The Closer Connection Exception is a very important provision in US international tax law, because it provides a potential way for individuals who meet the Substantial Presence Test to still be treated as nonresident aliens for US income tax purposes. This article explores the Closer Connection Exception, its requirements and its implications for US and foreign taxpayers.
Understanding the Closer Connection Exception
The Closer Connection Exception is found in Internal Revenue Code (IRC) §7701(b)(3)(B) and is further elaborated in Treasury Regulation §301.7701(b)-2. This exception allows an individual who would otherwise be considered a US tax resident under the Substantial Presence Test to be treated as a nonresident alien for income tax purposes if he can demonstrate a “closer connection” to a foreign country.
Key Requirements for the Closer Connection Exception
IRC § 7701(b)(3)(B) and Treas. Reg. § 301.7701(b)-2(a) lay out the Closer Connection Exception eligibility criteria that an an individual must meet:
1.The individual must be present in the United States for fewer than 183 days in the current calendar year;
2.The individual must maintain a tax home in a foreign country during the year;
3.The individual must have a closer connection to that foreign country than to the United States; and
4. An individual must be an eligible individual.
Let’s explore each of these three requirements in detail.
Closer Connection Exception: The 183-Day Rule
The first requirement of the Closer Connection Exception is fairly straightforward: the individual must be present in the United States for fewer than 183 days in the current calendar year. This is a hard limit. Even one additional day of presence will disqualify an individual from claiming this exception.
It is important to emphasize that this 183-day threshold is different from the count of days used in the Substantial Presence Test, which includes a lookback period. For the Closer Connection Exception, only days of physical presence in the United States in the current year are considered. Treas. Reg. §301.7701(b)-2(a)(1).
Closer Connection Exception: Foreign Tax Home Requirement
The second requirement for the Closer Connection Exception is that the individual must maintain a tax home in a foreign country during the year. IRC §911(d)(3) defines the concept of “tax home” as an individual’s principal place of business. “If the individual has no regular or principal place of business because of the nature of the business, or because the individual is not engaged in carrying on any trade or business within the meaning of section 162(a), then the individual’s tax home is the individual’s regular place of abode in a real and substantial sense.” Treas. Reg. §301.7701(b)-2(c)(1). This is obviously a very fact-dependent definition of tax home, which requires exploration of all relevant circumstances (such as the location of the individual’s permanent home, family and even personal belongings).
The individual’s foreign tax home must be in existence for the entire current year. It must also be located in the same foreign country for which the individual is claiming to have the closer connection. Treas. Reg. §301.7701(b)-2(c)(2).
Closer Connection Exception: Closer Connection to Foreign Country
The third and often most complex requirement of the Closer Connection Exception is demonstrating a closer connection to a foreign country than to the United States. Treasury Regulations state that this requires establishing “that the individual has maintained more significant contacts with the foreign country than with the United States”. Treas. Reg. §301.7701(b)-2(d).
This analysis of course requires a detailed exploration of all relevant facts and circumstances. Treas. Reg. § 301.7701(b)-2(d)(1) provide the following non-exclusive list of key factors that one must consider in determining whether a closer connection to a foreign country exists:
1.The location of the individual’s permanent home;
2.The location of the individual’s family;
3.The location of personal belongings;
4.The location of social, political, cultural, or religious organizations with which the individual has a relationship;
5.The location where the individual conducts routine personal banking activities;
6.The location where the individual conducts business activities;
7.The location of the jurisdiction in which the individual holds a driver’s license;
8.The location of the jurisdiction in which the individual votes;
9.The country of residence designated by the individual on his forms and documents; and
10. The types of official forms and documents filed by the individual, such as Form 1078 (Certificate of Alien Claiming Residence in the United States), Form W-8 (Certificate of Foreign Status) or Form W-9 (Payer’s Request for Taxpayer ldentification Number).
Regarding the first factor, individual’s permanent home, it does not matter whether a permanent home is a house, an apartment or a furnished room. It also does not matter whether the individual owns or rents his home. “It is material, however, that the dwelling be available at all times, continuously, and not solely for stays of short duration.” Treas. Reg. §301.7701(b)-2(d)(1).
