Navigating the complex landscape of U.S. tax regulations can be a daunting task, especially for individuals who split their time between the United States and other countries. One crucial concept that frequently comes into play is the Substantial Presence Test (SPT). This test is a critical determinant used by the Internal Revenue Service (IRS) to assess tax liability for individuals who are not U.S. citizens or green card holders but spend significant time in the U.S.
This article aims to provide a clear and detailed guide on the Substantial Presence Test, elucidating its criteria, implications, and how it applies to non-resident aliens. Our goal is to offer valuable insights that aid in achieving compliance with U.S. tax obligations, ensuring a thorough understanding of your tax residency status.
What is the Substantial Presence Test?
The Substantial Presence Test is a criterion set by the United States Internal Revenue Service (IRS) to determine an individual’s tax residency status in the U.S. It applies to non-U.S. citizens and assesses whether they have spent a sufficient amount of time in the United States to be treated as a resident for tax purposes. This test is pivotal as it affects how and to what extent individuals are subject to U.S. income taxes.
The test calculates this by counting the total days of physical presence in the U.S. over a 3-year period. If the sum equals or exceeds 183 days, the individual is considered a U.S. resident for tax purposes for that year. This determination has significant implications for an individual’s tax liabilities, as it dictates whether they are subject to U.S. tax on their worldwide income.
What are the days of presence in the United States?
Days of presence in the United States refer to the number of days an individual spends physically present in the country. This can include days spent for work, vacation, or any other purpose. For non-residents and foreigners, days of presence are often closely monitored to determine their tax liabilities and immigration status. For US citizens and residents, it can also impact their taxation and eligibility for certain benefits.
How to Calculate the Substantial Presence Test?
This determination is based on a specific formula, which includes the number of days present in the U.S. over the current and preceding two years. To meet this test, you must be physically present in the United States (U.S.) on at least:
- 31 days during the current year, and
- 183 days during the 3-year period that includes the current year and the 2 years immediately before that, counting:
- All the days you were present in the current year,
- 1/3 of the days you were present in the first year before the current year, and
- 1/6 of the days you were present in the second year before the current year.
If the total for these three amounts is equal to or more than 183, and you were present in the U.S. for at least 31 days in the current year, you meet the Substantial Presence Test.
These examples illustrate various scenarios of physical presence in the U.S. and how they impact one’s resident or non-resident status under the Substantial Presence Test.
Example 1: The Recent Arrival’s Journey
Scenario: Imagine Maria, who recently moved to the U.S. for a new job opportunity. Let’s examine her days spent in the U.S. over a three-year period to determine her tax status for income tax purposes.
- Days in the U.S. in 2024 (current calendar year): 120 days
- Days in the U.S. in 2023: 60 days
- Days in the U.S. in 2022: 30 days
Calculation: Using the substantial presence test, we calculate her days as follows: 120 days (current year) + 20 days (1/3 of 60 days in 2023) + 5 days (1/6 of 30 days in 2022) = 145 days.
Result: With a total of 145 days, Maria does not meet the 183-day presence threshold under immigration laws. Therefore, she retains her nonresident status for federal tax purposes this year.
Example 2: Increasing Presence and its Impact
Scenario: Meet John, an entrepreneur who’s been increasingly spending time in the U.S. for business. Let’s assess his status under the U.S. tax system for the past three years.
- Days in the U.S. in 2024: 100 days
- Days in the U.S. in 2023: 120 days
- Days in the U.S. in 2022: 140 days
Calculation: John’s presence is calculated as 100 days (current year) + 40 days (1/3 of 120 days in 2023) + 23.33 days (1/6 of 140 days in 2022) ≈ 163.33 days.
Result: John’s total presence of approximately 163.33 days does not satisfy the 183-day threshold. He remains a nonresident alien for income tax purposes in the current year.
