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Tax Residency Starting Date | International Tax Lawyer & Attorney

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In situations where a person was not classified as a resident alien at any time in the preceding calendar year and he became a resident alien at some point during current year, a question often arises concerning the tax residency starting date of such a person. This article seeks to provide a succinct overview of this question in three different contexts: US permanent residence, substantial presence test and election to be treated as a tax resident.

Tax Residency Starting Date: General Rule for Green Card Holders

Pursuant to IRC (Internal Revenue Code) §7701(b)(2)(A)(iii), the starting tax residency date for green card holders is the first day in the calendar year in which he or she is physically present in the United States while holding a permanent residence visa.  However, if the green card holder also satisfies the Substantial Presence Test prior to obtaining his green card, the tax residency is the earliest of either the green card test described in the previous sentence or the substantial presence test (see below).

Tax Residency Starting Date: General Rule for the Substantial Presence Test

Generally, under the substantial presence test, the tax residence of an alien starts on the first day of his physical presence in the United States in the year he met the substantial presence test. See IRC §7701(b)(2)(A)(iii).  For example, if an alien meets the requirements of the Substantial presence test in 2022 and his first day of physical presence in the United States was March 1, 2022, then his US tax residency started on March 1, 2022.

Tax Residency Starting Date: Nominal Presence Exception & the Substantial Presence Test

A reader may ask: how does the rule described above work in case of a “nominal presence” in the United States. IRC §7701(b)(2)(C) provides that, for the purposes of determining the residency starting date only, up to ten (10) days of presence in the United States may be disregarded, but only if the alien is able to establish that he had a “closer connection” to a foreign country rather than to the United States on each of those particular ten days (i.e., all continuous days during a visit to the United States may be excluded or none of them). There is some doubt about the validity of this rule, but it has never been contested in court as of the time of this writing.

This rule may lead to a paradoxical result.  For example, if X visits the United States between March 1 and March 10 and leaves on March 10; then later comes back to the United States on May 1 of the same year and meets the substantial presence test, then he may exclude the first ten days in March and his US tax residency will start on May 1.  If, however, X prolongs his visit and leaves on March 12, then none of the days will be excluded (since March 11 and 12 cannot be excluded under the rules) and his US tax residency will commence on March 1.

I want to emphasize that the nominal presence exception only applies in determining an alien’s residency starting date. It is completely irrelevant to the determination of whether a taxpayer met the Substantial Presence Test; i.e. the days excluded under the nominal presence exception are still counted toward the Substantial Presence Test calculation.

Tax Residency Starting Date: Additional Requirements for Nominal Presence Exception & Penalty for Noncompliance

The IRS has imposed two additional requirements concerning claiming “nominal presence” exclusion (again, both of them have questionable validity as there is nothing in the statutory language about them).  First, the alien must show that he had a “tax home” in the same foreign country with which he has a closer connection.

Second, Treas. Regs. §301.7701(b)-8(b)(3) requires that an alien who claims the nominal presence exception must file a statement with the IRS as well as attach such statement to his federal tax return for the year in which the termination is requested. The statement must be dated, signed, include a penalty of perjury clause and contain: (a) the first day and last day the alien was present in the United States and the days for which the exemption is being claimed; and (b) sufficient facts to establish that the alien has maintained his/her tax home in and a closer connection to a foreign country during the claimed period. Id.

A failure to file this statement may result in an imposition of a substantial penalty: a complete disallowance of the nominal presence exclusion claim.  Since IRC §7701(b)(8) does not contain the requirement to file any statements with the IRS to claim the nominal presence exception, the penalty stands on shaky legal grounds.  However, as of the time of this writing, there is no case law directly on point.

Additionally, as almost always in US international tax law, there are exceptions to this rule.  First, if the alien shows by clear and convincing evidence that he took: (a) “reasonable actions” to educate himself about the requirement to properly file the statement and (b) “significant affirmative actions” to comply with this requirement, then the IRS may still allow the nominal presence exclusion claim to proceed. Treas. Regs. 301.7701(b)-8(d). 

