Ep 04: To Be or Not to Be – Not Just a Question for Hamlet (Substantial Presence Test)
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In this episode of the International Money Café Podcast your co-hosts Jane Mepham CFP® and Manasa Nadig, EA explain exactly what you need to do to be considered a U.S. tax resident.
If you are a U.S. citizen or a green card holder (permanent resident), by default, you are a U.S. tax resident. If you don’t meet one of those conditions, the IRS has a cool test called the Substantial Presence Test (SBT) that determines how you should be treated for tax purposes.
The test consists of counting the days you have lived in the U.S. over a certain period.
Listen in as Manasa explains the test, including examples, to learn what the Substantial Presence Test is, how it’s used to determine your tax residency, and why it's so important.
The views and opinions are those of the speakers, and should not be considered financial, tax, or legal advice. Consult your advisor for any legal, cross-border tax, and financial advice.
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Speaker 1 (00:06):
Welcome to the International Money Cafe Podcast, the show where we filter out the noise on cross-border taxes, finances, and life in the us. I'm your host, Jen Metham, CFP.
Speaker 2 (00:18):
I'm your host Ade. Yay. Join us on this journey as we explore these unique challenges facing us, inbound outbound families and businesses onto the show.
Substantial Presence Test (SPT)
Speaker 1 (00:29):
In today's episode, we are going to address one of the questions that we see come across so that people ask us once they learn about this subject. So we're going to be talking about what's called the Substantial Presence Test, SPT. If you're not a US citizen or green card holder in the US your residency, and by this I mean your tax residency is determined by your substantial presence in the country. So in today's episode we're going to talk about what is the substantial presence test, what are the elections that you can make to claim or not to claim tax residency, who's a tax resident of the US and who's exempt from counting days for tax purposes. So what I'm going to do, because Manasa is a tax person in this show, I'm going to pass it on to her Manasa, would you like to maybe just start by answering the question? Why is SPT important?
Why is Substantial Presence Test Important?
Speaker 2 (01:30):
Definitely SPT is important because it determines your tax residency, which means that it determines how you'll file your taxes if you are a non-immigrant visa holder.
What is Substantial Presence Test?
So if we dig deeper into the official meaning of the substantial presence test, we can understand it better if we look at what it is not rather than what it's, let me explain that. You are considered to be a non-resident of the United States for US tax surfaces unless you meet one of two tests. One is the green card test, so you are a resident of US for federal tax purposes if you are a lawful permanent resident of the United States at any time during the calendar year, so this is known as the green card test. If you are in the United States already on a visa and then converted over to a green card, you are considered to have had tax residency through the year. But if you were not in the United States and you got your green card, so then you met your green card test at any time during the year but did not meet the SPT, your start date is the first day you are present in the US as a green card holder.
Speaker 1 (03:07):
Wait a minute, does it matter when you become a green card holder? Let's see if you become a green card holder in December versus in January, does it matter?
Speaker 2 (03:16):
Yeah, actually you can be both a resident and a non-resident in the same year for US tax purposes. This usually happens in the year you first arrive in the US or in the year in which you depart the us, you will file a dual status tax return for that year. There are a lot of planning opportunities there. You continue to qualify for residency under this test unless you voluntarily renounce your green card in writing with the U-S-C-I-S or your green card is terminated by the U-S-C-I-S or is terminated judicially by a US federal code. Let's go back to defining what a substantial presence test is. So a substantial presence test is based on a calendar year, just January 1st to December 31st. So you'll be considered a United States resident for tax purposes if you meet the SPT or the substantial presence test for the calendar year. And to meet this test, you must be physically present in the United States on at least, and I'll slow down here, 1 31 days during the current year and 183 days during the three year period that includes the current year and the two years immediately before that counting all the days you were present in the current year and one third of the days you were present in the first year before the current year and one sixth of the days you were present in the second year before the current year.
Speaker 1 (05:04):
Okay. So would it help if we went through maybe a small case study to kind of make this concrete?
