Tax Residency Starting, Termination Dates for Green Card Holders

Hey there fellow expatriation aficionados. Phil here with the every-other-Tuesday Expatriation Only newsletter.

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Simple Facts Meet Dumb Systems

This week is not a strictly an expatriation topic. The person who wrote to me is a newly-minted green card holder who intends to abandon his permanent resident status after 2.5 months in the USA.

He will not be a “long-term resident” and therefore the expatriation rules will not apply to him. What WILL apply to him, however, are the tax return filing rules. In a nutshell, someone with a fleeting presence in the United States faces a requirement to file U.S. tax paperwork when he had no income at all.

The Simple Facts

Let’s let him tell his story.

Hello,

I read a series of clarifications on green card holders and US tax filing on your website and would be glad if you share your thoughts on a following scenario.

1. I received an immigrant Visa in December 2015 due to my wife winning the green card lottery.
2. We arrived in the US in April 2016 and so became green card holders on the first day of US presence.
3. I will leave the US in June and then abandon my US green card properly – through filing the I-407 form in the US embassy in my home country
4. I will not have any income in the US or from any other sources worldwide during the time of my presence in the US/while holding a green card.

Question:

Do I have to file US tax return for the 2016 calendar year if I happen to earn something in 2016 during the time AFTER I have abandoned the green card?

I know I can claim tiebreaker rules according to the tax treaty between the two countries, in which case one has to file a return and claim tax treaty rules, but I think that should be only in case I have US sourced or related income for the calendar year or US earned income during a presence in the US as a legal resident.

I think if one has neither there should be no point in filing?

Let’s summarize the situation for him. For reasons of “keep it short” and “keep it simple” I am going to ignore my correspondent’s wife and what she needs to do.

• Green card obtained in December, 2015.
• Arrival in the USA with a green card in April, 2016.
• Leaves the USA in June, 2016 (planned).
• Files Form I-407 in June, 2016 while outside the USA (planned).

For his financial situation, let’s again keep it simple and make the following heroic assumptions:

• Ignore the FinCen Form 114 requirements that might or might not apply to this gentleman.
• Assume that he sold a non-U.S. asset of some kind and had $20,000 of capital gain in January 2016, before arriving in the United States. (I want to show the impact of taxable income earned BEFORE his arrival in the USA).
• Assume that he he will earn no income from April until June, while he is a green card holder living in the United States.
• Assume there are no other things happening in this gentleman’s life (ownership of shares of a foreign corporation, ownership of foreign mutual fund, partner in a foreign partnership, etc.) that independently trigger a tax return filing requirement. (Note: there are many other “returns” required from taxpayers other than the income tax return).

The Questions

The questions to answer are:

• Is he required to file a U.S. income tax return for calendar year 2015?
• Is he required to file a U.S. income tax return for calendar year 2016?
• If he is required to file a U.S. income tax return, what is the starting date and the ending date of his U.S. residency (for income tax purposes) in 2016?
• Are there other reasons he must file an income tax return (or something else)?

No Tax Return Filing Requirement for Calendar Year 2015

My correspondent is not required to file a U.S. income tax return in 2015. Although he is a resident alien for 2015, the starting date rules cause him to not have an income tax return filing requirement.

Green Card Holder = Resident Alien

Someone who holds the immigration status of “lawful permanent resident” is a resident alien for income tax purposes.¹ A green card holder is a lawful permanent resident:

An alien is a resident alien with respect to a calendar year if the individual is a lawful permanent resident at any time during the calendar year. A lawful permanent resident is an individual who has been lawfully granted the privilege of residing permanently in the United States as an immigrant in accordance with the immigration laws. Resident status is deemed to continue unless it is rescinded or administratively or judicially determined to have been abandoned.²

Resident Aliens File Tax Returns

Resident aliens must file tax returns.³ Some exceptions apply based on income levels, and we will talk about that shortly.

