A Canadian resident that the IRS has deemed to be a residential alien by way of having a substantial presence in the United States (the substantial presence test) is required to pay US income tax on his or her worldwide income. However, if it can be establish that a Canadian resident (or resident of another country) has a Closer Connection to Canada (or another country) than to the United States he or she may be able to retain their nonresident alien status and avoid being required to file US income tax returns. Additionally, nonresidents are not subject to other United States laws and regulations such as the requirements to report accounts held in foreign banks and financial institutions (FBAR) that apply to resident aliens.
Keeping Your Non-Resident Status: Closer Connection to a Foreign Country
Nonresidents will be considered to have a closer connection to a foreign country than to the United States if they or the IRS can establish that they have maintained more significant contacts with the foreign country than with the United States.
Nonresidents that otherwise meet the substantial presence test may be exempt from treatment as US residents for tax purposes if they meet the following criteria:
- They were present in the United States for fewer than 183 days during the year
- They establish that they had a tax home in a foreign country during the year, and
- They establish that during the year they had a closer connection to a foreign country than to the United States and that they had a tax home in that country (unless they had a closer connection to two foreign countries).
Keeping Your Non-Resident Status: Closer Connection to Two Foreign Countries
Nonresidents of the United States may demonstrate that they had a closer connection to two foreign countries (but not more than two) if they meet all five of the following conditions:
- That they maintained a tax home as of January 1, in one foreign country.
- That they changed their tax home during the year to a second foreign country.
- That they continued to maintain a tax home in the second foreign country for the rest of the year.
- That they had a closer connection to each foreign country than to the United States for the period during which they maintained a tax home in that foreign country.
- That they were subject to tax as a resident under the tax laws of either foreign country for the entire year or subject to tax as a resident in both foreign countries for the period during which they maintained a tax home in each foreign country.
Factors the IRS Considers in Determining a Closer Connection to Another Country
The IRS considers the following factors to determine if a nonresident alien has a closer connection to another country than to the United States:
- Where your principal home is located.
- Where your family is located.
- Where your automobile is located.
- Where your automobile is registered.
- Where your personal belongings, furniture, etc., are located.
- Where your bank with which you conducted your routine affairs is located.
- If you conducted business activities in a location other than your tax home.
- Where your driver’s license was issued.
- Where you are registered to vote.
- The country you list as your residence when you completed official documents.
- If you have ever completed:
- Form W-8 or Form W-8BEN (relating to foreign status).
- Form W-9, (Request for Taxpayer Identification Number and Certification).
- Form 1078, (Certificate of Alien Claiming Residence in the United States).
- Other official United States forms including:Form I-508, Waiver of Rights, Privileges, Exemptions and Immunities.
- Form I-508, Waiver of Rights, Privileges, Exemptions and Immunities.
- Form I-485, Application to Register Permanent Residence or Adjust Status.
- Form I-130, Petition for Alien Relative.
- Form I-140, Immigrant Petition for Alien Worker.
- Form ETA-750, Application for Alien Employment Certification.
- Form OF-230, Application for Immigrant Visa and Alien Registration.
- The country where you keep your personal, financial, and legal documents
- The country that you derive the majority income from.
- Amount of income from US sources.
- The countries were your investments are located.
- If you are covered by a health plan sponsored by a foreign government.
Non-Resident Tax Home
A nonresident’s tax home is his or her main place of business, employment, or post of duty regardless of where family home was maintained. If non-residents do not have a regular or main place of business due to the nature of their work, their tax home is deemed to be the place where they regularly live. Any person not fitting either of these categories is considered to be an itinerant whose tax home is wherever they work.
Nonresidents that meet the closer connection exception to the substantial presence test must file Form 8840 with the IRS to establish their claim that they are a nonresident of the United States by reason of that exception.
Nonresidents failing to file Form 8840 on time will not be eligible to claim the closer connection exception and may be treated as a US resident for tax purposes. However, they will not be subjected to tax penalties if they can show by clear and convincing evidence that they took reasonable actions to become aware of the filing requirements and significant steps to comply with those requirements.
When the Closer Connection Exemption Does Not Apply
Nonresidents are not eligible for the closer connection exception if any of the following conditions apply:
- They were present in the United States 183 days or more in the calendar year.
- They were a lawful permanent resident of the United States (if they hold a green card).
- They have applied for, or taken other affirmative steps to apply for, a green card; or have an application pending to change their status to that of a lawful permanent resident of the United States.
Nonresidents that are not eligible for the closer connection exception may still qualify for nonresident status by reason of a treaty.
Even though the IRS avoids applying criminal and financial penalties on back taxes owed as a result of non-residents being deemed to have a substantial presence in the US, the tax costs by themselves can be substantial. Furthermore, it must be remembered that the individual states have their own tax laws and there is no guarantee that the state will forgive penalties on back taxes owed.
AG TAX LLP CAN HELP
If you have any tax-related queries or need assistance with tax planning or filing please contact AG Tax. Our tax professionals are highly-experienced with U.S. and Canadian tax laws and can provide you the right guidance to handle your tax situation.
Aylett Grant Tax LLP is a full service accounting firm with a dedicated team of experts, who are highly-qualified and experienced in handling situations related to U.S., Canadian, and other international tax laws. We can assist with:
- Canadian Personal and Corporate tax returns
- Cross Border Taxation and Business Planning
- U.S. Personal and Corporate Taxation
- Disclosure of Foreign Assets and other information filings
- Retirement planning
- Estate Planning, Inheritance tax advice
To obtain a quote or to arrange for a consultation to discuss your tax related queries, please contact us at:
- 416-238-5920 (Greater Toronto Area, ON)
- 604-538-8735 (Greater Vancouver Area, BC)
- 780-702-2732 (Greater Edmonton Area, AB)
Disclaimer: The information in this publication is accurate as of the time of its publication. AG Tax assumes no responsibility for changes to tax legislation subsequent to the publication of this document. The information provided is for general information purposes only and should not be acted upon without seeking professional advice. If you would like to engage our services, please contact our staff and obtain authorization to send our firm confidential information. A client relationship is not created by the transmission of information. A client relationship is only formed with our firm when a scope and engagement letter signed by the firm and the potential client detailing the terms of engagement is present.