Substantial Presence Test Case Study
Speaker 2 (05:11):
Absolutely. I definitely think we need a case study here. So let's say Mike arrived in the United States. He arrived in the United States in 2019 and he continued to stay in the United States in 20 19, 20 20 and 2021. So let's say his stay in the United States was intermittent, he was traveling in and out of the United States back to his home country and so on during these three years. But in 2021, we now need to determine his tax residency. So to determine if you met or if Mike met the substantial presence desk for 2021 and let's say he was there in the country 120 days in each of these three years to keep matters simple in 20 19, 20 20 and 21 to meet the substantial presence test in 21, we count all of the days in 21, which is 120, we count 40 days in 2020, which is one third of one 20 and 20 days in 2019, which is one sixth of one 20. And now if you look at the total for the three year period, which is 180 days, you are not, or Mike is not considered a resident under the substantial presence test for 2021. So let's say he had some income from the US sources during this period, he would still file a US tax return, but it would be a 10 40 nr, which is a non-resident tax return, but that is kind of a high level look at substantial presence test and how you count the dates.
Speaker 1 (06:59):
That's great. So one of the question that I've also seen, or at least when you start reading up on this, is what is United States for purposes of the SPT test?
United States and SPT Test
Speaker 2 (07:14):
Yes, that's important to know because for the purposes of an SPT or a green card test, the United States unquote is it's all the 50 states and the District of Columbia, it is the territorial waters of the United States and you'll find this interesting when they talk about territorial waters. It's the seabed and subsoil of those submarine areas that are adjacent to the US territorial waters and over which the United States has exclusive rights under international law to explore and exploit natural resources. And let's just take this a little further. It does not include US territories or US airspace.
Speaker 1 (08:02):
It kind of raises the question I guess if you're flying in and where you were in the air space, but I guess we can deal with that later. But it also means I think based on what you are saying, that there are some exceptions to this rule. Would you like to go into some of that?
Exceptions to Rule
Speaker 2 (08:18):
Yes, there are exceptions to this rule. You do not count the days of presence in the United States with substantial presence test for those days. You are commuting to work in the US if you are a resident of Canada or Mexico. And if you regularly come into the US for work, you do not count those days. And then if you are transiting between two countries and you happen to be in the US for less than 24 hours a while on this transit, you don't count those days. Of course, if you are a crew on a foreign vessel, the days in the US is not counted. And also if you happen to be in the US but you are unable to leave the country because of a medical condition that develops while you were in the country, then those days are not part of the substantial presence test count and also the days when you are an exempt individual and there's more to the term exempt individual and we can dig deeper into that.
Speaker 1 (09:28):
Actually before we get to the next point, when you talk about crew members of foreign, it kind of brings to mind when you see all these cruise ships coming to the US and they end up docking in different areas. So it sounds like for those people, regardless of how long they dock, that does not apply. Is that accurate?
Foreign Vessel Docking
Speaker 2 (09:47):
I think that there is more to it than just that. I think the important part of that definition is the foreign vessels. So I guess it depends on where that cruise ship is registered and to what country it belongs to. Does that make sense?
Speaker 1 (10:05):
Yeah, it does and I think from what I've seen with some of those, they tend to be registered outside the us which is probably some of the considerations they've taken into account when they're trying to figure out unquote where they are registered. So that's actually a pretty good point. Do you have any more to add to this?
Overriding SPT Test
Speaker 2 (10:26):
Yes. So there are elections that you can make to not claim tax residency in the US or you can make an election to override the green card test or the SPT test and some of the cases where you are allowed to make elections which can override the green card test or the substantial presence test. And these are at a high level, this is the first year choice to be treated as a resident. There is also an election that a non-resident spouse who is married to a US citizen or a green card holder and they can make an election to be treated as a resident of the US even though they may not fulfill the days of presence in the us. And of course the other one is the closer connection to a foreign country. You can claim closer connection to a foreign country even though you were in the US and possibly passed this SPT. And of course there are treaties also known as double tax avoidance agreements between countries that might be worth looking into if you were looking for ways to avoid being treated as a US tax resident.
Speaker 1 (11:45):
Again, that actually raises some interesting planning opportunities. Just going back to where you are eligible to use the test but you choose not to. So if you choose to be treated as a resident or if you're non-resident spouse and you choose to be treated as a resident, this does mean you guys have to do your worldwide income reporting if you're filing a US residence, correct?
Speaker 2 (12:11):
Absolutely. And that is something that we always talk about those planning opportunities. On the one hand it seems like it's a great plan for someone who has to now file as married filing separate because they are in the US on a work visa or rather non-immigrant work visa and their spouse has not been able to join them because they don't have a visa yet. So it might seem like it's a good option to file jointly because you get a higher tax deduction and are able to be in a lower tax bracket and things like that. But if your non-resident spouse has other accounts and other bank accounts or has other information that now will also need to be declared or disclosed by United States because you became a resident of the US because of the selection, then that's definitely something that has to be taken into account. So it is a planning opportunity in the sense it might not work for everyone. That's a caveat that you have to think about
Speaker 1 (13:22):
Really what it sounds like if you have an opportunity to override this before you make that kind of a move, reach out to CPA or EA who does cross border taxes and probably look at the two options filing as non-resident versus filing as a resident before you make the decision. I like that.
