“Substantial Presence” Residency Test Addressed by IRS in Reaction to COVID-19
April 24, 2020
By Brent Lipschultz
The IRS has answered practitioners whose non-U.S. clients have been delayed in leaving the United States due to the COVID-19 situation. In Revenue Procedure 2020-20, Treasury and the IRS have given short-term relief to individuals who did not anticipate meeting the “substantial presence test” (described below) to become residents of the U.S. for federal income tax purposes during 2020 as a result of travel and related disruptions and potentially impacting an individual’s qualifications for certain treaty benefits.
The tax residency threshold in the U.S. is 183 days measured over the prior three years. The three-year average test is computed by adding all of the days spent in the U.S. during the current year, 1/3 of the days present in the prior year, and 1/6 of the days present in the second year before the current year (the “substantial presence test”). Foreigners who spend 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. However, those who qualify for tax residency in the U.S. are subject to taxation and reporting on worldwide assets.
Those benefiting from this relief include individuals who were not U.S. residents at the close of 2019, who are not lawful permanent residents at any point in 2020, who are present in the U.S. on each of the days of the individual’s COVID-19 “emergency period” (defined as a single period of up to 60 consecutive calendar days selected by an individual starting on or after February 1, 2020 and on or before April 1, 2020 during which the individual is physically present in the U.S. on each day), and who do not become U.S. residents in 2020 due to days of presence in the U.S. outside of the individuals’ COVID-19 emergency period.
An individual who meets the substantial presence test in 2020 (“eligible individual”) who intended to leave the U.S. during the individual’s COVID-19 emergency period but was unable to do so due to the virus, may exclude up to 60 calendar days of presence in the U.S. during the emergency period for purposes of applying the substantial presence test. The COVID-19 emergency will be considered a medical condition that prevented the eligible individual from leaving the U.S. on each day during the emergency period as required by the Internal Revenue Code’s medical condition exception but will not be treated as a pre-existing medical condition. Under the typical medical condition exception, an individual can exclude days of presence in the U.S. for purposes of the substantial presence test because the person was unable to leave the U.S. because of a medical condition. The medical condition must have arisen while the individual was in the United States and could not have been a pre-condition prior to arrival.
In addition, any days of presence during the emergency period on which an individual was unable to leave the U.S. will not be counted towards the person’s eligibility for treaty benefits.
The eligible individual will be presumed to have intended to leave the U.S. on any day during the individual’s emergency period, unless the person took steps to apply for a Green Card.
Procedure for Claiming the COVID-19 Medical Condition Travel Exception
Eligible individuals who have a requirement to file a Form 1040-NR for the 2020 tax year must claim the exception by attaching Form 8843, Statement for Exempt Individuals and Individuals with a Medical Condition, to their tax filing by April 15, 2021 (with extensions). For those not required to file a tax return for 2020, they should maintain all relevant records to support reliance on this Revenue Procedure and be prepared to produce the records and complete a Form 8843 if requested by the IRS.
Observation: Those taxpayers who are not required to file should prepare the Form 8843 and maintain the documents in a permanent file in the event of an IRS inquiry.
The Revenue Procedure contains special procedures to complete Form 8843 (not covered in this alert), as well as Form 8233, Exemption from Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Non-Resident Alien Individual.
Individuals who qualify for other exceptions to the substantial presence test, such as the closer connection test, do not need to claim the COVID-19 medical condition travel exception in order to claim the other available exceptions or they may claim all of the exceptions available to them. The closer connection exception to the substantial presence test requires a person to be present in the U.S. less than 183 days and have a closer connection during the year to a foreign country or countries in which such person has a tax home during the entire year.
For example, an individual who would otherwise meet the closer connection test by being in the U.S. for fewer than 183 days can use this exception to be considered a non-resident alien even after excluding days under the COVID-19 medical condition travel exception.