Example 3: Achieving Resident Alien Status
Scenario: Consider Emily, a researcher, who over time has transitioned to permanent residence in the U.S. We’ll explore her time spent in the U.S. across a three-year period to understand her tax obligations.
- Days in the U.S. in 2024: 150 days
- Days in the U.S. in 2023: 100 days
- Days in the U.S. in 2022: 120 days
Calculation: Emily’s days are summed up as follows: 150 days (current year) + 33.33 days (1/3 of 100 days in 2023) + 20 days (1/6 of 120 days in 2022) = 203.33 days.
Result: Emily’s total of 203.33 days exceeds the 183-day presence threshold. She now qualifies as a resident alien for income tax purposes, beginning in the current calendar year. Her next step is to file an income tax return reflecting her change in status.
Note on Permanent Residents: It’s important to distinguish that lawful permanent residents (green card holders) are generally considered as residents for tax purposes regardless of the days present in the U.S., and thus, are not subject to the Substantial Presence Test for determining their federal tax status.
What are the Exemptions in the Substantial Presence Test?
There are several exemptions to the Substantial Presence Test for U.S. tax purposes:
- Exempt Individuals: The term “exempt individual” does not refer to someone exempt from U.S. tax, but to anyone in the following categories:
- An individual temporarily present in the U.S. as a foreign government-related individual under an “A” or “G” visa, other than individuals holding “A-3” or “G-5” class visas.
- A teacher, trainee, or a scholar temporarily present in the U.S. under a “J” or “Q” visa, who substantially complies with the requirements of the visa.
- A student temporarily present in the U.S. under an “F,” “J,” “M,” or “Q” visa, who substantially complies with the requirements of the visa.
- Closer Connection Exception: Even if you meet the substantial presence test, you can still be treated as a nonresident of the United States for U.S. tax purposes if you:
- Were present in the United States less than 183 days during the year,
- Had a closer connection during the year to one foreign country in which you have a tax home than to the United States,
- Maintained a tax home in that foreign country during the entire year,
- Had not taken steps toward, and did not have an application pending for, lawful permanent resident status (green card).
- Medical Condition: Days you are unable to leave the U.S. because of a medical condition that develops while you are in the United States are not counted for the substantial presence test
Please note that this is a general explanation and individual circumstances can vary.
What to Do After Qualifying Under the Substantial Presence Test?
Once you’ve met the substantial presence test’s days requirement, it’s important to understand your new status as a tax resident and the associated responsibilities. Here’s what you need to do next:
- File a U.S. Income Tax Return: Transitioning from a foreign person to a U.S. resident for tax purposes means a change in your filing requirements. You are now required to report your worldwide income on Form 1040, reflecting your taxable income as a tax resident, instead of Form 1040NR which is used by nonresident aliens.
- Understand and Utilize Tax Treaties: If your country of origin has a tax treaty with the United States, it may affect your taxable income and filing status. Be aware of how these treaties can impact your income tax return.
- Report FBAR & FATCA: Meeting the substantial presence test also changes your reporting requirements. If you have foreign bank accounts, assets, or investments, you must report them through the Foreign Bank Account Report (FBAR) and the Foreign Account Tax Compliance Act (FATCA) forms. This ensures compliance with both U.S. and international tax laws.
- Comply with All Applicable Tax Laws: As a tax resident, you must adhere to all U.S. and international tax laws, which include accurate reporting of your worldwide income and any applicable taxes due.
Remember, failure to meet these reporting requirements could result in significant fines and penalties. To navigate the complexities of being a tax resident, especially regarding your income tax return and understanding tax treaties, it’s always a good idea to consult with a tax professional.
At 1040 Abroad, we understand that these regulations can be complex and daunting. That’s why we offer free tax advice via email to assist you with any questions you might have. There’s no reason not to contact us; our experts are here to help ensure you comply with all tax laws and to provide guidance tailored to your specific circumstances. This information is intended to be a general guide and may not apply to every individual situation, so don’t hesitate to reach out for personalized assistance.