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Determining Alien Tax Status

February 16 , 2024



Understanding the difference between a resident alien and a nonresident alien is essential to determining your tax liability. Resident aliens are taxed like U.S. citizens on their worldwide income. On the other hand, non-resident aliens are generally taxed only on income connected with the conduct of a U.S. trade or business and on certain types of U.S. source income. non-resident alien status provides various opportunities to benefit from U.S. tax laws.

The first step in the tax planning process is to determine your status as a non-resident alien. However, this process is complicated due to the numerous compliance issues related to residency. Generally, residency is determined by an applicable tax treaty. However, in absence of a treaty, you will be considered as a resident only if one of the following 3 conditions is met;

 

  1. You are a “Lawful permanent resident” of the U.S. at any time during the calendar year,

  2. You meet the “Substantial presence test”, or

  3. You elect to be treated as a resident alien.

 

Lawful permanent residence test.

This is known as the “Green card test”. This test is based upon an alien’s immigration status. If an individual has obtained a green card, he or she is a lawful permanent resident of the U.S. The individual who physically enters the U.S. with holding a green card is immediately identified as a resident alien.

 

Substantial presence test.

Firstly, if you are not present in the U.S. for at least 30 days in the current year, you do not meet this test. If so, you need to calculate the number of days which you are present in the U.S.

  1. The number of days in the U.S. in the current calendar year,

  2. One-third of the number of days of presence in the first preceding year, and

  3. One-sixth of the number of days in the second preceding year.

If the total of these three is more than 183, you are classified as a resident alien.

 

Exempt days.

You do not need to count in the substantial presence test and include the following:

  • Days commuting to work in the U.S. (if the taxpayer regularly commutes) from Canada or Mexico,

  • Days in transit in the U.S. for less than 24 hours,

  • Days in the U.S. as a crew member of a foreign vessel,

  • Days suffering from a medical condition that leaves one unable to travel, and

  • Days that one is an exempt individual.

 

Once both two tests are conducted and if one test is met, the start date of residency is determined as the earlier of the date the “Lawful permanent residence test” or the “Substantial presence test” is  met. In other words, the individual becomes a resident alien starting from the earlier of these two dates.

 

You may refer to the flow chart below to better understand how to determine alien tax status.



 


Closer Connection Exception to the Substantial Presence Test

Even if an individual meets the substantial presence test, he/she may still be treated as nonresidents of the United States for U.S. tax purposes under Internal Revenue Code Section 7701(b)(1)(B), if he/she:

  • Was present in the United States less than 183 days during the year, and

  • Had a closer connection during the year to one foreign country in which they have a tax home than to the United States, and

  • Maintained a tax home in that foreign country during the entire year.

 

If the taxpayer can show a closer connection to a foreign country(s) with Form 8840 — they will not be taxed as a US person. Legal permanent residents or non-residents who have applied for a green card do not qualify for the closer connection test.

 

U.S.-Japan Income Tax Treaty - Tiebreaker rules

Even if an individual is considered a resident based on the closer connection exception (e.g., spends 183 days or more in the U.S. during the year), there may still be hope under the tiebreaker provision of an income tax treaty. The taxpayer could make a treaty election on Form 8833 claiming residence in a foreign country.

 

For example, if a person is considered a resident of either Japan or the United States, the taxpayer must conduct and analyze his or her economic and other factors to determine the proper country of residence as described below.

  • Permanent Home Test: Whether the individual has a permanent home available to them in one of the countries. If a permanent home is available in only one country, that country is generally considered the individual's country of residence for tax purposes.

  • Centre of vital interests Test: If the individual has a permanent home in both countries or in neither country, the treaty looks at where the individuals center of vital interests lies; in other words, where they have a closer personal and economic interests.

  • Habitual Abode Test: If the individual has a center of vital interests in both countries or in neither country, the treaty looks at where the individual has a habitual abode; in other words, where they live regularly. This could be where they spend more time or where they have a regular presence.

  • Nationality Test: If the individual has a habitual abode in both countries or in neither, the next factor considered is nationality. If the person is a citizen of only one of the countries, that country is typically considered their country of residence for tax purposes.

  • Mutual Agreement Procedure: In the rare case that the individual is a citizen of both countries or of neither, and the above tests do not resolve the issue of residency, the competent authorities of the United States and Japan will determine the individual's residency through a mutual agreement, considering the person's facts and circumstances.

 

U.S.-Japan Income Tax Treaty - Income Earned While Present in the US

Article 14 of the U.S.-Japan Income Tax Treaty apportions taxing jurisdiction over the remuneration earned by a resident employee between Japan and the United States. Under Article 14, employee services are taxed in the jurisdiction where the services are performed. For example, if a Japanese citizen earns wages while working in the United States, the United States may tax the wages.

 

The U.S.-Japan Tax Treaty provides that the United States may tax the employment income of a nonresident to the extent that the employment services are performed in the United States, unless all the following conditions are met

  1. the employee is present in the United States for a period or periods not exceeding in the aggregate 183 days in any 12-month period beginning or ending in the taxable year; and

  2. the wages are paid by or on behalf of an employer who is a nonresident of the United States; and

  3. the remuneration is not borne by a permanent establishment which the employer has in the United States.

 

Other residency considerations:

Additionally, you may qualify for dual status residency. In this case, the tax year is spilt into two separate tax periods. In this scenario, the individual is taxed as a resident during one period and as a non-resident during the other. Finally, there are some specific rules for establishing and terminating residency, abandoning residency, and expatriating. Furthermore, it is necessary for all departing aliens, whether they are residents or non-residents, to obtain a certificate from the IRS, commonly referred to as a sailing or departure permit. This certificate certifies their compliance with U.S. income tax laws before departing the U.S.

 

When preparing your income tax return, we carefully examine the internal revenue code, tax treaties, and other regulations to uphold the highest standards of professionalism and proficiency in navigating the complexities of tax law to optimize your financial outcomes. We sincerely hope that our services align with your expectations, ensuring your utmost satisfaction.

 

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