Resident vs Nonresident Taxation Differences

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Is your client an alien? Sounds funny, but the IRS considers all individuals who are not U.S. citizens or U.S. nationals, aliens. If your client is not a U.S. citizen or national, they are either a nonresident alien or a resident alien. Residency impacts how an individual is taxed and what form they file.

Who is a Resident Alien?

An individual is a resident alien of the U.S. for tax purposes if they meet either the green card test or the substantial presence test for the calendar year. Resident aliens are treated as U.S. citizens for tax purposes, they are taxed on their worldwide income.

Green Card Test

You are a resident, for U.S. federal tax purposes, if you are a Lawful Permanent Resident of the United States at any time during the calendar year. This is known as the "green card" test. You are a Lawful Permanent Resident if you have been given the privilege, according to the immigration laws, of residing permanently in the U.S. as an immigrant. You generally have this status if the U.S. Citizenship and Immigration Services (USCIS) issued you an alien registration card, Form I-551, also known as a "green card.”

Substantial Presence Test

You will be considered a U.S. resident for tax purposes if you meet the substantial presence test for the calendar year. To meet this test, you must be physically present in the United States (U.S.) on at least: 31 days during the current year, and 183 days during the 3-year period that includes the current year and the 2 years immediately before that, counting:

  • All the days you were present in the current year, and
  • 1/3 of the days you were present in the first year before the current year, and
  • 1/6 of the days you were present in the second year before the current year.

The term United States (U.S.) includes the following areas:

  • All 50 states and the District of Columbia.
  • The territorial waters of the United States.
  • The seabed and subsoil of those submarine areas that are adjacent to U.S. territorial waters and over which the U.S. has exclusive rights under international law to explore and exploit natural resources.

The term does not include U.S. possessions and territories such as Puerto Rico, Guam, or the Virgin Islands. The term also does not include U.S. airspace.

You’re treated as present in the U.S. on any day you are physically present in the country, at any time during the day. So, if you enter the country at 11:55 pm, you will be considered physically present for that entire day.

Counting Days for the Substantial Presence Test

To help us understand the substantial presence test, let’s look at an example. Susan travels to the U.S. for business. In 2016, she spent 312 days in the country. In 2017, she spent 210 days. This year, 2018, she arrived on August 1st. How many days does she need to be physically present in the U.S. during the current year to meet the substantial presence test?

In 2016, we count 52 days which is 1/6 of the 312 days Susan was in the U.S. In 2017, we count 70 days, which is 1/3 of the 210 days she was in the U.S. For the current year 2018, she arrived on August 1st. On September 30th she will reach 61 days for the current year and 183 days for the past 3 years. She must depart by September 30th or she will meet the substantial presence test.

If she meets the substantial presence test this year, her residency start date will be January 1st, 2018. A taxpayer becomes a resident on the first day of the year they meet the substantial presence test. Susan will be considered a resident for tax purposes and her worldwide income will be subject to federal income tax. Keep in mind that her immigration status does not change or matter.

Is Jose a Resident?

Now let’s look at another example. Jose arrived in the U.S. 10 years ago. He is undocumented and not authorized to be in the United States. He does not meet the Green Card test. However, he does meet the substantial presence test. He is a resident for tax purposes and must file Form 1040 not 1040-NR.

Many people think that immigration status is directly related to residency, and it’s not. Although the immigration laws of the United States refer to aliens as immigrants, nonimmigrants, and undocumented aliens, the tax laws of the United States refer only to resident and nonresident aliens.

The IRS doesn’t care if you’re undocumented or not, they will tax you! Encourage your undocumented clients to file accurate tax returns and be compliant.

Exempt Individuals

Certain exempt individuals may exclude days from the calculation of the substantial presence test. Exempt individuals include:

  • An individual temporarily present in the U.S. as a foreign government-related individual under an “A” or “G” visa.
  • A student temporarily present in the U.S. under an "F," "J," "M," or "Q" visa, who substantially complies with the requirements of the visa.
  • A teacher or trainee temporarily present in the U.S. under a "J" or "Q" visa, who substantially complies with the requirements of the visa.
  • A professional athlete temporarily in the U.S. to compete in a charitable sports event.

To exclude days of presence, these exempt individuals must include Form 8843 with their income tax return. If they do not file an income tax return, they must mail Form 8843 to:

Department of the Treasury Internal Revenue Service Center, Austin, TX 73301-0215

Form 8843 must be filed by the due date (including extensions) for filing Form 1040NR. If it is not, the exempt individual will not be able to exclude days for the purpose of the substantial presence test.

Nonresident Aliens

Nonresident aliens pay tax only on U.S. income and are exempt from self-employment tax. Nonresident aliens who are required to file an income tax return must use Form 1040NR or Form 1040NR-EZ.

Wages paid to nonresident aliens employed within the United States by an American or foreign employer, in general, are subject to Social Security/Medicare taxes for services performed by them within the United States, with certain exceptions based on their nonimmigrant status.

In Summary

Understanding residency is a big first step in working with immigrant clients. Some individuals are here illegally yet are residents, others are here legally and are nonresidents. Do not confuse immigrations status with tax residency. When serving immigrant clients make sure to ask them if they are here on a special visa or work permit. Show empathy, hire bilingual bicultural staff, and help them file accurate tax returns. In the long run, your client base and profits will grow.

Author Bio: Antonio Martinez is the VP of Business Development for LTPA. In 2004 Tony earned a full-ride scholarship to the University of California, Berkeley. Tony majored in Engineering and was involved in various leadership and volunteer roles. Upon graduation, Tony joined the LTPA with a goal of building a national brand. As VP of Business Development, Tony has led the exponential growth of the organization and organized various events throughout the country. In 2014 Antonio became an Enrolled Agent with the goal of representing immigrant taxpayers before the IRS.