Second, under Treas. Regs. §301.7701(b)-8(e), the IRS has the discretion to ignore the taxpayer’s failure to file the required nominal presence statement if it is in the best interest of the United States to do so.

Tax Residency Starting Date: Election to Be Treated as a US Tax Resident

In situations where a resident alien elects to be treated as a US tax resident (for example, by filing a joint resident US tax return with his spouse), the tax residency date starts on the first day of the year for which election is made.  See Treas. Regs. §7701(b)(2)(A)(iv).

Contact Sherayzen Law Office for Professional Help with US International Tax Law, Including the Determination of the Tax Residency Starting Date

If you have foreign assets or foreign income or if you are trying to determine your tax residency status in the United States, contact Sherayzen Law Office for professional help.  Our law firm is a leader in US international tax compliance; we have helped hundreds of US taxpayers around the world and we can help you!

Contact Us Today to Schedule Your Confidential Consultation!

January 28 2021 Inbound Transactions Seminar | US International Tax Lawyer

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On January 28, 2021, Mr. Eugene Sherayzen, an international tax attorney and founder of Sherayzen Law Office, Ltd., co-presented with a business lawyer a seminar titled “Investing in US Businesses by Foreign Persons – Common Business and Tax Considerations” (the “Inbound Transactions Seminar”). The Inbound Transactions Seminar was sponsored by the International Business Law Section of the Minnesota State Bar Association. Due to the ongoing COVID-19 pandemic, the seminar was conducted online.

Mr. Sherayzen began his part of the Inbound Transactions Seminar with an explanation of the term “inbound transactions” and how it differs from “outbound transactions”. He then laid out a flowchart which represented the entire analytical tax framework for inbound transactions; the tax attorney warned the audience that, due to time restraints, the breadth of the subject matter only allowed him to generally highlight the most important parts of this framework.

Then, Mr. Sherayzen proceeded with an explanation of each main issue listed on the inbound transactions tax framework flowchart. First, he discussed the explanation of the concept of a US person and how it related to the flowcharted. The international tax attorney provided definitions for all four categories of US persons: individuals, business entities (corporations and partnerships), trusts and estates.

Then, Mr. Sherayzen focused on the second part of the flowchart – US income sourcing rules. After the general explanation of the significance of the income sourcing rules, the international tax attorney discussed in general terms the application of these rules to specific types of income: interest, dividends, rents, royalties, sales of personal property, sales of inventory, sales of real estate and income from services. Despite the time limitations, he was even able to provide a few examples of some of the most paradoxical outcomes of some of the US source-of-income rules.

The third part of the Inbound Transactions Seminar was devoted to the definition of “US trade or business activities”, an important tax term. Mr. Sherayzen provided a general definition and gave some specific examples, warning the audience that this is a highly fact-dependent issue.

In the next two parts of the seminar, the international tax attorney explained one of the most important terms in US taxation – ECI or Effectively Connected Income. Mr. Sherayzen not only went over all three ECI income categories but he also explained how ECI should be taxed. He also mentioned the affect of specific tax regimes (such as BEAT and branch taxes) on the taxation of ECI.

After finishing the left side of the flowchart (the part that was devoted to the analysis of the ECI of US trade and business activities), Mr. Sherayzen switched to the explanation of inbound transactions that do not involve US trade or business activities. In this last part of his presentation, the international tax attorney discussed the definition of FDAP income and the potential Internal Revenue Code and treaty exemptions from US taxation.

While the ongoing pandemic currently limits the number of options for conducting seminars, Mr. Sherayzen already plans future talks in 2021 on the subjects of US international tax compliance and US international tax planning.

26 U.S.C. Subpart A: Taxation of Recipients of Corporation Distributions

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This article is a second installment of our series of articles on corporate distributions. Today’s topic is the description of 26 U.S.C. Subpart A, which contains the most important tax provisions for our subsequent discussions of this subject.