Starting Date

When someone becomes a resident alien for income tax purposes by getting a green card, we have to know when that resident status begins – the starting date.

For someone who is a resident alien ONLY because of holding a green card (and not because of the substantial presence rule or an election to be a U.S. resident for income tax purposes), the starting date for resident alien status (and therefore as an income tax resident of the USA) is the first day that the person was physically present in the United States while having a valid green card issued to him:

An alien individual who was not a United States resident during the preceding calendar year and who is a United States resident for the current year will begin to be a resident for tax purposes on the alien’s residency starting date. . . . The residency starting date for an alien who meets the lawful permanent resident test (green card test), described in paragraph (b)(1) of § 301.7701(b)-1, is the first day during the calendar year in which the individual is physically present in the United States as a lawful permanent resident.⁴

For my correspondent, he received the green card in 2015. He was not a United States resident in 2014. This means that his residency starting date is the first day during 2015 in which he was physically present as a green card holder. Since he was not physically present at all in the USA in 2015, he does not have a starting date in 2015, and therefore is not a U.S. resident for income tax purposes in 2015.

Therefore No 2015 Tax Return

Since my correspondent does not have a starting date in 2015 for being a U.S. resident for income tax purposes, he does not file Form 1040 (the resident’s income tax return) for 2015.

April 2016 – Residency Starting Date

Following the chain of logic, my correspondent first physically arrived in the United States, with green card, in April, 2016. This means that he has a residency starting date in April, 2016, when he stepped off the airplane in the United States.⁵.

This is when the requirement to file an income tax return starts applying to him. He must file Form 1040 as well as all of the other tax paperwork required for U.S. residents and citizens – unless he can find an exception that excuses him from the paperwork.

Residency Continues Until Formal Abandonment of Visa

My correspondent’s status as a resident of the United States for income tax purposes (because he has a green card and he has a “starting date” by coming to the United States) will continue until he formally abandons the green card (or the U.S. government cancels his visa).⁶

June 2016 – Residency Termination Date

My correspondent, in fact, plans to formally abandon his green card. This will be done by filing Form I-407 with the Embassy in his home country when he returns there in June. Let us now look at the rules for determining the exact day on which he terminates his U.S. resident status (for tax purposes).

The general rule is simple: if you are a resident alien this year and you stop being a resident alien for some reason, the termination date is December 31, unless you can prove an earlier date:

An alien individual who is a United States resident during the current year but who is not a United States resident at any time during the following calendar year will cease to be a resident for tax purposes on the individual’s residency termination date. Generally, the residency termination date will be the last day of the calendar year.⁷

For my correspondent, his termination date will be the first day in June, 2016 after the date that he hands in the Form I-407 at the Embassy in his home country:

[T]he residency termination date for an alien who meets the green card test is the first day during the calendar year that the alien is no longer a lawful permanent resident if the individual establishes that, for the remainder of the calendar year, his or her tax home was in a foreign country and he or she maintained a closer connection to that foreign country than to the United States.⁸

But remember: to make his termination date be in June, 2016 rather than December 31, 2016, he must:

• Not be a U.S. resident for tax purposes in 2017;⁹ and
• Establish for the remainder of 2016 (from the date of handing in his Form I-407 until December 31, 2016) that his “tax home” was in another country, and that he had a “closer connection” to that country than he had to the United States.¹⁰

I am going to ignore a lengthy discussion of “tax home” and “closer connection” and what it all means. For my correspondent, it is simple: he is leaving the USA entirely and returning to live permanently in his country of birth. There will be no practical question about where his “tax home” is, or the fact that he has a “closer connection” to his country of birth than he has to the United States.

