Determining Valid U.S. Tax Residency

Tax residency is highly important in the United States, as tax brackets, tax deductions, reliefs or credits, Social Security requirements, and treaty benefits are all affected by the taxpayer’s residency status. Whether a person lives in the U.S. temporarily or may be affected by international tax treaties, understanding the rules governing tax residency is essential in order to avoid unnecessary complications and make informed financial decisions.

Important to Know! If individuals or corporations incorrectly determine their tax residency, they may face numerous consequences, such as double taxation, interest charges, penalties, or the loss of certain tax credits and deductions. When running a business or managing investments, even a small hit to the profit margin, such as excess taxes or penalties resulting from failure to pay taxes required by law, may harm the profitability of the business venture. Under U.S. law, there are certain tax benefits or similar forms of government support that taxpayers may be entitled to. However, before eligibility for those benefits is examined, the taxpayer’s tax residency must first be determined under the tests established for that purpose under U.S. law. In other words, is the taxpayer a U.S. resident for tax purposes?

U.S. Tax Residency for Individuals

Determining whether a person is considered a U.S. tax resident is not always straightforward, especially when dealing with non-citizens who live or work in the United States. To provide clarity, the IRS and the U.S. Citizenship and Immigration Services (USCIS) use several well-defined tests to examine tax residency status in the case of a person who is not a U.S. citizen, since a U.S. citizen is generally considered a U.S. resident for tax purposes.

These tests help distinguish between temporary visitors and those who have established a more permanent connection to the country.

The two tests commonly used under U.S. law to determine an individual’s tax residency are:

1. The Green Card Test;
2. The Substantial Presence Test.

These are alternative tests. In other words, if either test is met on its own, the individual will be considered a U.S. resident for tax purposes, with all the implications arising from that classification, primarily U.S. tax filing and payment obligations.

Under the Green Card Test, an individual will be considered a U.S. resident if they were legally granted lawful permanent resident status in the U.S. during the year under review. This status is usually obtained in the U.S. through the issuance of a green card to the individual, confirming that they are a lawful permanent resident of the U.S. Such persons are considered lawful immigrants and are granted U.S. tax resident status. USCIS has the authority to revoke a green card, and the individual may also voluntarily give up this status by filing Form I-407 with USCIS, under which they voluntarily relinquish the green card.

However, even if an individual was not granted lawful permanent resident status in the U.S. – that is, they do not have a green card – they may still be considered a U.S. resident under the Substantial Presence Test.

To meet the Substantial Presence Test, the individual must satisfy two cumulative conditions:

1. They were physically present in the United States for at least 31 days during the current year;
2. They were present for 183 days over the last three years, with the calculation including:

• all days of presence in the U.S. during the current year;
• one-third of the days of presence during the previous year;
• one-sixth of the days of presence during the year before the previous year.

It should be noted that certain exceptions apply, and some days cannot be counted. For example, days spent in the U.S. for less than 24 hours, when the United States serves only as a transit stop, are not counted. The IRS has published additional exceptions.

U.S. Tax Residency for Corporations

When dealing with entities, including corporations, partnerships, and other business structures, the criteria for U.S. tax residency become more complex due to different ownership structures and international operations. A corporation will be considered a U.S. tax resident if it was incorporated under the laws of the United States, one of the U.S. states, or the District of Columbia.

Corporations that are considered U.S. tax residents are taxed on their worldwide income, regardless of where in the world their activities take place.

Under the U.S. check-the-box regulations, certain eligible LLCs may elect to be taxed as corporations, thereby obtaining U.S. tax residency.

It is also important to note that any change in classification may be treated as a taxable event, since the IRS views such changes as though the entity underwent a restructuring. Finally, even if a corporation is considered a resident of another country, U.S. law will still continue to treat it as a domestic corporation for tax purposes, unless a treaty tie-breaker rule has been properly applied in order to claim benefits under that treaty.

Why Is Determining U.S. Tax Residency Status Important?

Determining U.S. tax residency is not merely a legal-technical matter. It carries far-reaching financial and strategic implications for both individuals and corporations. From the way income is taxed to whether certain deductions or treaty benefits apply, residency status affects key decisions regarding where to live, work, or operate a business.

Corporations, particularly in Delaware, benefit from both U.S. tax residency and Delaware tax residency due to the favorable rules applicable there with respect to income tax and a zero-estate tax rate. The number of authorities involved, and the complexity of the rules make understanding the substantive criteria for U.S. tax residency essential for individuals and entities alike, as this is a critical issue for compliance, financial planning, and avoiding preventable mistakes.

Whether you are a foreign investor, a multinational company, or a non-citizen living in the U.S., understanding your U.S. tax residency status is highly important.

TaxLink – Our Story in a Few Words

TaxLink is a certified public accounting firm with a team of professionals specializing in Israeli and U.S. taxation. Our hands-on experience working with the IRS and the Israel Tax Authority, together with our deep understanding of the interaction between the two systems, allows us to build an end-to-end solution tailored to your specific circumstances.

Most of our clients come to us because they are required to file in the U.S. – whether it is a Form 1040 return, FATCA reporting, FBAR reporting, or matters involving an investment or real estate asset in the U.S. We manage the process as one integrated whole in order to reduce errors, minimize duplication, and help prevent double taxation – all within the framework of the law and the treaty between Israel and the United States, and in accordance with your specific circumstances.

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