Electing Resident Alien Status Under Section 7701(b)(4)

[Note:  I am preparing the course materials for an all-day program I am teaching for the California Society of Certified Public Accountants on the taxation of multinational families.  This is a portion of the handout I am writing.]

You do not have a green card, and you were not in the U.S. for enough days to meet the substantial presence test.  You want to be a U.S. resident for income tax purposes.  Here is how you do it, by making a special election under Section 7701(b)(4) of the Internal Revenue Code.

Why

This election is used by nonresident aliens who become residents of the United States after the middle of the year, and do not hold a green card.  Therefore they will not qualify as a U.S. resident under either the substantial presence test or the green card test.

As a nonresident alien, the taxpayer will not be able to claim an itemized deduction for mortgage interest or property tax.  Or perhaps there are some foreign losses in the current year that could be taken on Form 1040 that cannot be taken on Form 1040NR.  By making the election described here, the taxpayer becomes a resident alien and will be able to take these deductions and thereby reduce his or her Federal income tax liability.

As you read the description of this election—and what is required to qualify for it—you will probably wonder whether the effort is worth the expected tax savings.

The requirements to satisfy are, like many things in tax law,  unnecessarily complicated. ((Internal Revenue Code Section 7701(b)(4)(A).))  In order to make the election for a particular tax year, you must know certain things about the past, and you must accurately predict certain things about the future.  Then there are complicated rules for what you do in the current year.

Prior Year: Be a Nonresident Alien

First, you must have been a nonresident alien in the prior year.  To be precise, you must not have been a resident alien under the definitions found Internal Revenue Code Section 7701(b)(1)(A) for the prior year. ((Internal Revenue Code Section 7701(b)(4)(A)(4)(ii); Treasury Regulations Section 301.7701(b)-4(c)(3)(i)(A).  The three ways to become a resident alien, as specified in Internal Revenue Code Section 7701(b)(1)(A), are to have a green card, meet the substantial presence test, or make an election to be a resident alien.))

Current Year: Be a Nonresident Alien

Second, you must be a nonresident alien for the current year. ((Internal Revenue Code Section 7701(b)(4)(A)(i); Treasury Regulations Section 301.7701(b)-4(c)(3)(i).))  This means that you fail both the green card test and the substantial presence test for the current year.

Current Year: 31 Consecutive Days in the United States

Third, you must be in the United States for 31 consecutive days in the current year. ((Internal Revenue Code Section 7701(b)-4(A)(iv)(I); Treasury Regulations Section 301.7701(b)-4(c)(3)(i).))  This means you are physically present ((Treasury Regulations Section 301.7701(b)-4(c)(3)(ii).)) in the United States on every day for 31 days in a row. ((Treasury Regulations Section 301.7701(b)-4(c)(3)(iii).))  You cannot be out of the country, even for a day.

These days in the United States do not count toward the “31 days in a row” requirement:

• If you are in the United States but you are an exempt individual ((Internal Revenue Code Section 7701(b)(3)(D)(i); Treasury Regulations Section 301.7701(b)-3(a)(1).)) because you have a specific type of visa status; ((Treasury Regulations Section 301.7701(b)-4(c)(3)(iv).  Form 8843 is used to report exempt individual status.))
• If you are present in the United States because you have a medical condition and cannot travel; ((The medical condition rules are found in Internal Revenue Code Section 7701(b)(3)(D)(ii); Treasury Regulations Section 301.7701(b)-3(a)(2).  The exclusion of these days from the “30 days in a row” requirement is found in Treasury Regulations Section 301.7701(b)-4(c)(3)(iv).))
• If you are in the United States solely because you are in transit between two foreign places; ((Treasury Regulations Section 301.7701(b)-3(a)(3) describes the concept of transit; Treasury Regulations Section 301.7701(b)-4(c)(3)(iv) excludes those transit days from the “31 days in a row” requirement.)) or
• If you are in the United States because are a regular commuter for employment purposes into the United States from Mexico or Canada. ((Treasury Regulations Section 301.7701(b)-3(a)(4) describes the commuter exception; Treasury Regulations Section 301.7701(b)-4(c)(3)(iv) excludes those commuter days from the “31 days in a row” requirement.))

Current Year: At Least 75% Time in the United States

Fourth, you must be in the United States for a period of continuous presence, starting with the first day of the 31 day period described above. ((Internal Revenue Code Section 7701(b)-4(A)(iv)(II).))  That phrase—“a period of continuous presence”—needs a definition. ((Treasury Regulations Section 301.7701(b)-4(c)(3)(iv).))