When He is Resident and Nonresident, Summarized

This means that my correspondent will have a short U.S. tax residency: from April until June, 2016. Before and after those dates, he will be a nonresident alien (in the eyes of the U.S. tax system):

• Nonresident alien in 2015 (had a green card, but no “starting date” because he was not physically present in the USA whilst having the green card visa status);
• Nonresident alien from January 1, 2016 until April, 2016, when he entered the United States as a green card holder;
• Resident alien from April, 2016 until June, 2016, when he plans to abandon his green card; and
• Nonresident alien from June, 2016 until December, 2016.

Additionally:

• Nonresident alien from January 1, 2017 until forever.¹¹

Tax Returns and Taxation – While a Nonresident

Someone who is a nonresident will only be required to file a U.S. tax return because of:¹²

• receiving income from U.S. sources; or
• being engaged in business in the United States, even if zero income is derived from it.

Based on my correspondent’s situation, neither of these will be true during the time that he holds the status of “nonresident alien”.

Income Before Becoming a Resident in 2016

This is where my little example of $20,000 of capital gain received in January, 2016 comes into play. Note that my correspondent was a nonresident alien at that time. His starting date for resident alien status was in April, 2016.

The capital gain came from sale of an asset in his home country (by assumption). Therefore, it is not income from a U.S. source. It will not trigger the requirement of filing an income tax return¹³ and it will not generate income that is taxable in the United States.¹⁴

Tax Returns and Taxation – While a Resident

A resident alien is required to file a U.S. income tax return as soon as his gross income is greater than a certain amount.¹⁵ That amount is the personal exemption amount plus the standard deduction amount. For calendar year 2016, the personal exemption amount is $4,050 and the standard deduction is $6,300. This means that until gross income is above $10,350, you do not have to worry about filing a tax return.

Aha. But for dual status taxpayers (someone who is a resident for part of the year and a nonresident for part of the year) many of the tax return rules are different. For my correspondent, who is a nonresident at the end of 2016, he will not be able to take the standard deduction. So we would worry about whether his income during the April – June, 2016 time period is greater than $4,050 – the personal exemption amount – in deciding whether he must file an income tax return or not.

He earned zero income during that time – from April until June, 2016, he lived in the United States using savings. So he does not have to file a U.S. tax return because his income is so low.¹⁶

In summary: there is no income to tax for the time period that my correspondent was a resident of the United States, and because there is no income, there is no income tax return required.

Even Though No Income Tax Is Required, Paperwork Is Required

The good news is:

“No U.S. income tax return required”.

The bad news is:

“If you want to establish June, 2016 as your termination date for U.S. income tax resident status, you have to file stuff with the IRS.”

Why You Must File Something for 2016

Let’s go back to the start of this now-very-long newsletter. The termination date for U.S. residence (and the first day of my correspondent’s status as a nonresident for U.S. income tax purposes) is the day after he turns in his green card by filing Form I-407 in a U.S. Embassy.

In order to prove that his termination date is in June, 2016 instead of the default December 31, 2016, he must prove his tax home is in another country, and he has a closer connection to that other country than he has to the United States.

In order to prove “closer connection” my correspondent must file some paperwork with the IRS.

The risk – if he does not file this paperwork to prove closer connections to another country – is that he will return to his home country, then earn a lot of money between June, 2016 and December 31, 2016. The IRS will then claim the right to tax that income.

What To File for 2016 To Claim a June, 2016 Termination Date

Remember that the job here is to prove “closer connection” and claim a “termination date”.¹⁷

What the IRS Wants to Know

The specific requirements for what must be disclosed to the IRS are:¹⁸

The statement filed by an individual described in paragraph (a)(3) of this section shall be dated, signed by the individual seeking to … establish a residency termination date, and verified by a declaration that the statement is made under the penalty of perjury. The statement shall contain the information described in paragraphs (b)(1) (i), (ii) and (iii) of this section and the following information (as applicable)—

(i) The first day that the individual was present in the United States during the current year;

(ii) The last day that the individual was present in the United States during the current year;

(iii) Dates of de minimis presence that the individual is seeking to exclude from his or her residency starting or termination dates;

