Closer Connection, Substantial Presence & Expatriation
Closer Connection, Substantial Presence & Expatriation: In a common situation, a taxpayer will seek to expatriate and relinquish their green card at the beginning of a new tax year. There may be some potential tax issues that they are seeking to avoid, and the sooner they give up their Green Card, the better. The individual gives up their green card and files an I-407 but they are still in the United States tidying up their affairs. The problem is that even though the expatriate is no longer a Legal Permanent Resident, if the person remains in the United States too long in the current year, they may meet the substantial presence test and still be subject to U.S. tax and reporting on their worldwide income and foreign assets, accounts and investments.
Closer Connection Form 8840
When a foreign nonresident person meets the substantial presence test and is required to report (and pay tax) on their worldwide income, as well as disclose all of their foreign accounts and assets — it is a very heavy burden, and completely unfair.
Even the Internal Revenue Service acknowledges that the substantial presence test can be unfair, and developed IRS Form 8840.
Form 8840 is used to show that even if the taxpayer meets substantial presence, they had a closer connection to a foreign country or multiple countries in the current tax year — and therefore they should not be subject to US tax as a US person.
Rather, they should be taxed as a foreign nonresident alien and only subject to US tax on their US sourced income.
Form 8840 Downside
The main downside for completing the form 8840 in order to show a closer connection in a year that a nonresident alien meets substantial presence, is that IRS accepted of the form is not guaranteed.
The IRS can dispute the filing of the form 8840 and then make the claim that the taxpayer is really a US person — and therefore should be subject to US tax on their worldwide income in the current year.
It is important that taxpayers who are considering filing a form 8840 in order to negate the substantial presence test and show a closer connection to a foreign country(s) to carefully review the instructions for form 8840 in order to get a better idea of what may be required in order to show a closer connection.
But, even if the IRS disputes the taxpayer’s position — the taxpayer can fight the IRS on the issue.
Where There is a Will, They (may) be a Way
Sometimes it is inevitable that a person who is expatriating in the current year will have to remain in the United States for an extended period of time, and become subject to the substantial presence test. But, just because the taxpayer is subject to the substantial presence test does not mean they will automatically be taxed on their worldwide income (or have to report foreign assets and accounts). Rather, they may be able to avoid substantial presence if they can show that they have a closer connection to a foreign country or countries, and file a timely form 8840.
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