In light of COVID-19, the IRS recently published Revenue Procedure 2020-20, Revenue Procedure 2020-27, and an FAQ on the IRS website, which restore some of the inadvertent U.S. tax consequences caused by the recent travel restrictions. The measures provide much needed guidance in relation to U.S. tax residency questions.
Significance of U.S. Tax Residency
U.S. income tax residents include U.S. citizens, green card holders and nonresident aliens who spend a certain number of days in the U.S. and meet the “substantial presence test” under IRS Section 7701(b). The U.S. taxed resident status may create unexpected tax consequences for foreign nationals, which include:
- Subject to tax on worldwide income as well as rigorous informational disclosure on worldwide assets;
- Even if the individual is not a resident in the current year, the number of days counted towards their residency may affect their U.S. residency status in the following two years;
- Estates of U.S. tax residents can be subject to worldwide tax at 40%.
How is U.S. Tax Residency Determined?
To meet the substantial presence test for the calendar year, a nonresident alien must be physically present in the U.S. for at least:
- 31 days during the current year, and
- 183 days during the three-year period that includes the current year and the two years immediately before that, counting:
- All the days they are present in the U.S. in the current year;
- One-third of the days they were present in the U.S. in the prior year; and
- One-sixth of the days they were present in the second prior year before.
Certain days do not count towards substantial presence test. One of the exceptions includes days spent in the U.S. due to a medical condition. However, this exception is very limited and does not cover pre-existing conditions or travel to the U.S. to obtain medical treatment.
Inadvertently Became a U.S. Resident?
Rev. Proc. 2020-20 issued on April 21, 2020 provides relief for certain nonresident aliens whose stay in the U.S. was extended due to COVID 19 related travel disruptions by expending the medical exception. It applies to individuals who do not necessarily have the COVID-19 virus and attempt to leave the U.S. but face canceled flights and other disruptions in form of shelter-in-place orders, quarantines, and border closures.
Rev. Proc. 2020-20 offers relief to exclude up to 60 consecutive days spent in the U.S. during a time period between February 1, 2020 and April 1, 2020, with the specific start date to be chosen by each individual.
This exception, however, does not apply to a person who was a U.S. tax resident at the end of 2019 or a green card holder.
It should be noted that the same provisions apply in determining the availability of treaty benefits with respect to income from employment and other dependent personal services performed in the U.S.
Do Not Qualify for Foreign Earned Income Exclusion?
U.S. income tax residents who live abroad are taxed on their worldwide income. However, qualified individuals may be eligible to exclude their foreign earnings from income up to an amount that is adjusted annually for inflation ($107,600 for 2020). In addition, qualified individuals can exclude or deduct certain foreign housing amounts.
Rev. Proc. 2020-27 provides that qualification for 2019 and 2020 foreign earned income exclusions (FEIE) under IRC Section 911 will not be impacted as a result of days spent away from a foreign country due to the COVID-19 emergency for a qualified U.S. income tax resident whose tax home is in a foreign country under the bona fide test or the physical presence test.
The period covered for qualified individuals in the People’s Republic of China, excluding Hong Kong and Macau (China) begins on December 1, 2019; and globally on February 1, 2020. The period covered will end on July 15, 2020, unless further extended by the IRS.
For example, a U.S. citizen living in China who left China on or after December 1, 2019, and returned on or before July 15, 2020, will still be eligible for the FEIE, provided all other requirements for the exclusion are met.
Relief for Incidental U.S. Trade or Business
Finally, the IRS published an FAQ providing relief for certain nonresident aliens and foreign corporations who may choose an uninterrupted period of up to 60 calendar days starting between February 1, 2020 and April 1, 2020 (the COVID-19 Emergency Period). During the Emergency Period services or other activities conducted in the U.S. would not be taken into account in determining whether the nonresident alien or foreign corporation is engaged in a U.S. trade or business, provided that such activities were performed by one or more individuals temporarily present in the U.S. and would not have been performed in the U.S. but for COVID-19 emergency travel disruptions.
Further, a similar relief applies in determining whether a nonresident alien or a foreign corporation has a permanent establishment in the U.S.
These COVID measures are quite intricate in application and availability. If you or your business employees are physically present in the U.S. due to the COVID-19 pandemic, relief opportunities are available. BPM’s international tax specialists are here to help. To learn more, contact Jessie Huen at [email protected] or Ekta Gade at [email protected].