(iv) Sufficient facts to establish that the individual has maintained his or her tax home in and a closer connection to a foreign country during a period of de minimis presence;

(v) Sufficient facts to establish that the individual has maintained his or her tax home in and a closer connection to a foreign country following the individual’s last day of presence in the United States during the current year or following the abandonment or rescission of the individual’s status as a lawful permanent resident during the current year;

(vi) Date that the individual’s status as a lawful permanent resident was abandoned or rescinded; and

(vii) Sufficient facts (including copies of relevant documents) to establish that the individual’s status as lawful permanent resident has been abandoned or rescinded.

How To Tell the IRS

There are two different rules for how to tell the IRS that you want to establish a termination date.

For people who are required to file an income tax return (either Form 1040 or Form 1040NR), the process involves attaching a statement to the income tax return that is filed. The specific tax return that applies depends on the person’s status on December 31 of the tax year. If on that day the individual is a nonresident alien for income tax purposes, then Form 1040NR or Form 1040NR-EZ will be filed. If the individual is a resident alien, Form 1040 (or its variants, Form 1040A or Form 1040-EZ) will be filed.

For people who are not required to file an income tax return, a statement is filed directly with the IRS.

The Regulations say:¹⁹

Individuals described in paragraph (a) of this section who are required to make a return on Form 1040 or 1040NR pursuant to paragraph (a) or (b) of § 1.6012-1 of this chapter must attach the statement described in paragraph (b) of this section to their return for the taxable year for which the statement is relevant. An individual who is not required to file either Form 1040 or 1040NR must file the statement with the Internal Revenue Service Center, Philadelphia, PA 19255 Department of the Treasury, Internal Revenue Service, Austin, Texas 73301-0215, on or before the date prescribed by law (including extensions) for making an income tax return as a nonresident for the calendar year for which the statement applies. The statement may be signed and filed for the taxpayer by the taxpayer’s agent in accordance with § 1.6061-1 of this chapter.

Note that the Regulations have not been updated to reflect the new mailing address for filing the statement, but I helpfully edited the Regulation to insert the correct address. You are welcome. For more information on this, go to the IRS web page.

An Entirely Different Way – Tax Treaty

What We Just Did

OK. We have established (at more than 3,000 words so far) that for a zero income person to enter the the United States on a green card and leave two months later, abandoning the green card, will require either:

• File a tax return and attach a required statement; or
• File a required statement directly with the IRS.

Easier (?) Alternative – Treaties

Let’s look at another way of achieving the result of logging someone (like my correspondent) out of the U.S. tax system permanently. This involves using an income tax treaty.

If my correspondent is a resident of a country that has a tax treaty with the United States (and in fact he will be, when he returns to his home country), he can make a claim under that treaty to make himself a nonresident of the United States for the entire tax year.

Why The Treaty Method Works

Article 4 of almost every treaty I know is the place to look. It has a series of tie-breaker rules. If a certain condition applies, treat the individual as a resident of Country X. If that condition does not apply, go to the next condition and see if it applies to tell us which country should claim him as a resident.

For someone like my correspondent, the rules will clearly make him – but for a few months in the middle of 2016 – a resident of his home country. I will not bother to parse the rules, but if you are interested in this, pull up any income tax treaty you like and look at Article 4. Read it as a chain of “if/then” statements, where the outcome of each statement is either a declaration of residency or an instruction to move to the next “if/then” statement.

How The Treaty Method Works

To claim the treaty exemption, you use Form 8833.

This is filed in one of two ways.

• Form 8833 is attached to an income tax return that is filed. In the case of my correspondent, it would probably be a Form 1040NR-EZ, or
• Form 8833 is filed as a stand-alone document at the normal place where the taxpayer would normally file a tax return.

