U.S. Tax Residency Threshold: COVID-19 Impact

The times we are living seem almost taken from the Tom Hanks film The Terminal. The film is about an Eastern European man who becomes stuck in New York’s John F. Kennedy Airport terminal when he is denied entry into the U.S. and is also unable to return to his native country because of a military coup. Would Hanks be considered a U.S. taxpayer if he was to spend significant days in a U.S. airport?

Many people who leave their home country to relocate to another, more tax-friendly jurisdiction may take time off and move to a third country for a temporary period of time to enjoy a vacation or settle their financial affairs in a tax efficient manner.  Often, people leave themselves very little leeway when they eventually leave the foreign country because they face a residence deadline.

COVID-19 has many countries locked down, with transportation at a standstill; and it is still not clear whether it will be short-lived or long-term. The residency triggering point is 183 days in the United States as well as many other jurisdictions. Will these people become unintended residents of a foreign jurisdiction?

The U.S. has not yet answered the question of how tax residency for those “COVID-19 refugees” who are not citizens or Green Card holders trapped here will be determined. However, various sections of the Internal Revenue Code and various country treaties hold the answer. 

Under IRC Sec. 7701, foreign individuals who come to the U.S. for business, medical visits or tourism who are unable to return to their home countries may become U.S. tax residents by virtue of the number of days spent in the U.S. They would therefore file the same tax forms and pay tax on a worldwide basis, similar to their U.S. citizen and Green Card holder counterparts.

The tax residency threshold in the U.S. is 183 days during a three-year period, including the current year and the two years preceding based on a formula (aka the Substantial Presence Test). The formula takes into account all of the days present in the current year, 1/3 of the days present in the first year preceding the current, and 1/6 of the days present in the second year preceding the current year. Typically, a foreign citizen who spends less than 120 days a year in the U.S. will not be a U.S. tax resident, but will be taxed as a non-resident on U.S.-sourced income or U.S. effectively connected income received in a particular year.

Assume someone comes to the U.S. on vacation and contracts the coronavirus while here or develops any other medical condition that essentially forces the person to be grounded in the U.S. In this case, a little-known exception provides that a person who is unable to leave the U.S. because of a medical condition that arose while here will not have to count those days for purposes of meeting the Substantial Presence Test. Essentially, those days are ignored and not counted for tax purposes.

If someone qualifies to exclude days of presence because of a medical condition, that person must file a fully completed Form 8843 with the IRS by its due date. If the due date is missed, the person may not exclude the days present in the United States, unless the individual can demonstrate by clear and convincing evidence that reasonable actions were taken to become aware of the filing requirements and significant steps to comply were taken. A physician must sign the statement on the form certifying the person was unable to leave the U.S. on the date shown and that there was no indication that the person’s condition was pre-existing.

Days cannot be excluded if a person was initially prevented from leaving, and was then able to leave but remained in the U.S. beyond a reasonable period. In addition, the days count in situations where a person left the U.S. and returned to get follow-up treatment for a condition that arose during a prior stay, or the condition existed before arrival in the U.S. and the person was then made aware of the condition.

Other solutions exist for those who may not have contracted the virus while they are in the U.S. If subsequently confined in the U.S., they will need to count those days and may ultimately meet the substantial presence test.  For such individuals who are in the U.S. for less than 183 days in 2020 and whose tax home is abroad, they may claim U.S. non-residency status by virtue of meeting the closer connection test.  These are individuals who have their primary residence, work, spend time, and have assets located in a particular country.  To qualify, those persons could not have applied for or changed their Green Card status and they would be required to file the IRS Form 8840 to explain the position taken.

If all else fails, the person, if living in a country with a treaty with the United States and deemed resident in both jurisdictions, may be able to rely on the treaty to claim non-residency status in the United States by virtue of relying on the residency tie breaker provision in the relevant treaty. The treaty looks to similar factors as the closer connection does and requires the person to file a different form, the IRS Form 8833.  It may be most advantageous for those individuals who have significant assets abroad to file under the closer connection test, which would exempt them from having to file most international U.S. forms such as the Foreign Bank Account Report (FBAR).

Most importantly, it is essential that persons keep calendars of the days in a particular jurisdiction or even get from Homeland Security the number of days in and out of the United States. Maintaining airline cancellation notices, getting doctors notices, and perhaps getting tested prior to entry to the United States become important documents to maintain for your tax advisor.