Non-US Citizens: How to Avoid Becoming a US Tax Resident

To illustrate the implications of becoming a permanent or tax resident of the United States and why proper planning is essential, let’s look at the example of one of our Nomad Capitalist friends.

Jonathan used to be a US green card holder. However, he realised that his little card came with some serious tax obligations that were not worth the benefits he thought he’d get out of the deal.

He surrendered his permanent resident status in the United States on the basis that this would be the end of the nightmare. He was sure that his US tax obligations were over now he’d given up his green card.

He was terribly wrong.

Jonathan discovered that a country he was not born in and was no longer tied to as a resident still demanded that he pay his ‘fair share,’ even though he was now living on the other side of the world.

It turns out Jonathan missed a few steps on his way out the door. 

Unfortunately, Uncle Sam was 100% legally justified in asking Jonathan to hand over his cash and whip up a colossal pile of tax documents.

True to character, the United States manages to make it difficult for anyone to cut ties with them – not just citizens but residents too. 

In fact, the US has even found ways to tax folks who are nonresidents.

This unpleasant reminder of just how wide a reach ‘the land of the free’ has on anyone who would dare to – even once – live or make money within its borders inspired us to tackle this topic once and for all.

We hope that fewer folks like Jonathan make the same mistake and unknowingly end up in the US tax trap.

US Citizenship-Based Taxation

For non-US citizens, the first distinction when it comes to avoiding taxation in the US is that between immigration law and tax law.

Immigration law divides people into numerous groups – citizens, resident immigrants, nonimmigrants and undocumented (illegal) immigrants – while tax law only divides them into two: resident and nonresident.

Whether you are a tax resident or not has little to do with your immigration status and is much more about the length of time you spend in the United States.

Understanding how the IRS applies the label of tax resident or nonresident will allow you to develop an informed plan about how much time you spend in the US.

This can help you avoid situations that oblige you to report your income and possibly even allow you to legally not pay taxes to Uncle Sam.

What Qualifies You as a US Tax Resident?

It is generally known that all US citizens and green card holders must file US tax returns. 

However, many people are unfamiliar with the laws that subject some nonimmigrants (those who move to the US on non-resident visas) to US taxation on their worldwide income.

If they are not careful, a nonresident visa holder can become a US tax resident.

So, what will officially qualify you as a tax resident in the United States? There are four ways to determine whether you qualify:

• Citizenship
• The Green Card Test
• An ‘Improperly’ Surrendered Green Card
• The Substantial Presence Test.

Since we’ve extensively covered the many options for reducing your tax burden as a US citizen in other articles, we’ll examine the last three options, which apply to resident aliens.

Resident aliens are non-US citizens who either have a green card or have spent 183 days or more in the United States in the past three years.

The Green Card Test for US Tax Residency

If you have applied for and been issued an alien registration card (commonly known as a green card), you are considered a lawful permanent resident of the United States. 

This automatically deems you a tax resident of the US from the date your new immigration status went into effect.

Unless you are eligible for an exception, you will be taxed on the same grounds as US citizens, with all the same laws, regulations and reporting obligations. 

Even if you live outside the United States, as long as you are a green card holder, you must report your worldwide income and pay any necessary taxes to the US.

An ‘Improperly’ Surrendered Green Card and US Tax Residency

As Jonathan’s story reminded us, simply surrendering your green card may not be enough to relieve you of your tax obligations.

Jonathan’s mistake? He forgot to inform the Department of Homeland Security that he had given up his green card.

The IRS still classifies you as a tax resident of the US until you notify the Department of Homeland Security that you have relinquished your permanent residence and have delivered the documentation they request.

Furthermore, if you leave the US for any period as a green card holder, you must obtain a certificate of compliance stating that you have paid your US taxes before leaving. 

In some cases, you may be required to file a tax return and pay any taxes due at the point of departure before leaving the country. If you do plan to leave, review Form 1040-C to learn what you must report.

The Substantial Presence Test for US Tax Residency

Each year, non-US citizens visit the United States as nonimmigrants for a variety of reasons. 

While some come as tourists, others come as college students, teachers, professors, athletes, exchange visitors, temporary workers, business people, diplomats, trainees, religious representatives, medical patients and more.

Even though they are not permanent residents, many of these folks could become tax residents of the United States if they spend a certain amount of time in the country each year. 

The test to determine whether or not they have reached that threshold is called the Substantial Presence Test.

Under the rules of the Substantial Presence Test, even illegal immigrants can be treated as US tax residents and must report and pay any taxes due.

Substantial Presence Test Rules 

The IRS will consider that you have a ‘substantial presence’ in the US if you:

• Were or will be in the US for at least 31 days during the current year; and
• Will spend at least 183 ‘days’ in the US within a three-year period.

