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Substantial Presence Test | US International Tax Lawyer & Attorney

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The substantial presence test is one of the most important legal tests in the Internal Revenue Code (IRC), because it determines whether a person is a US tax resident solely by virtue of his physical presence in the United States.  Additionally, this Test is essential to the determination of whether a person is a “US Person” for FBAR and Form 8938 purposes. In this article, I will explain the substantial presence test and highlight its main exceptions.

Substantial Presence Test: The Main Rule

In reality, there are two substantial presence tests; if either test is met, a person is considered to be a US tax resident unless an exception applies.

The first substantial presence test is met if a person is physically present in the United States for at least 183 days during the calendar year. 26 USC §7701(b)(3).  

The second substantial presence test (the so-called “lookback test”) is satisfied if two conditions are met: (1) the person is present in the United States for at least 31 days during the calendar year; and (2) the sum of the days on which this person was present in the United States during the current and the two preceding calendar years (multiplied by the fractions found in §7701(b)(3)(A)(ii)) equals to or exceeds 183 days. 26 USC 7701(b)(3)(A).  

Let’s discuss how exactly the lookback test works.  The way to determine to determine whether the 183-day test is met is to add: (a) all days present in the United States during the current calendar year (i.e. the year for which you are trying to determine whether the Substantial Presence Test is met) + (b) one-third of the days spent in the United States in the year immediately preceding the current year + (c) one-sixth of the days spent in the United States in the second year preceding the current calendar year. See 26 USC §7701(b)(3).

Substantial Presence Test: Presence

As one can easily see, a critical issue in the substantial presence test is to determine during which days a person is considered to be “present in the United States”. Pursuant to 26 USC §7701(b)(7)(A), a person is considered to be present in the United States if he is physically present in the United States at any time, however short, during the day, including the days of arrival and departure.

There are limited exceptions under 26 USC §§7701(b)(7)(B) and 7701(b)(7)(C) for: commuters from Canada and Mexico, foreign vessel crew members and persons who travel between two foreign countries with a less than a 24-hour layover in the United States.

Substantial Presence Test: Exempt Persons

In addition to the exceptions above, the Internal Revenue Code contains a large number of categories of persons exempt from the Substantial Presence Test. 26 USC §§7701(b). In other words, the days that these “exempt persons” spend in the United States do not count toward the Substantial Presence Test. Here is a most common list of exempt persons:

Foreign government-related individuals and their immediate family (26 USC §7701(b)(5)(B))

Teachers and trainees and their immediate family (26 USC §7701(b)(5)(C))

Foreign students on F-, J-, M- or Q-visas (26 USC §7701(b)(5)(D))

Professional athletes temporarily in the US for charitable sporting events (26 USC §7701(b)(5)(A)(iv))

Individuals unable to leave the US due to medical conditions (26 USC §7701(b)(3)(D)(ii))

A couple of notes on these categories. First, for the “professional athletes who are temporarily present in the United States to compete in a charitable sporting event” category, the sports event must meet the following requirements for the exemption to apply: (1) it must be organized primarily to benefit §503(c)(3) tax-exempt organization; (2) the net proceeds from the event must be contributed to the benefitted tax-exempt organization; and (3) the event must be carried out substantially by volunteers.

Second, concerning the last category “foreign aliens who are unable to leave the United States because of a medical condition”, Rev. Proc. 2020-20 expanded this medical condition exception to include “COVID-19 Medical Condition Travel Exception” for eligible individuals unable to leave United States during “COVID-19 Emergency Period”. The term COVID-19 Emergency Period is a single period of up to 60 consecutive calendar days selected by an individual starting on or after February 1, 2020 and on or before April 1, 2020 during which the individual is physically present in the United States on each day. An Eligible Individual may claim the COVID-19 Medical Condition Travel Exception in addition to, or instead of, claiming other exceptions from the substantial presence test for which the individual is eligible.

Substantial Presence Test: “Closer Connection” Exception

In addition to exceptions and exemptions listed above, there is one more highly important exception to the Substantial Presence Test called the “Closer Connection” Exception. Under 26 USC §§7701(b)(3)(C), a person is exempt from the application of the Substantial Presence Test if the following four conditions are met:

1) the person is present less than 183 days in the United States during the current year;

2) the person can establish that, during the current year, he had a tax home in a foreign country (obviously, “tax home” is a term of art that has its special significance for the purposes of the “closer connection” exception;

3) the person has a “closer connection” to that foreign country than to the United States; and

4) the person has not applied for a lawful permanent residency status in the United States.

