COVID-19 Travel Restrictions and Tax Residency
International tax and estate planning attorney, Ellina Berdichevsky, discuss the default rules on residency and the recent guidance issued by the IRS in Rev. Procs. 2020-20, 2020-27.
Stephanie Diaz
Welcome, everyone. I’m Stephanie Diaz, an attorney at Bilzin Sumberg in Miami, Florida. I’m joined by my colleague, Ellina Berdichevsky.
Ellina Berdichevsky
Thank you, Stephanie. Glad to be joining you today. Welcome, everyone.
Stephanie Diaz
Ellina and I work with the International Private Client Group of the firm, focusing on inbound planning and tax and estate planning for the international high net worth individuals. An important issue in our practice is the U.S. income tax residency of our clients.
Ellina Berdichevsky
That’s right, Stephanie. Although tax residency may sound straightforward, it can actually be quite complicated. Some of our listeners may be aware that the physical presence of individuals is one factor relevant to residency, and because of the travel restrictions and the overall environment created by COVID-19, some non-U.S. individuals may be spending much more time here in the U.S. than they had planned. So today, we’ll be discussing the default rules on residency and the recent guidance issued by the IRS in Rev. Procs. 2020-20, 2020-27, and an FAQ that was released.
Stephanie Diaz
Sure. So in the context of our practice, whether a client is a U.S. person for purposes of Code Section 7701(a)(30) is really important. So long as our clients are not U.S. residents for income tax purposes, which is different than estate tax purposes, they are only subject to U.S. income tax on U.S. source income which is generally things like dividends from U.S. corporations, rental income and beyond [such as] the sale of U.S. real estate, certain interest, of course, salary for services performed in the U.S., U.S. royalties and U.S. income effectively connected to a U.S. trade or business. This limited income taxation is vastly different from that of the U.S. people who are actually taxed on their worldwide income. A U.S. person can be an individual who is a resident for U.S. income tax purposes, specifically a green card holder, or other lawful permanent resident or a person who is substantially present in the U.S. Under the so-called substantial presence test, a person is a U.S. resident for a given calendar year if he or she is (1) present in the U.S. for 183 days or more in a given year, or is present in the U.S. for at least 31 days in the tested year, and the total days of U.S. presence for the tested year and the earlier two years equal or exceed 183 days on a weighted basis. Now, to do this weighted basis, you consider adding all the total days of the present or the tested year, one-third of the days present in the prior year, and a one-sixth of the days present in the second previous year. Exceptions to U.S. residency, of course, applies to students; individuals that demonstrate having a tax home in a foreign county, what’s known as a closer connection; and individuals whose residency is determined under a treaty. The student exception allows students to exclude certain days for purposes of a substantial presence test. Generally, a medical exception allows individuals present in the U.S. that are unable to exit the U.S. as planned due to a medical condition that arose during their visit or their time in the U.S., to be excluded. Considering the consequences of becoming a U.S. tax resident, our clients have been understandably curious concerning how their unplanned or extended visits in the U.S. as a result of the COVID-19 emergency might affect their U.S. income tax treatment.
Ellina Berdichevsky
And that’s exactly what this guidance is meant to address. It actually brings in the medical exception that you just mentioned into COVID-19 and applies it in an interesting kind of way. So Rev. Proc. 2020-20 addresses the effects of being in the U.S. for longer than you expected for purposes of both the residency, as we discussed, and some other treaty provisions, and also allows certain non-U.S. citizens to exclude a period of up to 60 days of physical presence in the U.S., with some restrictions and limitations that we’ll get into. So essentially, the IRS has created what they’ve termed a COVID-19 medical condition travel exception, and it can be claimed by a “eligible individual” during their COVID-19 emergency period. So you can exclude, if you are an eligible individual, up to 60 consecutive days of physical presence in the U.S. for purposes of both applying the substantial presence test and for determining whether you qualify for certain tax treaty benefits for income from personal services. So there are four requirements in order to be considered an eligible individual that can take this exception. First, you can’t be a U.S. resident in 2019 for tax purposes, either under the substantial presence test or the green card test. Second, you can’t be a lawful permanent resident, meaning you can’t be holding a green card at any point in 2020. Third, you have to be physically present in the U.S. on each of the days of your emergency period. And lastly, you cannot become a U.S. resident in 2020 either due to days of presence in the U.S. outside of this emergency period or because you got a green card in 2020. So the COVID-19 emergency period is a period of up to 60 consecutive days that begins on or after February 1st, 2020, and begins on or before April 1st, 2020. So this means that you could have a 60 day period, for example, that begins on March 1st and goes through April 30th, because the key is that the period has to begin between February 1st and April 1st, 2020. It does not have to end within that time. The Rev. Proc. is clear that an individual does not actually have to be infected with the virus to be eligible for relief and you could be able to travel, but just may feel unsafe doing so as a result of social distancing guidelines or other precautions that have come about because of the COVID-19 pandemic. You could just not want to travel or feel comfortable traveling during this period. You don’t actually have to have the virus or know anyone that has the virus. It is fairly broad in that sense. The guidance also provides relief to non-U.S. individuals that would have otherwise been eligible for certain income tax treaty benefits if they are performing personal service is in the United States and they can select a similar 60 day period that begins between February 1st and April 1st, 2020, and it would not be counted for the purposes of the 183-day rule that’s in the treaty benefits. The Rev. Proc. also makes clear that you can still claim other exceptions to residency, such as the closer connection exception and anything else that’s available within the Code. And while all this relief is a very welcome start, we’re wondering, [or] perhaps the top question is, whether the IRS will extend the day period past 60 days, although they haven’t mentioned anything of this sort in the guidance. Both the IRS and Treasury have [elsewhere] stated that they’re continuing to monitor these and other issues related to COVID-19 and so perhaps there may be some indication that they’ll at least consider extending the relief if there is a need. For instance, we know if somebody had a 60 day period begin on March 1st, it would already be over, and as of today, for example, there are still airports around the world in jurisdictions and countries that haven’t opened up their airports yet, so they really are restricted from traveling still and currently. So, Stephanie, how does an individual that’s eligible for the relief actually go about claiming the exception?