Technically, you could spend more than 183 days in the US over three years and still avoid becoming a tax resident. 

This is because the 183-day limit does not give equal value to the days from each year. 

The formula used to calculate how many days you spend in the US is as follows:

• Days you were present in the current year = 1
• Days you were present in the previous year = 1/3
• Days you were present two years previous = 1/6.

For example, while you may have spent 90 days in the US in year two, only 30 of those days would count toward the 183-day limit. 

Conversely, if you spent 183 days in the US during the current year, then you will automatically qualify as a tax resident, regardless of how many days you spent in the US for the two years previous.

You could, therefore, use various combinations of days spent in the US each year to stay within the limit. 

However, the general rule is that if you are physically present in the US for 120 days or less each calendar year, you will avoid qualifying as a US tax resident indefinitely.

Substantial Presence Test Exclusions

There are a few exclusions to the 183-day rule. For example, the days regular commuters who cross the border to work in the US from either Canada or Mexico do not factor into the formula. However, cross-border shopping trips will count as a full day toward the 183-day limit.

Another beneficial exclusion is that the days you stop in the United States while travelling between two other countries do not count. 

Additionally, if you were ever unable to leave the country due to a medical condition you acquired while in the US, the days spent receiving medical treatment will not count against you either. (Although you will have to file Form 8843 to claim the exception.)

Reporting Requirements for US Tax Residents

If you qualify as a US tax resident, you are subject to the same tax rules as US citizens. 

You must report your worldwide income, including all investment income, capital gains, regular employment income, income from non-US rental properties, and even income from foreign pensions.

 As a lawful permanent resident, you become a tax resident on the first day you are present in the US. 

Many permanent residents who obtain their residency at some point later in the year qualify for dual status in their first year. We’ll discuss the details of dual status in just a minute.

Finally, while becoming a tax resident does mean that you will have to report your entire worldwide income, it does not necessarily mean that the IRS will tax everything you report. 

Still, the reporting requirement is onerous enough to motivate many people to avoid ‌tax resident status.

Nonresident Alien and US Taxes 

The residence test contains numerous exemptions that relieve some legal aliens in the US from having to report or pay income tax. The IRS considers these folks nonresident for tax purposes – or tax nonresident.

Like the exclusions to the 183-day rule discussed above, the US offers exemptions for many qualifying individuals that allow them to stay in the US for a period longer than 183 days. 

There are three main types:

• Exempt Individuals
• Tax Treaties
• The Closer Connection Exception.

Exempt Individuals ​​From US Tax Residency

Nonimmigrants who qualify as exempt individuals can avoid ‌US tax resident status. 

These individuals must file Form 8843 to claim the exemption and be off the hook for reporting and paying taxes on their worldwide income. 

Exempt individuals include:

• Foreign government officers holding an A or G visa (A-3 and G-5 visas are not exempt)
• Teachers and trainees holding J or Q visas
• Students holding an F, J, M or Q visa
• Professional athletes competing in a charitable sports event in the US
• Employees of an international organisation
• Immediate family members of the individuals listed above.

The days an exempt individual spends in the United States will not count toward the 183-day threshold of the Substantial Presence Test, which would make them liable to report their worldwide income. 

This does not, however, exempt them from paying taxes on their US-sourced income.

Each exemption comes with its own timeline. For instance, teachers and trainees on a J or Q visa can claim ‌exempt individual status no more than two calendar years every six calendar years. 

Similarly, students are granted five exempt calendar years before they are subject to the Substantial Presence Test.

However, unlike the Substantial Presence Test, any day an exempt individual spends in the United States during a calendar year counts towards a full calendar year. 

If you arrive in December, for example, then that entire year will count toward one of your exempt calendar years. Plan accordingly.

Tax Treaties and US Tax Residency

The second way to avoid being labelled as a US tax resident by the IRS is through a tax treaty. 

To prevent double taxation, the US has tax treaties with over 60 countries. The credit obtained through such treaties is separate from and in addition to the foreign tax credits you can claim by filing Form 1116.

If you meet the following conditions, you will be considered a tax resident of both countries and can utilise a treaty election to avoid US tax residency:

• You are a citizen of one of the 60-plus countries the US has a tax treaty with
• You have worked in the US on a temporary work visa
• You have been physically present in the US for more than 183 days.

By filing Form 1040NR with a Form 8833 treaty election, you can be treated as a tax resident of your origin country and avoid being classified as a US tax resident.

This, of course, only applies if you can prove that your country of origin is your permanent home. 

While the tax treaty serves as a tiebreaker if you are equally a resident of both countries, it is difficult to claim the right to tax treaties if your ‘vital interests’ and ‘habitual abode’ are centred in the US.