I have addressed the Closer Connection Exception in detail here.

Substantial Presence Test:  Tax Treaty Exception

Tax treaties provide another exception. IRC §7701(b)(6) and Treas. Reg. §301.7701(b)-7 provide that an individual who meets the substantial presence test but is a resident of a treaty country under a tie-breaker provision of an income tax treaty may elect to be treated as a nonresident alien for US tax purposes. This election is made on Form 8833, Treaty-Based Return Position Disclosure.

It’s important to note that while this treaty election can significantly affect an individual’s US tax obligations, it does not negate the fact that the individual met the substantial presence test. This distinction is crucial for certain reporting requirements, such as FBAR and Form 8938.

Substantial Presence Test: Closer Connection Exception and Treaty Election vs. FBAR

One of the most common pitfalls of US international tax compliance relates to a situation where the substantial presence test is met but either a closer connection exception is claimed or an election is made to be taxed as a resident of another country.  In such a situation, even many practitioners incorrectly conclude that the taxpayer is not required to file FBAR.  This is not the case; even where a tax treaty foreign tax residency election or a closer connection exception claim is made, the taxpayer may still need to file an FBAR. 76 Fed. Reg. 10,234, 10,238; IRM 4.26.16.2.1.2(6) (11-06-15).

I will discuss this FBAR exception to the closer connection and tax treaty exceptions in another article.

Contact Sherayzen Law Office for Professional Help With US International Tax Law

Understanding the nuances of the US international tax law, including the Substantial Presence Test with its numerous exceptions and its implications for both tax residency and FBAR reporting, is essential for individuals who spend significant time in the United States. Given the complexity of these rules and their potential US tax impact, you need qualified professional help to properly navigate these complex rules.

This is why you need to contact Sherayzen Law Office.  Our international tax team is highly knowledgeable and experienced in this area of law. We have helped hundreds of US taxpayers to determine their US tax residency status, and we can help you!  

Contact us today to schedule your confidential consultation!

2022 2Q IRS Interest Rates | US International Tax Lawyers

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On February 23, 2022, the Internal Revenue Service (“IRS”) announced that the 2022 Second Quarter IRS underpayment and overpayment interest rates (“2022 2Q IRS Interest Rates”) will increase from the first quarter of 2022. This means that, the 2022 2Q IRS interest rates will be as follows:

  • four (4) percent for overpayments (three (3) percent in the case of a corporation);
  • one and one-half (1.5) percent for the portion of a corporate overpayment exceeding $10,000;
  • four (4) percent for underpayments; and
  • six (6) percent for large corporate underpayments.

The second quarter will start on April 1, 2022.

Under the Internal Revenue Code, these interest rates are determined on a quarterly basis. The IRS used the federal short-term rate for February of 2022 to determine the 2022 2Q IRS interest rates. The IRS interest is compounded on a daily basis.

The 2022 2Q IRS interest rates are important for many reasons for US domestic and international tax purposes. For example, the IRS will use these rates to determine how much interest a taxpayer needs to pay on an additional tax liability that arose as a result of an amendment of his US tax return through Streamlined Domestic Offshore Procedures and Streamlined Foreign Offshore Procedures. The IRS will also utilize 2022 2Q IRS interest rates with respect to the calculation of PFIC interest on Section 1291 tax.

As an international tax law firm, Sherayzen Law Office keeps track of the IRS underpayment and overpayment interest rates on a regular basis. Since our specialty is offshore voluntary disclosures, we often amend our client’s tax returns as part of an offshore voluntary disclosure process and calculate the interest owed on any additional US tax liability. In other words these interest rates are relevant to Streamlined Domestic Offshore Procedures, Streamlined Foreign Offshore Procedures, IRS Voluntary Disclosure Practice, Delinquent International Information Return Submission Procedures and Reasonable Cause Disclosures. We also need to take interest payments into account with respect to additional tax liability that arises out of an IRS audit.

Moreover, we regularly have to do PFIC calculations for our clients under the default IRC Section 1291 methodology. This calculation requires the usage of the IRS underpayment interest rates in order to determine the amount of PFIC interest on the IRC Section 1291 tax.

Finally, it is important to point out that the IRS will use the 2022 2Q IRS interest rates to determine the amount of interest that needs to be paid to a taxpayer who is due a tax refund as a result of an IRS audit or amendment of the taxpayer’s US tax return. This situation may also often arise in the context of offshore voluntary disclosures.

