Physical presence as a necessary condition for being a US “resident” under the Internal Revenue Code

 

This is the first in what I expect will be a series of posts on an issue we have yet to really focus on. Yes we all know what RBT is and so on but what we may not be so aware of, is how the US, while claiming we are “residents” of the U.S., doesn’t even give us equal (if not better) considerations than aliens/immigrants. And if this information doesn’t make you hopping mad, read it until it does.
 

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cross-posted from citizenshipsolutions dot ca
 
Introduction
Every country in the world with the exceptions of Eritrea and the United States claim tax jurisdiction based on “residence”. Although the tests for “residence” may differ, “residence based taxation” means that it is possible to sever your tax connection to a country by severing residence.

The nations of Eritrea and the United States impose taxation based on citizenship. U.S. citizens (primarily those “Born In The USA”) can NEVER sever their tax connection to the United States as long as they remain citizens. When it comes to U.S. citizenship-based taxation it is possible to NEVER have lived in the United States and still be subject to taxation!

Citizenship-based AKA “Place of Birth” Taxation is NOT based on any kind of physical presence or actual residence …

Q. Why is it that:

(from an email message I received)

“The British are called “subjects” but they are citizens; and the Americans are called “citizens” but they are “subjects”?

A. How about, as a proposed answer? (from an email message I received), because (CBT = “citizenship-based taxation”):

“CBT is a servitude (apparently some minds still can’t accept the abolition of slavery and racial segregation, so they have to reintroduce servitude). You, like any American “citizen” are in truth property of the IRS, and you will remain so unless you give up your citizenship (which means, like all serfs that you wold have to buy back your freedom from your master). If you don’t like the word “serf”, you may say that you are indentured. But that’s basically the same idea; you’re not free.
CBT is a problem of the rest of the world, because it is vile and
despicable: “No one shall be held in slavery or servitude; slavery and the slave trade shall be prohibited in all their forms.

Why? CBT means that an American is bound by birth to pay taxes to the US, even if they have never lived there. The truth is, all Americans (including you, including all people in Congress) live in serfdom. Those considering that CBT (i.e. being a serf) is a problem only for expats, are not really concerned by their liberty. They are cattle in a pen, they don’t know what freedom means. CBT has made the word “freedom”
meaningless.”

Strong language indeed! Offensive to some? Yes. But what about the concept itself? Is “citizenship-taxation” morally offensive? It depends on who you ask. Is it better to call U.S. citizens “prisoners”? There have been many references to the “prison of citizenship-based taxation“.

The simple fact of the matter is that:

1. The United States claims the right to impose world-wide taxation on people who do NOT live in the United States and on income earned outside the United States.

2. The United States requires all those who it defines as its citizens to comply with expensive, penalty laden reporting requirements that enforce the principle that: “U.S. citizens abroad are required to live as a U.S. resident lives”. This is the “When In Rome, Live as a Homelander” principle.

What this post is about

 
This post is NOT about “U.S. citizenship-based taxation” per se. This post is about the connection between “presence” in a country and taxation. U.S. citizens are ALWAYS U.S. tax subjects as long as they are citizens WHETHER THEY HAVE ANY PHYSICAL PRESENCE IN THE UNITED STATES OR NOT!
 
That said, CBT is a problem ONLY for those U.S. citizens who decide to live outside the United States. From the perspective of U.S. citizens living in the United States (“Homelanders”), the U.S. tax system is based on residence. Let them try to leave the United States of America!
 
The ONLY advantages to being a U.S. citizen are that you have the right to live, work and carry on business in the United States.
 
For U.S. citizens, “residence” is not a necessary condition for U.S. taxation.

Rather for those born in the United States, “citizenship” is a “sufficient condition” for U.S. taxation.
 
But, I have digressed …

This post is about “non-resident aliens” and the circumstances that may cause them to be converted from “non-resident aliens” to “resident aliens”. Once they have been converted from “non-resident aliens” to “resident aliens”, they are subject to the full force of the Internal Revenue Code.
 
Until they are converted to “residents”, non-resident aliens are subject to their specific and far narrower rules. These rules are found primarily in Internal Revenue Code S. 871. The mode of “taxation of non-resident aliens” combined with FATCA and the refusal of the United States to embrace the OECD Common Reporting Standard, reinforces the role of the United States as a Tax Haven.
 