The Instructions to Form 8833 say:

Attach Form 8833 to your tax return (i.e., Form 1040NR, Form 1040NR-EZ, Form 1120-F, etc.). If you would not otherwise be required to file a tax return, you must file one at the IRS Service Center where you would normally file a return to make the treaty-based return position disclosure under section 6114 (see Regulations section 301.6114-1(a)(1)(ii)) or under Regulations section 301.7701(b)-7.

For my correspondent, after he leaves the USA he would normally file a Form 1040NR or Form 1040NR-EZ at the Austin, Texas address of the IRS. So he would send Form 8833 there.

Impact of Filing Form 8833

The successful use of the treaty election makes the taxpayer a nonresident alien for the entire year. In other words, this obliterates the April – June time period that my correspondent was a resident alien, and converts his status during that time period to nonresident alien status. For the entire calendar 2016 he is a nonresident of the United States for income tax purposes and a resident of his home country.

The tax effect of the election is as follows:

• For computing income tax liability, look at all income and calculate U.S. income tax as if the taxpayer is a nonresident alien. In the case of my correspondent, the amount is zero, because he has zero income that would be taxable in the United States in 2016.
• For tax paperwork requirements, the taxpayer is treated like a resident alien. This means, for my correspondent, that any of the routine tax filings required of a resident alien (as to the April – June 2016 time frame) must be done. By heroic assumption, I think there are no such filings required.²⁰

What To Do?

OK. Enough of this “you have so many choices” and “on the one hand you can do this, and on the other hand I have four fingers and a thumb”. Let’s get real.

There are four choices (well, five really – the fifth is “do nothing and just leave the USA and never file anything, but I do not recommend that). I will discuss each of them in turn

Tax Return + Residency Termination Statement

File a dual status Form 1040NR-EZ for 2016 with a statement attached that establishes a residency termination date. For my correspondent, the termination date would be sometime in June, 2016 – the date he files the Form I-407 in the Embassy that formally abandons his permanent resident visa status.

Disadvantages:

• Extra paperwork – Form 1040NR-EZ, prepared as a dual status return.
• The attached statement to show closer connection is a bit of a freestyle writing exercise, which might be harder for someone than filling in Form 8833 (the treaty election form).

Advantages:

• An emphatic declaration of income (zero) which may be useful in the future in preventing future inquiries from the IRS. The three year statute of limitations applies. (After three years, the IRS is barred from challenging your tax return except for serious mistakes or deliberate lies).
• The paperwork enters the IRS system in the normal method. The tax return is an appropriate method of telling the IRS about things. They know how to process tax returns and (usually) how to get critical information out of the tax return and into their computers. The critical piece of information to get into the computers: the taxpayer is not a U.S. resident alien for income tax purposes, with an effective date for that status.

Tax Return + Treaty Election

File Form 1040NR-EZ for 2016 with Form 8833 (treaty election) attached to it. This claims nonresident status for the entire year for the taxpayer and declares that there is zero income earned that would be taxable in the USA, either as a resident or as a nonresident.

Disadvantage:

• Extra paperwork – Form 1040NR-EZ, festooned with zeros. Meh. Simple.
• You have to look up the treaty and fill in Form 8833 correctly.
• Done really correctly, you would add a separate statement to notify the IRS that the green card was abandoned as of mid-year, and even maybe attach a copy of I-407. So you are not really saving time for yourself.
• The treaty election does not eliminate all of the other collateral tax filing requirements that apply to an individual who would otherwise be a U.S. resident.

Advantage:

• It’s pretty bulletproof. The IRS is hard-pressed to deny treaty coverage.
• The tax return declares zero income, which is useful for the statute of limitations purpose.
• A tax return (compared to a stand-alone document) is a better carrier device for reporting information to the IRS and ensuring that data and taxpayer status (nonresident status, effective as of a specific date) is entered into the IRS computers.
• It makes the taxpayer a nonresident for US income tax purposes for the entire calendar year

Standalone Statement Establishing Residency Termination Date

File a stand-alone statement that establishes a residency termination date – if you want a residency termination date before December 31 of the year that the green card is abandoned.