Thus, the IRS underpayment and overpayment interest rates have an impact on a lot of basic items in US tax law. Hence, it is important to keep track of changes in these rates on a quarterly basis.

Beware of Flat-Fee Lawyers Doing Streamlined Domestic Offshore Procedures

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Recently, I received a number of phone calls and emails from people who complained about incorrect filing of their Streamlined Domestic Offshore Procedures (“SDOP”) packages by lawyers who took their cases on a flat-fee basis. In this article, I would like to discuss why a flat fee is generally not well-suited for a proper SDOP preparation and why clients should critically examine all facts and circumstances before retaining flat-fee lawyers.

A small disclosure: the analysis below is my opinion and the result of my prior experience with SDOPs. Moreover, I am only describing general trends and there are certainly exceptions which may be applicable to a specific case. Hence, the readers should consider my conclusions in this article carefully and apply them only after examining all facts and circumstances related to a specific lawyer before making their final decision on whether to retain him.

Flat-Fee Lawyers versus Hourly-Rate Lawyers

The two main business models that exist in the professional tax community in the United States with respect to billing their clients are the hourly-rate model and the flat-fee model. The hourly-rate model means that an attorney’s fees will depend on the amount of time he actually worked on the case. The flat-fee model charges one fee that covers a lawyer’s work irrespective of how much time he actually spends on a case.

Both billing models have their advantages and disadvantages. Generally, the chief advantage of an hourly-rate model is potentially higher quality of work. The hourly-rate model has a built-in incentive for attorneys to do as accurate and detailed work as possible, maximizing the quality of the final work product. An hourly-rate attorney is likely to take more time to explore the documents, uncover hidden problems of the case and properly resolve them.

The disadvantage of an hourly-rate model is that it cannot make an absolutely accurate prediction of what the legal fees will ultimately be. However, this problem is usually mitigated by estimates – as long as he knows all main facts of the case, an experienced attorney can usually predict the range of his legal fees to cover the case. Only a discovery of substantial unexpected issues (that were not discussed or left unresolved during the initial consultation) will substantially alter the estimate, because more time would be needed to resolve these new issues.

The chief advantage of the flat-fee model is the certainty of the legal fee – the client knows exactly how much he will pay. A secondary advantage of this model is the built-in incentive for flat-fee lawyers to complete their cases as fast as possible.

However, this advantage is undermined by several serious disadvantages. First, the flat-fee model provides a powerful incentive for lawyers to spend the least amount of time on a client’s case in order to maximize their profits; in other words, the flat-fee model has a potential for undermining the quality of a lawyer’s work product. Of course, it does not happen in every case, but the potential for such abuse is always present in the flat-fee model.

Second, closely-related to the first problem, the flat-fee model discourages lawyers from engaging in a thorough analysis of their clients’ cases. This may later result in undiscovered issues that may later expose a client to a higher risk of an unfavorable outcome of the case. Again this does not happen in every case, but I have repeatedly seen this problem occur in voluntary disclosures handled by flat-fee lawyers and CPAs.

Finally, a client may actually over-pay for a flat-fee lawyer’s services compared to an hourly-rate attorney, because a flat-fee lawyer is likely to set his fees at a high level to make sure that he remains profitable irrespective of potential surprises contained in the case. Of course, there is a risk for flat-fee lawyers that the reverse may occur – i.e. despite being set to a high level, the fee is still too small compared to issues involved in a case.

The effective usage of either one of these billing models differs depending on where they are applied. In situations where the facts are simple and legal issues are clear, a flat-fee model may be preferable. However, where one deals with a complex legal situation and the facts cannot all be easily established during an initial consultation, the hourly-rate model with its emphasis on thoroughness and quality of legal work is likely to be the best choice.

Flat-Fee Lawyers Can Be An Inferior Choice for Streamlined Domestic Offshore Procedures

In my opinion and based on the analysis above, in the context of an SDOP voluntary disclosure, a flat-fee engagement is particularly dangerous because of the nature of offshore voluntary disclosure cases.

Voluntary disclosures are likely to deal with complex US international tax compliance issues and unclear factual patterns. It may be difficult to identify all legal issues and all US international tax reporting requirements during an initial consultation. There are too many facts that clients may simply not have at their disposal during an initial consultation. Moreover, additional issues and questions are likely to arise after the documents are processed. I once had a situation where I discovered that a client had an additional foreign corporation with millions of dollars only several months after the initial consultation – the corporation was already closed and the client forgot about it.