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Different kinds of visas = Different kinds of “physical presence” to the United States
 
From a U.S. perspective, if you are NOT a U.S. citizen, you are an alien. Aliens will enter the United States under different kinds of Visas or (in some cases) with NO visa.
 
The “Green Card” (permanent residence Visa) vs. Other Kinds of Visas (not for permanent residence)
 
How are “non-U.S. citizens” AKA “aliens” taxed under the Internal Revenue Code? At what point does an “alien” become a “resident” of the United States?
 
S. 7701(a)(30) tells us that “U.S. Person” includes a “resident”. When does an “alien” become a “resident”?
 
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S. 7701(b)(1)(A) defines when and ONLY when an “alien” becomes a “resident”.
 
The circumstances INCLUDE:
 
The Green Card Test – lawfully admitted as a “permanent resident”
 
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Note that a Green Card gives the right of “permanent residence”. Therefore the (rebuttable) presumption is that Green Card Holders have an actual physical presence in the United States.
 
Q. Is it possible for a Green Card Holder to rebutt the presumption that he is a U.S. “resident”?

A. Yes, the Green Card Holder may be able to make use of a “Treaty Election” (normally Article IV) of a Tax Treaty. Does the availability of the Treaty Election presume that one should NOT be at tax resident of more than one country? Does the presume that a person should be subject ONLY to taxation where he actually resides? Does this assume a presumption of “residency based taxation”? It’s interesting to read the criteria to determine “tax residency” under the “Canada U.S. Tax Treaty“.
 
Article IV of the Canada U.S. Tax Treaty reads:
 
Article IV
Residence
 
2. Where by reason of the provisions of paragraph 1 an individual is a resident of both Contracting States, then his status shall be determined as follows:
 
(a) he shall be deemed to be a resident of the Contracting State in which he has a permanent home available to him; if he has a permanent home available to him in both States or in neither State, he shall be deemed to be a resident of the Contracting State with which his personal and economic relations are closer (centre of vital interests);

(b) if the Contracting State in which he has his centre of vital interests cannot be determined, he shall be deemed to be a resident of the Contracting State in which he has an habitual abode;

(c) if he has an habitual abode in both States or in neither State, he shall be deemed to be a resident of the Contracting State of which he is a citizen; and

(d) if he is a citizen of both States or of neither of them, the competent authorities of the Contracting States shall settle the question by mutual agreement
 
The “tie breaker” provision of the treaty seems to assume that:

1. People should NOT be tax residents of more than one nation; and

2. They should be treated as “tax residents” of the country where they actually reside.

Meets the “substantial presence” test
 
Note that “substantial presence test” is found in S. 7701(b)(3) and needs to be read very carefully.

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A. Defending yourself against having actually met the “substantial presence test”

Note that S. 7701(b)(3)(B) provides a “defense” to meeting the “substantial presence” test. This defense is generally referred to as the “closer connection” exemption. It is NOT available to U.S. citizens (they are not aliens) or to Green Card Holders (they are already “residents”).

It is generally claimed by filing IRS Form 8840.
 


 
By filing Form 8840, one is taking the position that:

Yes, I have met the “substantial presence test”. But, I have a closer connection to another country.

The “defense” is based on S. 7701(b)(3)(B) of the Internal Revenue Code. This “defense” is NOT based on Article IV of the Tax Treaty. Notice that the defense is based on being a tax resident of being another nation. Can one infer that the Internal Revenue Code assumes that people should NOT be considered to be “tax residents” of two countries?

The “closer connection test” seems to assume that:
 
1. People should NOT be tax residents of more than one nation; and

2. They should be treated as “tax residents” of the country where they actually reside.
 
B. Defending the allegation that you have met the “substantial presence test” in the first place

To meet the “substantial presence test” you are required to have spent a certain number of days in the United States. S. 7701(b)(5) specifies days of ACTUAL physical presence in the United States that are NOT to be counted as “physical presence”.
 
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continued
 
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Significantly, this section of the Internal Revenue Code specifically references S. 101(15) of the Immigration and Nationality Act to clarify exactly which kind of visa holder is entitled to this exemption. In other words, the focus is on the specific kind of visa that the person used to enter the United States.

The “exemption” is generally claimed by filing IRS From 8843.
 