It means that you start counting on the first day of the 31-day period of continuous presence.  From that day until December 31, you determine whether you were physically present ((Treasury Regulations Section 301.7701(b)-4(c)(3)(ii).)) in the United States at least 75% of the time.  This is harder than it looks.  You are instructed to include some days that you are outside the United States, and to exclude some days that you are inside the United States.  And you have extra work to figure out the correct “Day 1” to use to compute whether you satisfy this requirement or not.

In calculating whether you were “in the United States” for at least 75% of the time, you can count days abroad as if you were in the United States If you are out of the United States for fewer than five days—only for purposes of determining whether you satisfy the “period of continuous presence” requirement. ((Treasury Regulations Section 301.7701(b)-4(c)(3)(iv).))  The moral of this story is clear: do not leave the United States, or if you do, make very brief trips abroad.

Conversely, some days that you are physically within the borders of the United States are not counted toward the 75% test of the “period of continuous presence.”  These are the same types of days that are excluded for the “31 days in a row” requirement:

• If you are in the United States but you are an exempt individual ((Internal Revenue Code Section 7701(b)(3)(D)(i); Treasury Regulations Section 301.7701(b)-3(a)(1).)) because you have a specified type of visa status; ((Treasury Regulations Section 301.7701(b)-4(c)(3)(iv).  Form 8843 is used to report exempt individual status.))
• If you are present in the United States because you have a medical condition and cannot travel; ((The medical condition rules are found in Internal Revenue Code Section 7701(b)(3)(D)(ii); Treasury Regulations Section 301.7701(b)-3(a)(2).  The exclusion of these days from the “period of continuous presence” requirement is found in Treasury Regulations Section 301.7701(b)-4(c)(3)(iv).))
• If you are in the United States solely because you are in transit between two foreign places; ((Treasury Regulations Section 301.7701(b)-3(a)(3) describes the concept of transit; Treasury Regulations Section 301.7701(b)-4(c)(3)(iv) excludes those transit days from the “period of continuous presence” requirement.)) or
• If you are in the United States because are a regular commuter for employment purposes into the United States from Mexico or Canada. ((Treasury Regulations Section 301.7701(b)-3(a)(4) describes the commuter exception; Treasury Regulations Section 301.7701(b)-4(c)(3)(iv) excludes those commuter days from the “31 days in a row” requirement.))

It gets worse.  Consider the possibility (because the author of the Treasury Regulations considered it) that your hapless taxpayer has more than one “31 days in a row” period of presence in the United States.  For satisfying the “period of continuous presence” requirement, you must figure out a starting date.  Which of the 31-day periods do you use as Day 1 for the “period of continuous presence” requirement?

It’s easy. ((This, of course, is flat-out sarcasm.))  Look at each 31-day period, and figure out whether the taxpayer satisfied the “period of continuous presence” requirement by being in the United States for at least 75% of the days between the starting point of each 31-day period and the end of the calendar year.

• If you satisfy the “period of continuous presence” requirement for all of the 31-day periods, you use the first of those 31-day periods. ((Treasury Regulations Section 301.7701(b)-4(c)(3)(iv).))
• If you do not satisfy the “period of continuous presence” requirement for the first of the multiple 31-day periods but you do satisfy it for a later 31-day period, then you use the starting date of the earliest of those later 31-day periods to satisfy the “period of continuous presence” requirement. ((Treasury Regulations Section 301.7701(b)-4(c)(3)(iv).))

Next Year: You Meet the Substantial Presence Test

Fifth and finally, you must be in the United States for a sufficient number of days in the NEXT calendar year to satisfy the substantial presence test. ((Internal Revenue Code Section 7701(b)(4)(A)(iii); Treasury Regulations Section 301.7701(b)-4(c)(3)(i)(B).))  It does not matter whether you are treated as a resident alien because you a green card or not. ((Internal Revenue Code Section 7701(b)(4)(A)(iii); Treasury Regulations Section 301.7701(b)-4(c)(3)(i)(B).))  Indeed, it would seem that becoming a citizen will not satisfy this requirement. You must be physically present in the United States for a sufficient number of days in the following year to be a resident alien under the substantial presence test.

Effective Date for Electing Resident Alien Status

If you meet all of the requirements, ((Internal Revenue Code Section 7701(b)(4)(A).)) you may elect to be treated as a resident of the United States for the current year. ((Internal Revenue Code Section 7701(b)(4)(B)))  The effective date for the election—the first day on which you are treated as a resident of the United States—is the first day of the “period of continuous presence” that applies to you.  ((Internal Revenue Code Section 7701(b)(4)(C); Treasury Regulations Section 301.7701(b)-4(c)(3)(i).))  That is, it is the first day of the “31 days in a row” in the United States that kicks of the “period of continuous presence” in which you were physically in the United States for at least 75% of the days between that first day of the 31-day period and December 31.

