I received an email today from a CPA with an interesting situation. I shot him a quick email to respond to a question, but the situation is interesting enough that it is worth sharing.
I have a practice in (U.S. city near the US/Mexico border). I’m seeing a prevalence of a nonresident alien spouse & children living in the U.S. for security purposes while the working spouse lives and works in Mexico. Working spouse visits family in the U.S. for short periods of time (no substantial presence), brings cash for living expenses, mortgage, etc. In this case, I believe that there is no U.S. tax impact because the nonresident alien spouse has no income (from any source) and the amount in the U.S. is under the restricted marital deduction. Let me know if I’m missing anything.
I am not going to cover all of the possible U.S. tax implications. Let’s just talk about income tax compliance for the U.S.-resident spouse. Let’s ignore the working spouse who lives/works in Mexico. Let’s ignore the children.
U.S. resident for income tax means disclosure requirements apply
Regardless of visa status, the nonworking spouse living in the United States is probably here too many days per year, so will be a resident alien for U.S. income tax purposes. This is almost built into the example, by definition. The nonworking spouse is in the United States full-time for personal safety reasons.
At first blush, this seems like an inoffensive situation. The nonworking spouse has no income, therefore being a U.S. resident (thus exposed to income tax on worldwide income) carries no cost — what’s the income tax on zero income?
However, once the nonworking spouse is a resident, it is not only the income tax cost that is a worry. It is all of the other junk in the Internal Revenue Code (and elsewhere) that we now have to worry about:
* Form TD F 90-22.1;
* Form 8938 (maybe; the filing requirements are baroque in their complexity);
* Form 5471; and
* Other bizarre stuff.
One of the forms in that “bizarre stuff” category that the nonworking spouse will have to worry about is Form 3520. The nonworking spouse is a U.S. resident because of the substantial presence test. The working spouse is making gifts to the nonworking spouse, so the nonworking spouse can, y’know, feed the kids ‘n stuff. This must be reported on Form 3520 if the gift exceeds $100,000 per year.
Tax treaty doesn’t solve the problem
The income tax treaty between the United States and Mexico doesn’t solve the problem. Let’s assume that the nonworking spouse (living in the USA with the kids) can qualify to claim the treaty benefits. Making the election under Article 4 (the treaty tie-breaker provisions) to be taxed as a resident of Mexico rather than a resident of the United States will not solve the compliance problems.
The Treasury Regulations say that when you make a treaty election to be treated as a nonresident alien for income tax purposes, this is only effective as to the method of calculating your U.S. tax liability. For that purpose, you compute your income tax as a nonresident alien. For all other purposes, you are still a resident alien. This means you still have to file Form TD F 90-22.1, Form 3520, etc. etc.
Closer connection exemption probably doesn’t work, either
There is another way a person can opt out of being treated as a resident for U.S. tax purposes. See Form 8840, which is the form used to claim that you really, truly live in another country and you are not a resident of the USA for income tax purposes.
This can work for many people, but it probably won’t work for our spouse living in the United States. In order to use this, you must be in the United States under 183 days in the year. The living situation my CPA friend described assumes nearly 365 days per year in the United States.
Moral of the story
I haven’t talked about the kids or the working spouse in Mexico who goes back and forth across the border. I haven’t talked about estate tax or gift tax. The moral of this story is simple: there are no reflexive, obvious answers to international tax situations. This stuff is complex and complicated. The IRS seems hell-bent on penalizing every paperwork foot-fault it can find.
Do not give instant answers. They’re probably wrong. Or at least incomplete.
Do not accept (or expect) instant answers, for the same reasons.