Stephanie Diaz
Sure. So eligibility is one meaty factor, but then once you’re ready to apply the relief, it’s similar to the medical exception I alluded to earlier. Eligible individuals that want to take advantage of relief are going to be required to file Form 1040NR and attach Form 8843, which is the Statement for Exempt Individuals and Individuals with a Medical Condition, to their 1040NR. Both forms have to be filed on time, including any applicable extensions. So to the extent that someone is already here, he might want to think about engaging an accountant and working together as needed to apply for any extensions that might be convenient. Individuals, who are not required to file [Form]1040NR, should retain all the relevant records to support their reliance on this exception, of course, because that could be requested by the IRS in the future, and be prepared to produce the records. This doesn’t mean that they shouldn’t also file [Form] 8843. That form will still be required. Interestingly, the guidance doesn’t specify what such relevant records means, so we expect it’s going to include a variety of documents and it will depend on the facts and circumstances, but an update to the alert may be forthcoming.
Ellina Berdichevsky
Right. Hopefully we’ll get some more clarity on what those records will be. The other Rev. Proc. that the IRS released was addressed to essentially kind of the opposite [situation], U.S. individuals that are U.S. citizens and are U.S. taxpayers, but they work abroad and they take what’s called a foreign earned income exclusion, or perhaps they plan to take this exclusion, and essentially it excludes all of or a certain amount of the income that they earn abroad as well as a certain housing cost from their U.S. taxable income so as to make it not taxable in the U.S. There are a couple of requirements for the foreign earned income exclusion and the Rev. Proc. addresses one of them, and that is what’s called the bona fide residency requirement. And that’s basically a requirement that the individual have a certain amount of physical presence in the country in which they’re working over a consecutive 12 month period. For those purposes, there’s a provision in the foreign earned income exclusion rules that allows individuals to still qualify as bona fide residents even if they leave a country due to some sort of event such as war or civil unrest and there’s a whole bunch of other things listed, and the IRS has declared COVID-19 as kind of a global occurrence of these events in any other foreign country in the world. So individuals that take the foreign earned income exclusion can leave those countries, return to the U.S. or go to another country perhaps where it’s safer, and be in the U.S. during a period of time that they want to take the foreign earned income exclusion and still be considered a bona fide resident for those purposes. The period that the IRS has designated is basically any time that any individual that has left their foreign country of residence on or after February 1st, 2020, but before July 15th, 2020, [the individual] will still be treated as a qualified individual for the bona fide residency portion of foreign earned income exclusion. If you’re a resident of China, it goes back to December 1st, 2019. So you could have left as early as December 1st and still be considered a bona fide resident for the period that you’re gone. There are other [requirements], for example the tax home requirement of the foreign earned income exclusion, [which] is not addressed by the Rev. Proc. in either this sense [as it relates to the foreign income exclusion] or in another sense that we are curious about, specifically, for students that are in the U.S. on their F visas and who may otherwise have a change in tax home because of COVID-19 because they weren’t able to leave when they had planned to leave, if they were only students for part of the year. There’s a lot of fact particular and fact specific cases that are not perhaps clearly addressed by this Rev. Proc. or not at all addressed by the Rev. Proc. So we’ll see if we get more guidance on those. The FAQ released pertains to certain non-U.S. individuals and non-U.S. businesses that are performing services in the United States. For example, if a non-U.S. individual that works for a foreign company is stuck in the U.S. and is working remotely and performing services from the United States for that foreign business, the FAQ say that they can have a similar 60 day period. They may exclude that uninterrupted period of 60 days during which services were provided in the U.S. for purposes of determining whether the non-U.S. individual or non-U.S. company’s activities rose to the level of a U.S. trade or business, or permanent establishment in the case of a treaty country, which would in normal circumstances just make that business taxed in the United and taxable in the United States. So although individuals can be comfortable knowing that they can perform services and not have a U.S. trade or business or permanent establishment created during these 60 days, they still don’t know how that income from the services performed will be taxed. So we’re hoping to get some guidance on whether or not that [personal services income] will be subject to the U.S.’s 30% withholding tax regime, absent the $3,000.00 de minimis exception or an income tax treaty application, and we’ll hopefully get some of those answers in the coming months. We’ll see what happens in the time ahead.We actually don’t know how much we can rely on FAQs because FAQ guidance doesn’t represent official guidance that can be relied on for things like penalty relief. So businesses and individuals should be careful in relying on that [FAQ] for certain things.
Stephanie Diaz
Yeah. Thank you. That’s a good reminder for our listeners. And we should also remind them that we’ve issued an alert to this point, so if they have more information that they’re looking for as to these Rev. Procs. [2020-20 and 2020-27] and guidance on substantial presence during the COVID-19 pandemic, they can certainly view those on our website. So thank you for listening, and thank you, Ellina, for joining me in this update.
Ellina Berdichevsky
Of course. Thanks, everyone, for joining us today and we hope to see you next time.
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