26 U.S.C. Subpart A: Purpose

26 U.S.C Subpart A is the first part of Part I of Subchapter C, which deals with corporate distributions and adjustments. The main purpose of Subpart A is to establish the rules for taxation of recipients of corporate distributions. In other words, this section of the Internal Revenue Code deals with a situation where a corporation distributes or is deemed to have distributed something – a property, stocks, et cetera – to its shareholders. The focus here is not on the corporation, but on how its shareholders should be taxed.

26 U.S.C. Subpart A: §§301-307

26 U.S.C. Subpart A contains seven tax sections: IRC (Internal Revenue Code) §§301-307. All of these provisions are very important for both US domestic and international tax purposes.

IRC §301 establishes a general tax framework for corporate distributions and specifically deals with the distributions of property classified as dividends under IRC §316.

IRC §§302-304 describe the tax rules related to redemptions of stock (as defined in §317(b)), including some very specific situations. For example, §303 deals with distributions in redemption of stock to pay death taxes. The main provision, however, is §302 with its four tests which are highly important for determining whether a redemption of stock will be treated as a sale under §1001 or a corporate distribution under §301.

IRC §305 focuses on the special tax rules concerning stock dividends. It establishes the general rule that stock dividends are not taxable, but it also contains numerous exceptions to the general rule. More exceptions to the general rule may be found in §306.

IRC §306 deals with dispositions of “§306 stock” as defined in §306(c). §306 is very important to taxpayers because, with a few exceptions, it treats a disposition of §306 stock as ordinary income. This section also contains a loss non-recognition provision.

Finally, IRC §307 explains the calculation of cost-basis of stock received by shareholders as a result of a §305(a) distribution. This section has very important implications not only to stock dividends in general, but also to stock dividends made by a PFIC (Passive Foreign Investment Company). The calculation of PFIC tax and PFIC interest with respect to a disposition of such PFIC stock dividends are directly influenced by §307.

Contact Sherayzen Law Office for Professional Tax Help Concerning Corporate Distributions

Sherayzen Law Office is an international tax law firm highly-experienced in US and foreign corporate transactions, including corporate distributions. We have helped our clients around the world not only to engage in proper US tax planning concerning cash, property and stock distributions from US and foreign corporations, but also resolve any prior US tax noncompliance issues (including conducting offshore voluntary disclosures). We can help you!

Contact Us Today to Schedule Your Confidential Consultation!

IRS Waives 2018 Estimated Tax Penalty for Certain Taxpayers | Tax News

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On January 16, 2019, the IRS announced that it would waive the 2018 estimated tax penalty for taxpayers who paid at least 85% of their total tax liability during 2018, either through federal income tax withholding, quarterly estimated tax payments or the combination of both of these payment methods. These changes will be integrated in the forthcoming revision of Form 2210 and instructions.

The 85% threshold is a reduction from the usual 90% threshold required to avoid a penalty. It appears that this new limitation will apply only to the 2018 estimated tax penalty.

Why did the IRS single out the 2018 estimated tax penalty for this additional relief? Very simple – the IRS is trying to help the taxpayers who were unable to properly calculate the needed tax withholding and estimated tax payments due to the numerous changes to tax laws introduced by the 2017 Tax Cuts and Jobs Act.

The IRS probably also feels that its own federal tax withholding tables could have contributed to underpayment of tax by many taxpayers. When they were released in early 2018, the updated federal tax withholding tables reflected only the lower tax rates and the increased standard deduction. The tables, however, did not fully reflect other changes, such as the elimination of personal exemptions (including exemptions for dependents) and the severe limitations placed on  itemized deductions. Hence, if a taxpayer relied on the federal tax withholding tables, he would have been unfairly exposed to the 2018 estimated tax penalty had the IRS refused to grant this relief.

In all fairness, it should be mentioned that the IRS attempted to correct its mistake by initiating a very extensive education campaign (which also involved all IRS partner groups) for taxpayers with respect to the need to check on their tax withholding.