First Ask for an Extension

Actually making the election to be treated as a resident alien in the current year is tricky, because you do not qualify for the election until you meet the substantial presence test for the following year. ((Treasury Regulations Section 301.7701(b)-4(c)(3)(i)(B).))

The election is made by filing a statement on Form 1040 for the year for which you want to make the election. ((Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(A).))  However, you cannot make the election until you have satisfied the substantial presence test for the following year. ((Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(A).))  This guarantees you will miss the filing deadline for the current year, of course.

As a result, the Regulations allow you to apply for an extension of time to file your current-year income tax return.  You will get enough time to accrue enough days to satisfy the substantial presence test in the following year, plus a “reasonable period”. ((Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(A).))  You must apply for this extension of time prior to the due date for filing the tax return for the year in which you want to make the election (i.e., the usual April 15 deadline).  You do not include extensions—even if you file Form 4868 and get an extension until October 15, you must still apply for the extension of time for purposes of this particular election before the April 15 filing deadline.

There is no form for this election, and no specific instructions exist for how to make the election for resident status under Section 7701(b)(4).  As a result, we look to the default rules under the Regulations for guidance on how and where to make the election.  These rules tell you to make the request for extension in the form of a letter. ((Treasury Regulations Section 1.6081-1(b)(1).))  The letter must “clearly set forth” information about the tax return for which a filing deadline extension is requested, ((Treasury Regulations Section 1.6081-1(b)(1)(i).)) and enough facts to allow the examining officer to figure out whether to grant the extension or not. ((Treasury Regulations Section 1.6081-1(b)(1)(ii).))  Presumably, providing all of the information required under the Section 7701(b)(4) regulations would satisfy this requirement.

The extension request is sent to the place where you would be required to file your income tax return. ((Treasury Regulations Section 1.6081-1(b)(1).))  This should be the place where you would file your Form 1040, assuming your application for resident status under Section 7701(b)(4) is successful.

Interestingly, the default rules for granting extensions of time to file returns have time limits that are at odds with the specific rules for the extension of time under Section 7701(b)(4).  The default rules say that the Commissioner may grant a “reasonable” amount of time as an extension. ((Treasury Regulations Section 1.6081-1(a).))  However, “reasonable” is limited by a flat prohibition on extensions greater than six months. ((Treasury Regulations Section 1.6081-1(a).))  We have a collision between a six month limit in the general Regulations about extensions of time, ((Treasury Regulations Section 1.6081-1(a).)) and an open-ended amount of time allowed under the specific Regulations for making the Section 7701(b)(4) election. ((Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(A).))  Go with the open-ended authorization and ask for enough time for you to guarantee that you satisfy the substantial presence requirement for the year following the year for which you wish to make the election.

In addition to filing the extension request at the right time, you must make an estimated tax payment.  The payment is computed as if you are a nonresident alien for the entire election year. ((Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(A).))

Election for Dependent Children

If you are making the election for yourself, you can also make the election for a dependent child. ((Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(B).))

The Election Statement

Once you have satisfied the substantial presence test for the following year, you will file your Form 1040 for the year for which you want to make the election to be treated as a resident alien.  The information required in this statement is specified in the Regulations: (( Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(C).))

• Your name and address; ((Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(C).))
• A statement that you were not a resident of the United States in the immediately preceding tax year; ((Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(C)(1).))
• A statement that you are a resident alien under the substantial presence test in the year following the election year; ((Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(C)(2).))
• The actual number of days of presence in the United States that you had in the year following the election year; ((Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(C)(3).))
• The starting and ending date of the 31-day period of presence in the United States for the election year; ((Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(C)(4).))
• The starting and ending dates of the period of continuous presence in the United States for the election year; ((Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(C)(4).)) and
• If you were out of the United States for five or fewer days during the period of continuous presence in the election year (so that those days are in fact treated as if you were in the United States, even though you were not), (( Treasury Regulations Section 301.7701(b)-4(c)(3)(iv).)) those dates are identified. (( Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(C)(5).))

The statement must be a “signed declaration” that you are making the election. (( Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(C).))  If you are making the election for a dependent, you must include all of that information for the dependent as well. ((Treasury Regulations Section 301.7701(b)-4(c)(3)(v)(C).))  Although the Regulations do not require it, I suggest you attach a copy of the extension correspondence to your Form 1040.

Conclusion

These rules are astonishingly complex.  The likely tax benefit to an individual making the election will probably be outweighed by the cost of professional fees incurred in making the election.  If the taxpayer makes the election himself or herself, the opportunity cost and brain damage incurred is likely to yield an economic benefit slightly lower than the Federal minimum wage.  Why bother?