatically considered a resident alien for tax purposes;
- Substantial Presence Test – An individual is considered a resident alien for tax purposes, if the individual either –
- Resided in the U.S. for 31 or more days in the current tax year; and
- Resided in the U.S. for 183 or more days over the current tax year and two preceding tax years; counting
- All days present during the current year (i.e. 2010)
- 1/3 of the days present during the preceding year (i.e. 2009)
- 1/6 of the days present during the second preceding year (i.e. 2008)
I know – confusing. Here is an example: Let’s assume you were present in the U.S. for 120 days in the current and two preceding years. For the substantial presence test, you would count:
- 120 days for 2010
- 40 days for 2009 (1/3 of 120)
- 20 days for 2008 (1/6 of 120)
- Total = 180 days
In this example, you would not be considered a resident alien under the substantial presence test because the total above was less than 183 days. Of course, if at any point during 2010 you were a legal permanent resident (i.e. green card holder), you would be considered a resident alien regardless of the days you were actually present in the U.S. during 2010.
Dual Status Taxpayers
It is possible for a taxpayer to be both a resident alien and a non-resident alien in the same tax year. This is most common in the year of arrival in the U.S. or departure from the U.S.
For instance, an individual – let’s call him Roger Federer – has been a resident of the U.S. for five years, and paying U.S. income tax just like a U.S. citizen for all five years. On June 30, 2010, Roger leaves the U.S. to go back to his native Switzerland. For the first half of 2010, Roger is a resident alien and will pay U.S. income tax on all of his worldwide income – including the businesses he owns in Switzerland, France, and Australia. For the second half of 2010, Roger is a non-resident alien, and he will only pay U.S. tax on income derived from U.S. sources (i.e. the severance pay he received from his U.S. employer).
A resident alien of the U.S. files Form 1040 just like a U.S. citizen. They pay tax on all of their worldwide income, from whatever source derived.
A non-resident alien who has U.S. source income files Form 1040-NR. They will only pay tax on the income that is specifically derived from U.S. sources.
Many developed nations have a worldwide tax system similar to the U.S. In order to alleviate double taxation, the Foreign Tax Credit is available to offset U.S. tax with any taxes paid to foreign governments on the same income. Additionally, the U.S. has tax treaties with many nations that reduce the tax rate on certain types of income, such as interest, dividends, rents, and royalties. If you believe you are eligible for either the Foreign Tax Credit or treaty benefits, you should definitely speak with a tax advisor, as these are particularly complex areas of tax law.
If you are resident alien who is permanently departing the U.S. , you are required to obtain a “sailing permit” (also known as a departure permit or certificate of compliance). Once an individual leaves U.S. soil, it becomes much more difficult to collect tax from them; therefore, the IRS requires an individual to certify that they have paid all of their tax prior to leaving.
A sailing permit can be obtained from your local IRS office – located here in Denver. You will be required to complete one of two forms: Form 2063 or Form 1040-C.
Form 2063 is a very short, simple form that some individuals may be eligible for if they did not earn any income during the current tax year. Most individuals, however, will be required to file Form 1040-C which summarizes all of the income received in the current year and calculates any tax due. All taxes must be paid prior to departure in order to receive your sailing permit.
Form 1040-C is not a final tax return. You will still be required to file your final tax return, which is determined by your residency status at the end of the year. Therefore, once Roger Federer files his 1040-C and receives his sailing permit, he must still file Form 1040-NR by the following April 15th in order to have met his U.S. reporting requirements.
Any taxpayer facing some form of international tax issues is strongly advised to consult with a tax advisor. The rules in this area are highly complex, and it is just as possible to overpay your tax as it is to underpay it. Lanphier Accounting specializes in international tax compliance and has advanced training in such areas as Foreign Tax Credit calculations and non-resident income issues.
Please feel free to contact us with additional questions in this area, as we have barely even skimmed the surface in this post.
For more information, I recommend reading the IRS’ publication on this matter – Publication 519 – which will tell you everything you never cared to know on this subject.
I hope our readers are still “proud to be Americans” even after reading about taxes on our blog. Thank you for stopping by and we look forward to serving your tax and accounting needs in the future.
Lanphier Accounting LLP
600 17th St., Suite 2800 South
Denver, CO 80202