It is important to point out that the taxpayers should pay a lot more attention to their tax withholding for 2019 so that a 2018 estimated tax penalty does not turn into a 2019 estimated tax penalty. This is especially true for taxpayers who will now owe (maybe, somewhat unexpectedly for them) taxes on their tax returns. The highest-risk taxpayers are, of course, those who have itemized their deductions and complex income. Sherayzen Law Office also warns that taxpayers with foreign income are within this high-risk category.

New 11 IRS Compliance Campaigns | International Tax Lawyer & Attorney

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On November 3, 2017, the IRS Large Business and International Division (“LB&I”) announced the rollout of additional 11 IRS Compliance Campaigns in addition to the 13 already existing campaigns. Most of these campaigns directly address the IRS concerns with respect to US international tax law compliance. Let’s explore these new 11 IRS Compliance Campaigns.

New 11 IRS Compliance Campaigns: What Does This Mean for Taxpayers?

The issue-based IRS Campaigns is the brand-new strategy of the IRS to maximize the utility of its strained resources. Unlike previous efforts, a Campaign basically focuses on a specific issue that may carry a significant non-compliance risk and, then, applies a variety of solutions (called “treatment streams”) to increase the compliance with respect to this issue. The treatment streams range from development of an externally published practice unit, potential published guidance to issue-based examinations.

From a taxpayer point of view, the new strategy means that, if the IRS announces a new campaign, US taxpayers associated with the risk issue at the heart of a new campaign are at increased audit risk.

New 11 IRS Compliance Campaigns: General Emphasis on International Tax Compliance

Seven out of total eleven campaigns are focused on international tax compliance. This means that the IRS continues to give priority to international tax enforcement. Hence, US taxpayers who own foreign assets or are involved in international business transactions are likely to be affected by the IRS campaigns and should make sure they are in full US tax compliance.

Let’s briefly describe each of the new 11 IRS Compliance Campaigns.

New 11 IRS Compliance Campaigns: 1120-F Chapter 3 and Chapter 4 Withholding

This campaign focuses upon verification of the withholding credits before the claim for refund or credit is allowed. To make a claim for refund or credit to estimated tax with respect to any U.S. source income withheld under chapters 3 or 4, a foreign entity must file a Form 1120-F. Before a claim for credit (refund or credit elect) is paid, the IRS must verify that withholding agents have filed the required returns (Forms 1042, 1042-S, 8804, 8805, 8288 and 8288-A).

In other words, this campaign is designed to verify withholding at source for 1120-Fs claiming refunds.

New 11 IRS Compliance Campaigns: Swiss Bank Program

A non-surprising new addition to campaigns that will focus on tax and FBAR noncompliance of US beneficial owners of Swiss bank and financial accounts. The IRS will draw on the materials supplied to the DOJ by Swiss Banks as part of the Swiss Bank Program.

New 11 IRS Compliance Campaigns: Foreign Earned Income Exclusion

This campaign is likely to affect US taxpayers who reside overseas. The campaign will focus on taxpayers who claimed Foreign Earned Income Exclusion, but did not meet the requirements for claiming them. The IRS will address noncompliance through a variety of treatment streams, including examination.

New 11 IRS Compliance Campaigns: Verification of Form 1042-S Credit Claimed on Form 1040NR

The campaign’s goal is to ensure the amount of withholding credits or refund/credit elect claimed on Forms 1040NR is verified and whether the taxpayer has properly reported the income reflected on Form 1042-S.

New 11 IRS Compliance Campaigns: Agricultural Chemicals Security Credit

The first of the new four domestic campaigns. The Agricultural chemicals security credit is claimed under Internal Revenue Code Section 45O and allows a 30 percent credit to any eligible agricultural business that paid or incurred security costs to safeguard agricultural chemicals. The credit is nonrefundable and is limited to $2 million annually on a controlled group basis with a 20-year carryforward provision. In addition, there is a facility limitation as outlined in Section 45O(b). The goal of this campaign is to ensure taxpayer compliance by verifying that only qualified expenses by eligible taxpayers are considered and that taxpayers are properly defining facilities when computing the credit. The treatment stream for this campaign is issue-based examinations.