 

By filing Form 8843, one is taking the position that certain days that you were actually present in the United States should NOT be counted as a day toward meeting the “substantial presence” requirement. Notice how the basis for the “exemption” is tied to very specific kinds of visas and specific reasons for actually being present in the United States. A practical description of
 

  • who must file Form 8843
  • why Form 8843 must be filed
  • how Form 8843 defends one against meeting the “substantial presence” test may be found here.

 
The “exemption from days toward the “substantial presence test” seems to assume that:

1. People should NOT be tax residents of more than one nation; and

2. They should be treated as “tax residents” of the country where they actually reside.
 
One might think that the United States has a system of “residence based taxation” …

Notice that the obvious purpose of the S. 7701(b) and Article IV of the Tax Treaty are to ensure that, for non-citizens”, a “physical presence” in the United States is met before one is treated as a “tax resident”?
 
In the case of “aliens” it appears that “residence” is a necessary but NOT a sufficient condition for U.S. taxation.
 
What is it about a “U.S. place of birth” that makes U.S. citizens exceptional?

 
Why should this be different for citizens? Why shouldn’t citizens also be required to have a “physical presence” in the United States before becoming a “resident” for tax purposes? Why should ONLY U.S. citizens be “tax residents” of the United States even if they reside outside the United States?
 
The usual answer to this question is:
 
It’s Cook v. Tait! By God in 1924, the Supreme Court of the United States (per Justice McKenna) ruled that the United States could impose taxation on its citizens abroad.
 
I am not certain that Cook v. Tait can be interpreted to mean that the United States can impose taxation on ALL of its citizens abroad. As I noted in a previous post about “Cook v. Tait”:
 
“Citizenship taxation” is a relic of the post that probably was NOT justifiable in 1921. If it was justifiable as a general principle, note that even in 1921, the definition of “citizen” in Article 4 of Regulation 62:

4. A citizen is defined as follows: “An individual born in the United States subject to its jurisdiction, of either citizen or alien parents, who has long since moved to a different country and established a domicile there, but who has neither been naturalized in or taken an oath of allegiance to that or any other foreign country, is still a citizen of the United States.”
 
This appears to mean that if Cook HAD become a naturalized citizen of Mexico OR taken an oath of allegiance to Mexico, that he would NOT have been considered to be a U.S. “citizen” for tax purposes. It also means that all those “so called Americans abroad” who emigrated to other countries and became citizens of those countries would NOT have been considered U.S. citizens for tax purposes! This suggests that “citizenship taxation” does NOT have the rich history that it’s advocates claim. It also means that the new U.S. concept of the “Tax Citizen” which began in 2004 is NOT the entrenchment of an old principle but the establishment of a new principle.
 
Interesting, assuming that Cook had become a citizen of Mexico and was residing in Mexico, perhaps Justice McKenna should have ruled that:
 
The definition of “U.S. citizen” for tax purposes seemed to assume that:

1. People should NOT be tax residents of more than one nation; and

2. They should be treated as “tax residents” of the country where they actually reside.
 
Conclusion …
 
Those born in the United States are NOT exceptional. In order for the United States to participate in the global world:
 
As Jackie Bugnion so persuasively argues, Residence should be a “necessary condition” for U.S. taxation for ALL people!

 
John Richardson
 

9 thoughts on “Physical presence as a necessary condition for being a US “resident” under the Internal Revenue Code

  1. Lynne Swanson

    @Stan: Definitely a minefield. I always boggles my mind how insane all of this is. Essentially anyone born in the U.S. should not spend more than 35 days a year there.

    But people born outside the U.S. can spend up to six months a year there and qualify for the closer connection to their home country.

    Americans have the “right to be stupid.” (John Kerry on his first international trip as Secretary of State)

    They are determined to continuously exercise their “right to be stupid.” Unfortunately, too many innocent people in the U.S. and around the world are trapped by their stupidity.

    Reply
  2. Stan Clyde

    I’m sure many US / Canadian dual citizens reading this article can see the issues of CBT in a new light. However what many of us would really like to understand is…..
    If you are a US born dual US/Canadian citizen and regularly file US taxes annually what are the substantial presences rules that apply to us as non-resident US citizens? For example, do snowbirds who are non resident US/Canadian dual citizens qualify for the same substantial presence tests that non-resident aliens currently enjoy? It would seem that we would not be able to utilize the closer connection exemption (Form 8843) simply because we are classified as US / Canadian dual citizens even though we would meet the closer connection exemption criteria. This certainly sounds like discrimination based on the mere fact we have chosen to live outside the US.

