Tax Prophet FAQ February 13, 1996

Frequently Asked Tax Questions --February 13, 1996

This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper, February 13, 1996

Dollars & Sense

ROBERT L. SOMMERS

Note: This exercise is for educational purposes only and is not intended to be legal or tax advice. Your particular facts and circumstances must be considered when applying the U.S. tax law. You should always consult with a competent tax professional with respect to your particular situation.

Questions

Question: As a non-U.S. citizen, I moved to the U.S. on a temporary basis. Will I be considered a U.S. resident and, if I am, what are my income tax consequences? [Answer]
Question: As a foreign student attending school in the United States under a student (F1) visa, do I owe U.S. income tax on my foreign income? [Answer]
Question: As a foreign teacher or trainee living in the United States under a J1 visa, do I owe U.S. income tax on my foreign income? [Answer]

Answer to Question #1: The U.S. government taxes its citizens and even residents on their world-wide income. Whether a foreign person is considered a resident is determined under two separate tests: (1) a physical presence test and (2) a closer connection test. For example, if a foreign student earns $10,000 from investments made in his home country ("foreign-source" income) and earns $5,000 while working in the U.S. ("U.S.-source" income), only the U.S.-source income will be subject to tax, unless the student is considered a resident. Then, usually, the entire $15,000 will be subject to U.S. tax, absent an income tax treaty to the contrary (although there also could be a foreign tax credit for taxes paid to the foreign country on the foreign-source income).
The physical presence test involves an actual counting of days the person is physically present in the U.S. Generally, if a foreign person was physically present in the U.S. for at least 31 days during the present year, and a combined total of 183 or more days for the present year and the previous two years (to determine the total days, count the full number of days in the present year, 1/3 the days in the previous year and 1/6 days in the earliest year), he will be considered a U.S. resident. There are exceptions for diplomats, foreign government-related individuals (A and G visa holders), students, teachers, trainees, commuters from Canada or Mexico, individuals in transit between two foreign countries, professional athletes, and persons here for medical treatment for a condition that arose while he or she was in the U.S. Often, the person's family gets the same exclusions.

Even if you meet the physical presence test, you may not be considered a resident if you maintain a closer connection with another country. This option is available only if you were not present in the U.S. for 183 days or more during the year in question. The closer connection test evaluates such subjective factors as your business, professional and social contacts (including the location of your home, family, automobiles, business, church, social clubs, and where you vote) with the foreign country as compared with the U.S.

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Answer to Question #2: Physical presence and closer connection tests used to determine residency apply to students as well. A limited exception, however, permits students to earn foreign-source income without paying U.S. income tax.
If you have complied with your visa requirements and have filed proper disclosure documents, you can exclude your physical presence in the U.S. for a maximum of five calendar years (presence even for one day during a calendar year will count that year toward the 5-year maximum). Thereafter, you become a U.S. resident and your foreign-source income will be taxed, unless you can demonstrate you will not permanently reside here. This is accomplished by maintaining a closer connection to another country and by not taking affirmative steps towards permanent residency ("green card") status.

Students must annually file the disclosure statement to explain they are entitled to exclude days of presence in the U.S. Failure to properly file will result in the loss of this benefit and will cause the student to be taxed on worldwide income.

Residency status will actually benefit those with substantial U.S.-source income and little or no foreign-source income since a resident is entitled to all credits and deductions from world-wide income allowed under the Internal Revenue Code.

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Answer to Question #3: This depends on how many years you reside in the U.S. and whether it is a U.S. or foreign entity that is paying you. Rules for teachers and trainees are similar to those for students, but with several significant differences. A foreigner who was present in the U.S. as a student, teacher or trainee during any 2 of 6 sequential calendar years will be treated as a U.S. resident.
This limitation extends to 4 of the last 6 years if all compensation is paid under certain government exchange or training programs. Also, all compensation paid by a foreign employer is exempt from U.S. taxation, regardless of whether it is received in the U.S. or another country.

Unlike the limitation period for students which is absolute, teachers and trainees may renew their 2-of-6-year and 4-of-6-year limitation periods every 7 years.

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