An individual’s non-U.S. citizen classification under the U.S. Tax Code has a major bearing on that person’s tax rate and income-reporting obligations. To serve a client’s tax-services needs adequately, a professional must be able to navigate the effects of a client’s status as a non-citizen on the tax consequences to that client. This article will provide a brief summary of the interplay between immigration status and the attendant tax consequences. Please note that the rules and regulations relating to non-citizen tax issues are very complex and the scope of this article is necessarily limited to the broad and general issues in this area. There are many exceptions, elections, options, and tax treaty effects available that are not covered in this article. This article discusses federal tax matters only. Seek competent tax advice when consulting with your clients.

CATEGORIES OF FOREIGN NATIONALS UNDER FEDERAL TAX LAW
Under immigration law there are three general categories of aliens—immigrants, non-immigrants, and undocumented or “out of status” immigrants. However, there are only two categories of foreign nationals under federal tax law—“resident alien for U.S. tax purposes” and “non-resident alien for U.S. tax purposes.” Also, special consideration is given for dual-status aliens. The tax definition of “U.S. resident” has little or nothing in common with immigration law definitions and is based on entirely different principles. A major source of confusion is the common usage of the term “resident alien” in both immigration and income-tax vernaculars. In immigration matters, “resident alien” usually refers to a person with legal-permanent-resident status. The term as used here is a descriptor of “legal status.” However, in its tax usages, the term “resident alien” generally denotes, more or less, where the person principally resides—principally residing inside the United States or principally residing outside the United States. Persons or entities not falling within the tax definition of resident are non-resident by default. Internal Revenue Code (IRC) §7701(b) and related regulations contain the specific rules to be used in determining whether a person or entity is a resident for federal income tax purposes. ⑴

ESTABLISHING RESIDENCE
Under federal tax law, there are two categories of non-citizen: 1) non-resident alien, and 2) resident alien. ⑵ A non-resident alien is an individual who is not a U.S. citizen nor a U.S. resident under the “green card” test, the substantial-presence test, or the first-year election. A non-resident alien is typically only taxed on income generated in the United States or income “effectively connected” with the United States.

A dual-status alien is an individual who is not a U.S. citizen and who was a non-resident alien for part of the year, but was also a resident alien for part of the year. The most common dual-status tax years are the year of arrival and the year of departure. The dual-status alien is taxed under the rules for non-residents during the non-residency period and is taxed on worldwide income for the period for which residency for tax purposes applies.

A resident alien, on the other hand, is an individual who meets either the “green card” test or the substantial-presence test for the calendar year. These tests are usually applied separately for each year. A taxpayer’s tax in a prior year does not necessarily determine residency in the current year. These tests apply only for federal income tax purposes for all years after 1984, and are summarized as follows:

“Green Card” Test
An individual is a resident for tax purposes if he or she is a lawful permanent resident of the United States at any time during the calendar year. ⑶ If at any time the individual has been given the privilege of residence according to U.S. immigration laws, he or she is a lawful permanent resident of the United States. This status is typically attained if U.S. Citizenship and Immigration Services (USCIS) has issued an alien registration card—i.e., green card. An individual continues to have resident status under this test unless the status is taken away from him or her, or he is administratively or judicially determined to have abandoned the privilege.

Substantial-Presence Test
A qualified individual under this test is considered a “resident alien for U.S. tax purposes.” An individual who is neither a U.S. citizen nor a lawful permanent resident is considered to have a substantial presence in the United States if he or she is physically present in the United States for at least:
● 31 days during the current year; and
● 183 days during the 3-year period that includes the current year and the 2 immediately prior years. ⑷

Interestingly, non-immigrants under federal immigration laws can be deemed a resident under this test.

To count “present days” under the substantial-presence test, all the days the individual was present in the current year are first tallied. Next, one-third of the days the individual was present in the first year before the current year are tallied. Lastly, one-sixth of the days the individual was present in the second year before the current year are tallied. Thus, if a foreign national is never present for 122 days or more a year, then he or she will avoid tax treatment as a resident under this test. ⑸

Treasury Regulation §301.7701(b)-4
Tax considerations are further affected by Treasury Regulation §301.7701(b)-4, which sets forth certain rules for allocating income between periods of non-residence and residence in those years where U.S.-residence status begins or ends. ⑹ (A part-year resident, who is both a resident alien and non-resident alien at different times in the year, is a “dual-status” alien.) For the first year of residence, a person becomes a resident either on the first day in which he or she is physically present as a lawful permanent resident (the “green card” test) or, under the substantial-presence test, on the first day during the calendar year in which he or she is in the United States. ⑺ For the last year of residence, the taxpayer ceases to be a resident on the last day of the year unless he or she qualifies for an earlier date. An earlier termination date may be the last date the taxpayer has permanent resident status (under the “green card” test) or the last day of physical presence (under the substantial-presence test) only if he or she establishes a closer connection to a foreign country for the remainder of the year and also makes the appropriate election to be taxed as a dual-status taxpayer. ⑻ For these purposes, there is a de minimis presence test, according to which a person may be present in the United States for up to ten days without triggering the starting date (or postponing the termination date) where he or she is able to establish a closer connection to a foreign country during that time. Individuals who do not meet either the green card or substantial-presence tests and are in the United States at least 31 consecutive days during the current year may elect to be treated as residents during the current year if certain Treasury Regulation §301.7701(b)-4(c)(3) conditions are met. ⑼

First-Year Election
If the physical-presence test is not met in the initial year it may be advantageous to make a “first-year election” under IRC §7701(b)(4)(B) to be a dual-status resident alien. ⑽ The election does not allow an individual to take the standard deduction or file jointly to take advantage of preferential tax rates. Rather, it subjects worldwide income to U.S. taxation for the period of residence, but a foreign tax credit is available for foreign source income included therein. The benefits of making the election should be reviewed case- by-case and may be significant in light of the additional deductions and credit available.

Practice Pointer: In particular for clients entering the United States who: a) have significant net worth and/or significant income; b) own interests in business enterprises and assets outside the United States; and c) are entering the United States under one of the investor or employment transfer visas, it would be quite valuable to the client for the immigration attorney to inform the client of the tax impact of becoming a “resident for U.S. tax purposes.” This helps the client avoid accidentally subjecting themselves to this worldwide-reporting scheme without prior knowledge. Many clients in this group will pursue their green cards, but will often take a year or two to prepare their affairs abroad to deal with the effects on their U.S. tax reporting as efficiently as possible.

⑴ See IRC § 7701(b).
⑵ See IRC § 7701(b).
⑶ IRC §7701(b)(1)(A).
⑷ IRC §7701(b)(3).
⑸ See Treas. Reg. § 301.7701(b)-1(c)(2)(i)–(ii).
⑹ See Treas. Reg. § 301.7701(b)-4.
⑺ IRC §7701(b)(2)(A)(iii).
⑻ See Internal Revenue Service, Department of the Treasury, Pub. 519, U.S. Tax Guide for Aliens 89 (Cat. No. 15023T, 2010).
⑼ See Treas. Reg. §301.770(b)-4(c)(3).
⑽ See IRC § 7701(b)(4)(B).