Tax Resident and Non-Resident Individuals in the US and the US Tax Laws

Just like any country in the world, the US has its own taxation laws that help the country to generate revenue for supporting its growth (or payment of a debt). For individuals living in the US, the applicability of US taxation depends on many factors including citizenship status, residency status, and source of income. While the taxation laws of US are complex, there are various things related to taxation that individuals living as aliens in the US should definitely know.

We discussed the topic with a well-known US tax advisor based in Europe, Matthew Ledvina, to understand the particulars of when someone is resident or not resident in the US.

US Tax Resident versus non-US Tax Resident

A US tax resident is chargeable for US income tax and capital gains tax on a worldwide basis. This means that no matter where the US tax resident receives the income or gains they must report it, and pay US tax. So, if a US tax resident sells a property in Paris for a capital gain, she must pay US tax on that transaction. On the other hand, a non-resident will only be bound to pay taxes on income that comes from US sources, eg rental income, dividends paid from US companies. .Other than that, no US taxes will be levied on the worldwide earnings of non-US resident.

US Resident for Tax Purposes

To identify whether an individual is to be considered as a US resident or not, three factors are considered. The first one is the immigration status, the other being the number of days for which the individual is physically present in the US and the third one is the connection with a country other than the US.

Speaking about the immigration status, people who hold green cards automatically become US resident from the US taxation viewpoint. They have to report their worldwide income to the IRS. The taxation law of the country also claims an individual to be a tax resident if he lives more than 183 days involving the current year and two previous calendar years.

The total days of presence are calculated using a test identified as substantial presence test. One important prerequisite for substantial presence test to become applicable is that the individual should be physically present in the country for at least 31 days in the current calendar year.

Of course, a US citizen is always a US tax resident no matter what, even if she lives in Europe. There are no exceptions to this rule.

Closer Connection Exception

Even if an individual meets the substantial presence test, there is an exception that can still allow him to remain a non-US tax resident. The exception is known as closer connection exception and requires fulfilment of three conditions that are as follows:

• Presence in the US for less than 183 days during the year

• Maintaining a foreign country as the tax home and obliged to pay taxes to that country for the entire year

• Closer connection with a country other than the US, which is also the tax home

For this exception, individuals have to fill and submit the Form 8840 to the IRS. However, it is important to note that the exception is not valid in case an individual has applied for a status change in the same year. For instance, if a person has applied for the green card, then she will be ineligible for the closer connection exception.

It is quite clear that the non-US citizens living in the US are categorized as either non-US residents or US residents depending on certain factors. While the non-US residents are subject to pay taxes only on US source income, the taxation applicable to US tax resident is identical to that of the US citizens.

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