As a general rule, U.S. citizens and U.S. tax “residents” are subject to U.S. federal income tax on their respective worldwide income irrespective of source. An individual who is neither a U.S. citizen nor resident is generally subject to U.S. income tax only with respect to certain types of U.S. source income that is either FDAP (fixed, determinable, annual or periodical) or ECI (effectively connected with a U.S. trade or business.)
The key determinant of U.S. federal income tax liability is, therefore, residence of the taxpayer.
An individual who is not a U.S. citizen (i.e. an alien) is treated as a U.S. resident during a tax year and is, therefore, subject to U.S. income tax on worldwide income (subject to treaty relief) if the individual holds a green card, satisfies a “substantial presence test” or makes an election to be treated as a U.S. tax resident. The green card test is straightforward. If the taxpayer holds one lawfully, they are a U.S. resident for tax purposes. The substantial presence test is more involved. Under this test, a taxpayer who is not a U.S. citizen and does not hold a green card will be treated as a U.S. resident for income tax purposes taxed on a worldwide basis if they are (i) physically present in the U.S. for 183 days or more during the year; or (ii) physically present in the U.S. for at least 31 days during that calendar year and satisfies a “physical presence test” under a three year look back rule. This look back rule is satisfied if the sum of the following exceeds 183 days:
- the number of days of the taxpayer’s physical presence in the current year;
- one third the number of days of his physical presence in the U.S. in the first preceding calendar year and
- one sixth the number of days of his physical presence in the U.S. in the second preceding calendar year
It is important to note that if a taxpayer is deemed a resident for tax purposes in the U.S., they may also be deemed residents of another country for tax purposes. In such a case, we look at the applicable treaty, if there is one, for relief from the double taxation.