As families and the economy continue to become more globalized, it is increasingly common for people around the world to have investment, business, or familial connections to countries other than their home country, especially the U.S. For U.S. tax purposes, understanding the effect of these connections is critical to planning and compliance. The first step to identifying potential U.S. tax exposure is to evaluate if you are a U.S person for estate/gift tax and income tax, and the answer is not always the same. Status as a U.S. person does not mean you do or do not pay and file taxes, rather, it determines if you are taxed under the rules for a U.S. person or the rules for a non-resident alien.
For income tax purposes, those who are considered U.S. citizens or residents for tax purposes are referred to as “U.S. persons.” For estate and gift tax purposes, those who are considered U.S. persons are referred to as “U.S. domicilaries.” Determining whether you are a U.S. person or domicilary is critical because it impacts which tax rules apply. At first glance, it may seem simple to determine citizenship and residency status, but a variety of factors may complicate the analysis, and the status can change over time which will complicate long term tax planning. It is also possible to be a U.S. person for income tax purposes and a non-resident for estate and gift tax purposes and vice versa.
U.S. Status for Income Tax
Generally, there are 3 reasons why you might be considered a U.S. person for income tax purposes. (1) You are a U.S. citizen, (2) you are a green card holder, or (3) you meet the substantial presence test. The first two possibilities are generally straightforward; you either are a U.S. citizen/green card holder or you are not. However, the substantial presence test can be a bit more complicated.
The substantial presence test involves a calculation based on the number of days a person is present in the U.S. There are some exceptions to the substantial presence test which further complicates the analysis. Some individuals who meet the substantial presence test will not be considered U.S. persons if they spent less than half the current year in the U.S., have a tax home in another country, and have a closer connection to the other country than the U.S. Other individuals are not subjected to the substantial presence test such as foreign government employees and students. If you are not a U.S. citizen or green card holder and spend a substantial amount of time in the U.S., you should carefully consider whether you will meet the substantial presence test in any given year.
If you are a U.S. person for income tax purposes, you must report worldwide income and must report certain foreign financial accounts, investments, and businesses. It is critical to be aware of when you are a U.S. person to avoid failing to meet your U.S. tax obligations and potentially being subject to steep penalties.
U.S. Status for Estate and Gift Tax
Residency for estate and gift tax is determined differently than for income tax. For estate and gift tax purposes U.S. persons are (1) U.S. citizens and (2) all others who are domiciled in the U.S. at the time of the gift or their death. A person has a domicile in the U.S. if they live in the U.S., even for a short time, with the intent to remain there indefinitely. Once a person has a domicile in the U.S., they keep it until it is shown to have changed. It is worth noting that being physically present in the U.S. alone does not establish domicile unless there is an intent to remain in the U.S. indefinitely.
When domicile is challenged by the IRS, they look to immigration status, home ownership, employment, statements of intent on visa applications and tax returns, time spent in the U.S., voter registration, location of family, location of assets, and all other relevant facts to determine where someone is domiciled. To effectively plan for estate and gift tax, it is critical to determine where your domicile is and to keep records which can be used as evidence to prove your domicile if challenged.
It is equally important to be aware of when you are a U.S. person for purposes of estate and gift tax as it is for income tax. U.S. persons are always subject to estate and gift tax on their worldwide assets. Non-residents are subject to estate and gift tax only on property situated in the U.S.; however, the exemption from tax is much lower. This means there is potential for critical tax planning regarding estate and gift tax status.
The first step to any international tax planning is always determining U.S. status. Not only is this a key determination, but it also gives the opportunity for planning. If you have any ties to the U.S., it is imperative you determine if you will be taxed as a U.S. person or a non-resident.