Substantial Presence Test in The United States
Introduction:
The United States (U.S.) is home to millions of immigrants who have come to the country for various reasons, including work, study, and family reunification. As a non-U.S. citizen, it is essential to understand the U.S. tax system, which can be complicated and confusing, especially for those who are not familiar with it.
One crucial aspect of the U.S. tax system is the Substantial Presence Test (SPT), which is used to determine whether an individual is a resident or nonresident for tax purposes. This article will provide an in-depth explanation of the Substantial Presence Test in the United States, its importance, and how it works.
What is the Substantial Presence Test?
The Substantial Presence Test is a formula used to determine an individual's U.S. tax residency status for federal income tax purposes. The test measures the number of days an individual has been physically present in the United States over a three-year period, taking into account a weighted average of the number of days present in the current year, the preceding year, and the second preceding year.
The SPT is important because it determines whether an individual is a U.S. resident or nonresident for tax purposes. If an individual meets the criteria of the SPT, they are considered a U.S. tax resident and must report their worldwide income on their U.S. tax return. If an individual does not meet the criteria of the SPT, they are considered a nonresident and only need to report U.S.-source income on their tax return.
Who is Subject to the Substantial Presence Test?
The SPT applies to non-U.S. citizens who are physically present in the United States. Generally, individuals who are not U.S. citizens are classified as either resident aliens or nonresident aliens for tax purposes. Resident aliens are taxed on their worldwide income, while nonresident aliens are taxed only on their U.S.-source income.
For tax purposes, an individual is considered a resident alien if they meet either the Green Card Test or the Substantial Presence Test. The Green Card Test is met if an individual has been granted lawful permanent resident status in the U.S. by the U.S. Citizenship and Immigration Services (USCIS) and is not considered a "closer connection" to a foreign country.
The SPT applies to individuals who do not meet the Green Card Test but have been physically present in the U.S. for a specific period. An individual is considered a resident for tax purposes if they meet the Substantial Presence Test for the current year.
How Does the Substantial Presence Test Work?
The SPT formula counts the number of days an individual has been physically present in the United States over a three-year period. The formula is as follows:
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Count all the days an individual was present in the U.S. during the current year.
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Count one-third of the days an individual was present in the U.S. during the first preceding year.
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Count one-sixth of the days an individual was present in the U.S. during the second preceding year.
If the sum of these three numbers is 183 or more, the individual is considered a U.S. tax resident for the current year. If the sum is less than 183, the individual is considered a nonresident for tax purposes.
Example:
To illustrate how the Substantial Presence Test works, consider the following example:
Sarah is a citizen of France who arrived in the United States on January 1, 2021, and has been present in the U.S. since then. Sarah was also present in the U.S. for 120 days in 2020 and 60 days in 2019.
To determine Sarah's U.S. tax residency status for 2021, we apply the SPT formula as follows:
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Count all the days Sarah was present in the U.S. during 2021, which is 365 days.
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Count one-third of the days Sarah was present in the U.S. during 2020, which is 40 days (120/3).
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Count one-sixth of the days Sarah was present in the U.S. during 2019, which is 10 days (60/6).
The sum of these three numbers is 415 days. Since the total is more than 183 days, Sarah is considered a U.S. tax resident for 2021 and must report her worldwide income on her U.S. tax return.
Exceptions to the Substantial Presence Test:
There are some exceptions to the SPT, which can exempt individuals from being considered a U.S. tax resident for the current year, even if they meet the physical presence requirements. The most common exceptions are the "Closer Connection Exception" and the "Exempt Individual Exception."
- Closer Connection Exception:
The Closer Connection Exception applies to individuals who have a closer connection to a foreign country than to the United States. To qualify for this exception, an individual must meet all of the following requirements:
- Be physically present in the U.S. for fewer than 183 days during the current year.
- Have a tax home in a foreign country during the current year.
- Have a closer connection to a foreign country than to the U.S. during the current year.
To demonstrate a closer connection to a foreign country, an individual must file Form 8840, "Closer Connection Exception Statement for Aliens," with the IRS. The form must be filed by June 15th of the following year.
- Exempt Individual Exception:
The Exempt Individual Exception applies to individuals who are exempt from counting days of presence in the United States for the purposes of the SPT. The most common categories of exempt individuals are:
- Foreign government-related individuals, such as diplomats and their families
- Teachers and trainees under a J or Q visa
- Students under an F, J, M, or Q visa
Exempt individuals are not required to file a U.S. tax return, but they may choose to do so if they have U.S.-source income that is subject to U.S. income tax.
Consequences of Failing the Substantial Presence Test:
If an individual fails the SPT and is considered a nonresident for tax purposes, they are only taxed on their U.S.-source income, such as wages earned in the U.S., rental income from U.S. property, and capital gains from the sale of U.S. assets.
However, if an individual fails to meet the SPT for a particular year but meets the criteria in a subsequent year, they may be subject to what is known as the "first-year choice."
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