For these reasons, SDOP and offshore voluntary disclosures in general require an individualized, detailed and thorough approach as well as a hard-to-determine (during an initial consultation) depth of legal analysis which is generally ill-fit for a flat-fee engagement. A flat-fee lawyer is unlikely to accurately estimate how much time is required to complete a client’s case and, hence, unlikely to accurately set his flat fee for the case.

This can cause a huge conflict of interest as the case progresses. I have seen a number of cases where, in an attempt to remain profitable, flat-fee lawyers did their analysis too fast and failed to properly identify all relevant tax issues; as a result, the voluntary disclosures (including SDOP disclosures) done by them had to amended later by my firm. This caused significant additional financial costs and mental stress to my clients.

In my opinion, this potential conflict of interest makes the flat-fee model unsuitable for the vast majority of the SDOP cases.

Beware of Some Flat-Fee Lawyers Including Unnecessary Services Into the Flat Fee

This applies only to a tiny minority of flat-fee lawyers. I have observed several times where flat-fee lawyers included irrelevant services that the client never used to increase the flat fee for the case (for example, audit fees for years not included in the SDOP). My recommendation is that, if you decide to go with a flat-fee arrangement, you should make sure that it includes only the services that you will likely use.

Contact Sherayzen Law Office for Professional Help With Streamlined Domestic Offshore Procedures

Sherayzen Law Office is a leader in SDOP disclosures. We have helped clients from over 70 countries with their offshore voluntary disclosures, including SDOPs. Our firm follows an hourly-rate billing model, because we value the quality of our work above all other considerations. Of course, we make every effort to make our fees reasonable and competitive, but our priority is the peace of mind of our clients who know that they can rely on the creativity of our legal solutions and the high quality of our work.

Contact Us Today to Schedule Your Confidential Consultation!

Coronavirus Offshore Voluntary Disclosure: Problems & Opportunities

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The advancement of coronavirus in the United States and around the world has significantly disrupted the normal conditions and assumptions for a US taxpayer who engages in an offshore voluntary disclosure of his unreported foreign income and foreign assets. I will refer to a voluntary disclosure conducted in this context of the coronavirus disruptions as Coronavirus Offshore Voluntary Disclosure. In this essay, I would like to discuss the most unique problems and opportunities that arise in the context of a Coronavirus Offshore Voluntary Disclosure.

Coronavirus Offshore Voluntary Disclosure: Most Important Problems

The spread of coronavirus created two important problems to conducting an offshore voluntary disclosure of foreign assets and foreign income.

The first and most significant problem is the ability of taxpayers to obtain the information necessary for the correct completion of US international information returns such as FBAR (FinCEN Form 114), Form 8938, Form 8865, Form 5471, et cetera. Oftentimes, in order to complete these returns, taxpayers have to retrieve information from many years ago.

This is a difficult task even without the coronavirus, because electronic access is often limited to just a few years. In cases that involve small and regional banks, the electronic access to information may simply not exist. Hence, a taxpayer often has to engage in a long process of mailing letters to banks requesting information; it is also a standard practice for taxpayers to personally travel to a foreign financial institution to obtain the necessary information.

The coronavirus prohibitions have made such travel virtually impossible due to cancellation of flights between countries. Even traveling within a country has been severely impacted. Moreover, there have been significant disruptions to ability of taxpayers to access financial institutions in the quarantined areas, such as northern Italy. Many financial institutions have simply closed their branches and ceased to operate in a normal way.

The combination of all of these factors has significantly curtailed taxpayers’ ability to collect the vital information necessary for the completion of an offshore voluntary disclosure.

The second most important problem caused by the coronavirus panic are communication disruptions. During a voluntary disclosure, taxpayers need to have access to their financial advisors and their international tax attorney. I’ve already explained above how the coronavirus bank closures have affected such communications.

The most significant communication issue between a taxpayer and his international tax attorney has been limited to mailing documents, particularly securing an original signature for Certifications of Non-Willfulness, Reasonable Cause Statements, amended tax returns and certain other IRS documents (such as Extension of Statute of Limitations in the context of an IRS audit). The coronavirus containment procedures have affected the flow of regular mail around the world and have caused significant delays in obtaining signed documents from clients.

It should mentioned that the normal communications between a client and his attorney were not significantly impacted. If there were any communication problems, this is most likely the result of the attorney’s failure to take advantage of modern means of communication.

Sherayzen Law Office’s usage of email, phone, Skype, Viber and certain other platforms for information exchange and other modern means of communication has assured continuous and uninterrupted communication between our firm and our clients. We have also encouraged and helped our clients to adopt certain procedures to mitigate other problems that have risen as a result of the coronavirus panic.