Closer Connection Exception: Multiple Foreign Countries
A question arises in this context: what if an individual has connections not to just one, but two foreign countries? Can an individual have a tax home in two or more countries?
Generally, an individual can have a closer connection to only one foreign country. However, it is possible to have a closer connection to two foreign countries in a single year if the individual moved their tax home during the year. In such cases, the individual can have a closer connection to each country for the part of the year they maintained a tax home in that country.
Treas. Reg. §301.7701(b)-2(e) lays out a detailed legal test in this case of multiple foreign country connections. In order for an individual to be able to claim the Closer Connection Exception in cases of close contacts with more than one foreign country, this individual must satisfy the following conditions:
(1) The individual maintains a tax home beginning on the first day of the current year in one foreign country;
(2) The individual changes his or her tax home during the current year to a second foreign country;
(3) The individual continues to maintain his or her tax home in the second foreign country for the remainder of the current year;
(4) The individual has a closer connection to each foreign country than to the United States for the period during which the individual maintains a tax home in that foreign country; and
(5) The individual is subject to taxation as a resident pursuant to the internal laws of either foreign country for the entire year or subject to taxation as a resident in both foreign countries for the period during which the individual maintains a tax home in each foreign country.
Closer Connection Exception: Eligible Individual
As stated above, the final condition for the Exception is that an individual must be an eligible individual. Ineligible individuals include: (a) individuals who have applied for status as a lawful permanent resident of the United States (i.e., applied for a green card), and (b) individuals who have an application pending for adjustment of status. IRC §7701(b)(3)(C).
Treas. Reg. §301.7701(b)-2(f) specifically sets forth the following list of actions which would make an individual ineligible to claim the Closer Connection Exception:
“Affirmative steps to change status to that of a permanent resident include, but are not limited to, the following—
(1) The filing of Immigration and Naturalization Form I-508 (Waiver of Immunities) by the alien;
(2) The filing of Immigration and Naturalization Form I-485 (Application for Status as Permanent Resident) by the alien;
(3) The filing of Immigration and Naturalization Form I-130 (Petition for Alien Relative) on behalf of the alien;
(4) The filing of Immigration and Naturalization Form I-140 (Petition for Prospective Immigrant Employee) on behalf of the alien;
(5) The filing of Department of Labor Form ETA-750 (Application for Alien Employment Certification) on behalf of the alien; or
(6) The filing of Department of State Form OF-230 (Application for Immigrant Visa and Alien Registration) by the alien.”
Closer Connection Exception: Form 8840
To claim the Closer Connection Exception, eligible individuals must file Form 8840, Closer Connection Exception Statement for Aliens, with the IRS. This form must be filed by the due date of the individual’s nonresident alien income tax return (Form 1040-NR), including extensions. Form 8840 requires detailed information about the individual’s presence in the United States, tax home, and factors demonstrating a closer connection to a foreign country. Failure to timely file this form may result in the individual being unable to claim the exception. Treas. Reg. §301.7701(b)-8(c).
Closer Connection Exception: Interaction with Tax Treaties
It’s important to note that the Closer Connection Exception is separate from any residency determinations under tax treaties. An individual who does not qualify for the Closer Connection Exception may still be able to claim nonresident status under a tax treaty’s tie-breaker rules. Conversely, qualifying for the Closer Connection Exception may eliminate the need to rely on treaty provisions. See Treas. Reg. §301.7701(b)-7.
Closer Connection Exception: Implications for Other Reporting Requirements
While the Closer Connection Exception can significantly alter an individual’s US income tax obligations, it is very important to understand that it may not exempt the individual from all US reporting requirements, particularly information returns such as FBAR and Form 8938.
Contact Sherayzen Law Office for Professional Help With US International Tax Law
US international tax law is extremely complex. The Closer Connection Exception and its potential impact on an individual’s tax status is just an example of this complexity. This is why, if you have assets in or income from foreign countries, you need to seek the professional help of Sherayzen Law Office. We are a leading US international tax law firm which offers comprehensive support in US international tax compliance (including IRS offshore voluntary disclosures) and US international tax planning. Our deep understanding of and extensive experienced in US international tax law allows us to proffer a professional advice tailored to your specific circumstances.
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