Speaker 2 (13:45):
Yes, yes. At any given point in time, this is something that I would definitely want someone if they think that they fall into any one of these options that we talked about that they should work with a professional. Yes.
Speaker 1 (14:01):
Great. It then basically means when you think about what we've said so far that they are exempt individuals for purposes of SPT or substantial presence test, would you like to go into some of this?
Exempt Individuals for Purposes of SPT
Speaker 2 (14:16):
Yes, there are exempt individuals for purposes of SPT and this is part of our discussion about what we, A status you are under when you are in the us some we A statuses which are non-immigrant. Wes allow you to be in the country to do a certain type of work, but the days that you are in the US are not considered as part of the substantial presence test for determining your tax residency. And some of these visas are an individual who's temporarily present in the US as a foreign government related individual and they're under NA or a G visa and also individuals holding A three or G five class visas or G visa as are usually visas for issued to those who work for world organizations like the World Bank or the un, A teacher or trainee temporarily present in the US under a J or a Q visa. Also a student temporarily present in the US under an FJM or Q visa and a professional athlete who is temporarily present in the US to compete in a charitable sports event. So these are the visa holders who are exempt from counting days under SPT,
Speaker 1 (15:41):
Which is all great, but then it raises, we just seem to be going down the rabbit hole, but that's fine. It kind of raises the next question. So if you want to exclude days of presence in the US for SPT purposes, how do you go about doing that?
Excluding days of Presence in the US for SPT Purposes
Speaker 2 (15:58):
If for some reason you are in the US but you do not want to count the number of days of presence in the US for tax purposes, you establish a closer connection exception to counting these dates. And this is very technical and unique to each individual and we definitely cannot go this in a podcast episode. I would say you should reach out to a cross-border tax professional who can help you with this. And the closer connection exception is also available to those who may not be able to leave the US as we spoke earlier due to medical reasons which are diagnosed while they will hear those are some of the options to exclude your days of presence in the US for SPT purposes.
Speaker 1 (16:45):
Okay. So what it sounds like, I think what it's coming down to is your immigration status is not really the same as your tax residency status and none of the tax residency status or types of bad. It's really just comes down to it's a matter of understanding where you are, where you fall into and then acting accordingly, right?
Speaker 2 (17:12):
Yes. And also being mindful of what this means to your situation. We all know that if you become a tax resident of the us, you have to declare your worldwide income and your worldwide assets. And that is sometimes the most important reason why you have to count the number of days that you can be classified as a tax resident of the us, especially if you are switching from one visa status to another. For example, we talk about this a lot. If you are a student and now you are going to become an H one B visa holder, what happens to this SPT? Or if you are on an H one B or an L one visa and you're switching to a green card, what happens to SPT or what happens to closer connection? Or if you are on a different visa status like a jwe and you decide that you're going to continue to stay in the us, then there are ways that things can be looked at retroactively at your income. These are some of the many different situations where SPT becomes important to look at and something that you want to talk about with a task professional who is informed in this area.
Speaker 1 (18:37):
Yeah, no, that sounds great. So is there anything else you'd like to add to this?
Speaker 2 (18:42):
I think we covered a lot of the SPT information here today, which is of course high level and some of this information is unique to each of you if this were to apply to you. So again, I reiterate working with a tax professional is important.
Speaker 1 (19:00):
I completely agree with you. So what's coming through is it's a bit of a complex area, it's always a good idea. Anytime you're not sure you're thinking about changing your status or you're just trying to figure out which way to go, you really want to reach out to a professional. So thank you so much for tuning into this episode. Would really appreciate it if you can go to all the major platforms where you get your podcast and give us a like, and if you know your friends or people that will be interested in this information, please share it with them. Thank you so much. This is Jane and
Speaker 2 (19:38):
This is Melissa. Bye
Speaker 3 (19:40):
Bye. Thank you for listening to the International Money Cafe podcast. The content is for informational and educational purposes only and should not be used as a substitute for professional advice. Seek the advice of your qualified service provider with any questions you may have regarding your cross border finances and tax needs.