United States

Treaty based residency protection only goes so far

TAX BLOG


Foreign nationals who spend more than 183 days in the U.S. may face U.S. federal tax liability unless they can qualify for treaty benefits. For example, if a foreign based international businessman spends a significant amount of in the U.S. he may, under a relevant treaty, avoid U.S. tax residence, and thereby avoid U.S. taxation, if he has a closer connection to a foreign jurisdiction. However, while the treaty may provide protection from substantive tax liability it may not provide relief from return filing obligations.

Absent treaty protections it is possible that individuals with significant ties to multiple countries may be considered residents in those countries. These “half residents” often rely on the tie-breaker provisions of income tax treaties to establish a singular residence for tax purposes. However, U.S. income tax treaties generally only settle the question of residence for a limited purpose of determining whether a person is subject to income tax liability. Treasury regulations make this clear stating, “other than the computation of the individual's United States income tax liability, the individual shall be treated as a United States resident” for purposes of applying the federal tax laws. Therefore, half residents must still comply with all filing requirements; they just don’t pay a tax.

This result is often confusing. Since no tax is owed many may mistakenly assume that filings are not required. However, this is not true and the failure to file the appropriate forms may result in significant penalties. For example, a treaty based non-U.S. resident may be considered a U.S. person for purposes of determining if a foreign corporation is a controlled foreign corporation and therefore required to file a Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations.

Other forms that may be required include:

  • Form 8938, Statement of Specified Foreign Financial Assets
  • Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts
  • Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships
  • Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation
  • Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund

Individuals claiming treaty-based residency should seek the guidance of a qualified tax advisor in order to carefully evaluate all filing requirements in both the U.S. and any other country where may have filing or tax paying obligations. 


Jamison Sites

Manager

jamison.sites@rsmus.com.

Areas of focus: Washington National TaxInternational Tax Planning