Advantage:

• Simple letter that you write using the requirements listed in the Treasury Regulations.

Disadvantages:

• I’m a Nervous Nellie and I don’t necessarily trust free-standing forms floating through the IRS. Will the data get entered properly into the system?
• You have not filed a tax return, which has some impact (I’m not going to dissect it now) on the statute of limitations question. It is possible that the three year clock does not start to tick on the IRS and its right to audit you for the calendar year in question. Or not. I haven’t looked at this.
• If you need to prove to a foreign government or foreign bank that you are not a U.S. taxpayer (because of FATCA), a simple letter to the IRS looks weaker than a tax return with the same information attached to it. Of course, the Form I-407 is the strongest proof that all ties have been cut with the United States.

File a Stand-Alone Form 8833

If you are not required to file an income tax return, you can file a stand-alone Form 8833 (treaty election).

Advantage:

• Simple.

Disadvantage:

• Free-floating piece of paper vs. piece of paper attached to an income tax return – which is more likely to get processed properly by the IRS?
• No income tax return is filed, so what is the impact on the statute of limitations?
• Proof of non-U.S. status for FATCA purposes in the future is not as clear-cut as it could be. The Form 8833 says that the individual is a nonresident of the USA for income tax purposes for a single year, but that’s all.

The “Do Nothing” Choice

Of course, there is a fifth choice: do nothing.

Advantage:

• It is easy to accomplish.

Disadvantage:

• It is vital to decouple cleanly and visibly and loudly from the United States because the scourge of FATCA will haunt anyone living abroad who has or might have or once had or thought about having U.S. status.
• Will the IRS wake up someday and say “Where is the tax return?” It is hard to reconstruct the past. It is easy to do work in real time (now). Your future self will curse your today self for being lazy. 🙂
• What will the “do nothing” approach do if you want future immigration or work visas to enter and live in the United States? How can you prove that you took care of all of your tax obligations while you were a green card holder?

Me?

I prefer filing tax returns with attachments. I am always a little bit afraid of free-standing documents, because I do not know how they will be processed by the IRS. Mistakes have been known happen. (Dream: some day I would love to go on a tour of an IRS facility to see what happens when the U.S. Postal Service backs up the truck and dumps a few tons of tax returns on the loading dock. It must be insanely hard to process all of that paperwork correctly). But this is just my paranoia.

I like to do stuff today that prevents future messes tomorrow.

I am an enthusiast for excessive overkill when it comes to solving problems. (See my point about preventing future messes).

Based on these considerations, I would file Form 1040NR-EZ with a treaty election on Form 8833. I would attach the residency termination statement as required in the Regulations, but claim nonresidency for the entire year based on the treaty. I would attach a copy of the Form I-407 with proof of filing, so the IRS has this in their system. Now they know that you cannot be a resident alien based on green card visa status.

To my mind, this has the highest possibility of solving the problem permanently, at the cost of an extra few hours of work right now.

Reasonable minds may differ. Your good judgment, fortunately, is not encumbered by my opinions.

Disclaimer

So there you have it. A simple email from a guy who had a major disruption in his life (move to USA, leave USA) in the course of a few months. A seemingly simple answer. Over 5,000 words.

I’m not your lawyer, dear reader. And I am not my correspondent’s lawyer or tax advisor either. Treat this as a generalized explanation that can start to the analysis. It’s a Wikipedia article. And you know how “reliable” (yay for scare quotes) Wikipedia is. This is just as reliable as a Wikipedia article, approximately more or less..

Go hire someone. With the information here, you will be able to shop for expert assistance–your BS filter is now highly tuned. Do what you need to do, and have a good life.

As Click and Clack, the Tappet Brothers, used to say “Don’t drive like my brother”. My advice: don’t rely on what I tell you. 🙂

See you in a couple of weeks.

Phil.