Lamentably, using a tax treaty to be taxed as a US nonresident does not mean that you are free of your reporting obligations. 

The IRS will still expect you to report financial accounts and interests in foreign corporations, trusts, and partnerships.

Pros and Cons of Becoming a US Tax Resident

While the US offers some benefits to its residents, becoming a tax resident also comes with its own challenges. 

Pros of Becoming a US Tax Resident

Access to Public Benefits: As a tax resident, you contribute to the Social Security system, which can provide you with retirement, disability and other benefits.

Opportunities for Investment: Tax residents can avail themselves of stock market and real estate investment opportunities. 

Education and Scholarships: As a tax resident, you may qualify for in-state tuition at public colleges and universities, significantly reducing educational fees. Residents often have better access to scholarships and federal financial aid.

Cons of Becoming a US Tax Resident

Global Tax Obligations: The most significant disadvantage of becoming a tax resident in the United States is its worldwide income taxation. US tax residents are required to pay taxes on their global income, which can be complex and costly, especially if you have significant international financial interests.

Complex Tax Regulations: On top of being taxed no matter where you go, residents must endure the complexity of tax filing. The US tax system is well known for its complexity.

State Taxes: On top of federal taxes, you may be subject to state and local taxes, which vary widely and can add significantly to your tax burden.

Double and Exit Tax: While tax treaties can help reduce some double taxation issues, not every country has this agreement with the US. If you do choose to depart, the US government may also implement an exit tax. 

Legal and Financial Reporting: Tax residents must comply with the Foreign Account Tax Compliance Act (FATCA), requiring detailed reporting of foreign assets, which can be burdensome and intrusive.

Alternative Tax Residences 

Once you’ve considered what you want out of a residency, you should explore your options. 

The following countries are just a few of the most popular places to get an easy second residency. 

If you are a high-net-worth entrepreneur or investor, they may be worth considering.

The Bahamas

The Bahamas not only offers the opportunity to obtain residence in a tropical paradise, but its main attraction for foreign investors is its tax-free regime.

Residents enjoy no personal income tax, corporate income tax, capital gains tax, sales tax, withholding tax, gift or inheritance tax, or probate fees, making it a true tax haven.

Unlike many countries, tax residency in the Bahamas is straightforward – spend over 183 days a year there, and you become a tax resident without the burden of high taxes.

It’s easy to obtain a temporary residence permit by completing a few forms and paying the fee.

However, the government is tightening regulations, meaning that while you can secure a temporary permit for a year or two, permanent residency will require a significant investment of at least US$750,000 in real estate or a local business.

So, while getting a second residency is simple in the short term, permanent settlement demands a financial commitment.

The Cayman Islands

The Cayman Islands residence program offers a tropical island lifestyle, but obtaining a residence permit is costly, starting at over US$1 million.

The Cayman Islands attracts attention for its tax-friendly policies: there is no income, property or corporate tax. This allows individuals to move, obtain a residence permit, and potentially reduce their tax burden to zero.

To become a permanent resident as someone of independent means, you need an annual income of US$150,000 and must invest US$1.2 million in real estate.

Overall, establishing a second residence is relatively easy for those with the financial means, requiring minimal time spent on the islands.

Latvia

Those seeking a path to EU citizenship are turning to Latvia.

This Northern European country has a favourable tax environment, with a minimum corporate tax rate of 20% and reasonable personal income tax rates.

To obtain a two-year residence permit, you can invest €250,000 in property or government bonds, plus fees of around €12,500. This permit can be renewed for up to five years.

As a resident, you enjoy all EU rights and can apply for Latvian citizenship after ten years. However, if you plan to pursue citizenship, you should live in Latvia for at least six months each year in the five years leading up to your application. 

US Tax Residency: FAQs

Avoid US Taxes Forever

​​The pursuit of international diversification, whether for business, investment or lifestyle reasons, often brings people to a crossroads with US tax obligations. 

While the allure of global citizenship is undeniable, the US tax system, with its claim on worldwide income, can feel like a ball and chain. 

With careful strategising, the hope of avoiding US taxes forever can go from a pipe dream to a tangible mission.

This isn’t about tax evasion – it’s about legally making use of the options available. 

For some, that might entail setting up a bona fide permanent home to permit them to sever their ties with the US. 

For others, it might involve exploiting tax treaties, corporate structuring and offshore investment vehicles to optimise their global tax burden. 

The key to both is proactivity. Don’t wait for the IRS to dictate your financial future. Seek expert advice, understand the nuances of residency and explore the many pathways to financial freedom from taxes.

To create a bespoke solution for your life without US taxes, reach out to the Nomad Capitalist team.