    Reply
    1. Lynne Swanson

      @Stan:  I’m sorry for the delay in responding.  I have not been on line for several days.

      I don’t know the answer to your question.   Common sense tells me you should be able to meet the closer connection test in the same way that a non-resident alien can.

      But after five years of dealing with this issue, I know there is no common sense when dealing with IRS, US Treasury, FATCA, FBARs, FinCEN, etc.

      Does anyone else knpow the answer to this question?

       

    2. Lynne Swanson

      @Stan:  I have an answer for you.  You will not like it. Common sense does not apply.

      Lawyer John Richardson says “The answer is no.”

      John also says:

      US citizens do NOT have the opportunity to take the closer  connection exemption to defeat the substantial presence test. This is because US citizens are always subject to the full force of US tax rules regardless of where they live and regardless of how many days they spend in the USA. As such the substantial presence test (which can apply only to non-resident aliens) does not apply to them.

      This is worse than discrimination. I’m sorry to be the bearer of this answer to you.

       

    3. Stan Clyde

      Lynne,
      Thank you for responding to my question. You are right, I don’t like the answer from John, although I’m a big fan of his.

      I’m now convinced this one issue will likely result in thousands of dual US/CDN citizens advancing their decision to renounce US citizenship sooner than later. There is simply no advantage for me to remain a US citizen at my age (70). Renouncing with it’s attendant costs sounds cheaper than having to worry about even brief visits to the US without triggering the substantial presence test and the loss the foreign tax credit. The alternative? Spending two months in the winter in Mexico rather than Florida or Arizona.

    4. Lynne Swanson

      @Stan:  Mexico sounds much more interesting and fun than Florida or Arizona.

      Plus Mexico will not insist you file endless forms, will not demand income taxes from you and will not try to snoop into your bank accounts.

      It may also be possible to get an appointment to renounce faster at a Consulate in Mexico than it is to do it in Canada. Or you can try another South American country or one of the Carribean islands to renounce.  Arctic Greyling did that.  I think it was Columbia where he renounced when he was spending the winter there.

      Buen Viaje!

    5. Stan Clyde

      @Lynne,
      I believe I found the answer to my question for those US/CDN dual citizens who want to spend time visiting friends or relatives in the US. Well….it’s a minefield. Essentially, I can spend a maximum of 35 days per calendar year in the US. If it exceeds 35 days I could no longer claim the foreign tax credit allowance (as outlined on IRS form 2555). This covers those dual citizens who spend at least 330 days per year outside the US. As mentioned, it will simply speed up the renouncing process.
      Stan

  3. nobledreamer-Tricia Post author

    For me, the value of this post is to focus on the efforts of the US to make allowances for obvious unfairness in the case of aliens/immigrants with regard to residence and taxation. And the fact that no such allowances are made for citizens. We have:

    treaty/tie-breaker rule
    substantial presence test
    closer connection test
    exemption from days toward“substantial presence test

    all demonstrating that US policy allows for situations in which:

    1. People should NOT be tax residents of more than one nation; and

    2. They should be treated as “tax residents” of the country where they actually reside.

    There is simply no such attention to citizens. This is clearly punitive.

    AND, the ultimate kicker, Cook v Tait demonstrates that either the judge had a screw loose or else, that people cannot read.

    4. A citizen is defined as follows: “An individual born in the United States subject to its jurisdiction, of either citizen or alien parents, who has long since moved to a different country and established a domicile there, but who has neither been naturalized in or taken an oath of allegiance to that or any other foreign country, is still a citizen of the United States.”

    They can’t have it both ways.

    This could be very important in creating a way to “lead” the US to changing this ridiculous policy.

    Reply
  4. nobledreamer-Tricia Post author

    Is “citizenship-taxation” morally offensive? It depends on who you ask.

    Damn straight it is morally offensive.
    When I calculated number of accounts x number of years x $10k it amounted to the approximate valuation of my house.* I was scared to death that we would lose our house in order to pay FBAR penalties.

    I would say that is morally offensive.

    *at the time, there was much emphasis on the fact that the unclarity of the penalty rule forced one to assume the worst; this was right after OVDI 2011, the horror stories of OVDP 2009, before the Fact Statement of 2011 and long long before any Streamlined Program.

    Reply

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