Coronavirus Offshore Voluntary Disclosure: Unique Opportunities

The coronavirus panic created not only unusual problems, but also unique opportunities for taxpayers with undisclosed foreign assets and foreign income. I will discuss here the two most important coronavirus opportunities.

First, the spread of this virus has given more time for noncompliant US taxpayers to bring their tax affairs into compliance with US tax laws. Not only has the IRS ability to pursue new international tax cases has been impacted by the virus, but the IRS moved the tax filing deadline to July 15, 2020. This means that taxpayers suddenly have three more months to work on their offshore voluntary disclosures without any interruption with respect to current tax compliance.

Second, more time means that taxpayers now can plan for and adopt more complex and beneficial strategies with respect to their offshore voluntary disclosures. For example, taxpayers who were planning to file extensions can now adopt a strategy to shift their voluntary disclosure period by timely filing their 2019 tax returns and 2019 FBARs.

Contact Sherayzen Law Office for Professional Help With Your Offshore Voluntary Disclosure

If you have undisclosed foreign bank accounts and other foreign assets, contact Sherayzen Law Office for professional help. We have successfully helped hundreds of US taxpayers to bring their tax affairs into full compliance with US tax laws, and we can help you!

Contact Us Today to Schedule Your Confidential Consultation!

Attribution Rules: Introduction | International Tax Lawyer & Attorney

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One of the most popular tax reduction strategies is based on shifting an ownership interest in an entity or property to related persons or related entities. In order to prevent the abuse of this strategy, the US Congress has enacted a large number of attribution rules. In this brief essay, I will introduce the concept of attribution rules and list the most important attribution rules in the Internal Revenue Code (“IRC”).

Attribution Rules: Definition and Purpose

The IRC attribution rules are designed to prevent taxpayers from shifting an ownership interest to related persons or entities. They achieve this result through a set of indirect and constructive ownership rules that shift the ownership interest assigned to third parties back to the taxpayer. In other words, the rules disregard the formal assignment of an ownership interest to a related third party and re-assign the ownership interest back to the assignor for specific determination purposes.

For example, in the context of determining whether a foreign corporation is a Controlled Foreign Corporation, all shares owned by the spouse of a taxpayer are deemed to be owned by the taxpayer if both spouses are US persons.

Attribution Rules: Design Similarities and Differences

The IRC contains a great variety of attribution rules. All of them are very detailed and have achieved a remarkable degree of specificity. Behind this specificity, all of the rules are always concerned with the substance of a transaction rather than its form. Hence, there always lurks a general question of whether there was a tax avoidance motive when a taxpayer entered into a transaction.

In spite of the fact that they share similar goals, the rules differ from each other in design. Most of these differences can be traced back to legislative history.

List of Most Important Attribution Rules

Here is a list of the most important attribution rules in the IRC (all section references are to the IRC):

1. The constructive ownership rules of §267, which apply to disallow certain deductions and losses incurred in transactions between related parties;

2. The constructive ownership rules of §318, which apply in corporate-shareholder transactions and other transactions, including certain foreign transactions expressly referenced in §6038(e).

3. The constructive ownership rules of §544; these are the personal holding company rules which apply to determine when a corporation will be subject to income tax on undistributed income.

3a. While they are now repealed, the foreign personal holding company rules of §554 are still important. In the past, they applied to determine whether US shareholders of a foreign corporation would be taxed on deemed distributions which were not actually made;

4. Highly important Subpart F constructive ownership rules of §958, which apply to determine when US shareholders of a Controlled Foreign Corporation should be taxed on deemed distributions which are not actually made;

5. The PFIC constructive ownership rules of §1298, which apply to determine whether a US shareholder is subject to the unfavorable rules concerning certain distributions by a PFIC and sales of PFIC stock; and

6. The controlled group constructive ownership rules of §1563 which determine whether related corporations are subject to the limitations and benefits prescribed for commonly controlled groups.

This is not a comprehensive list of all attribution rules, there are other rules which apply in more specific situations.

Contact Sherayzen Law Office for Professional Help With the Attribution Rules

The rules of ownership attribution are highly complex. A failure to comply with them may result in the imposition of high IRS penalties.

This is why you need to contact the highly experienced international tax law firm of Sherayzen Law Office. We have helped US taxpayers around the globe to deal with the US tax rules concerning ownership attribution, and We Can Help You!

Contact Us Today to Schedule Your Confidential Consultation!