New 11 IRS Compliance Campaigns: Deferral of Cancellation of Indebtedness Income

This is an interesting addition and a correct one to the campaigns; I also believe that this area suffers from high rate of noncompliance. This issue stems from the Great Recession of 2008; in 2009 and 2010, a lot of US taxpayers elected to defer their cancellation of indebtedness (“COD”) income incurred as a result of reacquisition of debt instruments at an issue price less than the adjusted issue price of the original instrument. Such taxpayers should have reported their COD income ratably over a period of five years beginning in 2014 through 2018.

Furthermore, whenever a taxpayer defers his COD income, any related original issue discount (OID) deductions on the new debt instrument, resulting from debt-for-debt exchanges that triggered the original COD must also be deferred ratably and in the same manner as the deferred COD income.

The goal of this campaign is to ensure taxpayer compliance by verifying that taxpayers (who properly deferred COD income in 2009 and 2010) actually properly reported it in subsequent years beginning in 2014. The campaign will also look at situations where an accelerating event occurred and required earlier recognition of income under IRC § 108(i). The treatment stream for this campaign is issue-based examinations. The use of soft letters is under consideration.

New 11 IRS Compliance Campaigns: Energy Efficient Commercial Building Property

The goal of this campaign is to ensure taxpayer compliance with the section 179D (Energy Efficient Commercial Building Deduction). Section 179D allows taxpayers who own or lease a commercial building to deduct the cost or portion of the cost of installing energy efficient commercial building property (EECBP). If the equipment is installed in a government-owned building, the deduction is allocated to the person(s) primarily responsible for designing the EECBP. The treatment stream for this campaign is issue-based examinations.

New 11 IRS Compliance Campaigns: Economic Development Incentives Campaign

The goal of this campaign is to ensure taxpayer compliance with respect to a variety of government economic incentives. These incentives include refundable credits (refunds in excess of tax liability), tax credits against other business taxes (for example, payroll tax), nonrefundable credits (refunds limited to tax liability), transfer of property and grants. The common problems targeted by this campaign are situation where taxpayers improperly treat government incentives as non-shareholder capital contributions, exclude them from gross income and claim a tax deduction without offsetting it by the tax credit received. The treatment stream for this campaign is issue-based examinations.

New 11 IRS Compliance Campaigns: Section 956 Avoidance

This campaign focuses on situations where a CFC loans funds to a US Parent (USP), but nevertheless does not include a Section 956 amount in income. The goal of this campaign is to determine to what extent taxpayers are utilizing cash pooling arrangements and other strategies to improperly avoid the tax consequences of Section 956. The treatment stream for this campaign is issue-based examinations.

New 11 IRS Compliance Campaigns: Corporate Direct (Section 901) Foreign Tax Credit

Domestic corporate taxpayers may elect to take a credit for foreign taxes paid or accrued in lieu of a deduction. The goal of the Corporate Direct Foreign Tax Credit (“FTC”) campaign is to improve return/issue selection (through filters) and resource utilization for corporate returns that claim a direct FTC under IRC section 901. This campaign will focus on taxpayers who are in an excess limitation position. The treatment stream for the campaign will be issue-based examinations. The IRS emphasized that this is just the first of several FTC campaigns. The IRS further specified that future FTC campaigns may address indirect credits and IRC 904(a) FTC limitation issues.

New 11 IRS Compliance Campaigns: Individual Foreign Tax Credit (Form 1116)

This campaign addresses taxpayer compliance with the computation of the foreign tax credit (“FTC”) limitation on Form 1116. Due to the complexity of computing the FTC and challenges associated with third-party reporting information, some taxpayers face the risk of claiming an incorrect FTC amount. The IRS will address noncompliance through a variety of treatment streams including examinations.