A Complete Guide to the Substantial Presence Test (with an example)

Non-US residents generating international income while on a work visa (or perhaps without a visa) are tasked with defining the time they spent in the US to see what taxes and filming forms are applicable or necessary. The way these non-US Citizens/non-Legal Permanent Residents determine if forms such as FBAR or FATCA are necessary or applicable to their situation, and how these taxpayers determine if they are to be considered a US resident for tax purposes, is by meeting the Substantial Presence Test. This metric uses a few different ratio models, has a few exceptions, and can be generally broken down as follows (and as outlined by the IRS website):

To meet this test, you must be physically present in the United States (U.S.) at least:

1. 31 days during the current calendar year, and
2. 183 days during the 3-year period that includes the current calendar year and the 2 years immediately preceding that year, including:
   1. All the days you were present in the US in the current year, and
   2. One-third of the days you were present in the initial year before the current year, and
   3. One-sixth of the days you were present in the second year before the current calendar year.

To dive further in, this test is only applicable to those who live outside of the US but spend a substantial amount of time in the country, so long as they don’t qualify for an 8843 Exemption or an 8840 closer connection test. Form 8840 provides the relevant party with a way to avoid becoming a US citizen for tax purposes by thoroughly proving a closer connection to a foreign nation (or nations). The 8843 Exemption is for those that meet the Substantial Presence Test, but feel they are not subject to, or deserve an exemption from, US taxation for worldwide income. Both forms are very involved, and the IRS is passionately committed to ensuring foreign accounts compliance and enforcing severe offshore penalties and fines.

If the Substantial Presence Test is passed by a person earning worldwide income, it means they have spent enough time in the US to be considered a US citizen for tax purposes and must report income earned in that country. The taxpayer is then required to report any and all offshore accounts, assets, and investments through relevant tax forms such as FATCA Form 8938, the FBAR, and FATCA Form 8938. Failure to report these international finances could result in detrimental fines and harsh penalties. These consequences can be easily avoided by enlisting the services of Dimov Tax. We can help you process your IRS Offshore Disclosure and determine if you have spent enough time earning income in the US to qualify as a US taxpayer. 

If unexempt, passing the Substantial Presence Test means your worldwide income will be taxed according to US tax law. This leads us to the standard filing of the 1040 Tax Return, the typical form used by US Citizens and Legal Permanent residents. If you hold bank accounts in foreign nations, you must file an FBAR to clearly disclose this information to the IRS. Again, failure to disclose such accounts could result in hefty fines and IRS penalties. Foreign nationals, so long as they meet the Substantial Presence Test, are also required to file a 1040 Tax Return and any applicable FBAR, since they will also be considered an American citizen in terms of taxation.

For new US residents, the 1040-NR should be filed until they have earned full citizenship or have become a Legal Permanent Resident. Even after years of US citizenship and normal taxation practices, worldwide income should still be reported, and foreign account and asset reporting standards are still to be met. Willful failure to report foreign income and investments could result in a 100% financial penalty, and even unwilful failure to disclose offshore accounts could result in major fines and even criminal investigations.

Substantial Presence Test can help you decide if you have spent enough time in the US to be considered a US taxpayer. Here is an example of how to deduce your eligibility based on the current year, the 1st preceding year, and the 2nd preceding year:

Example: An individual is present in the U.S. for 82 days in 2022, 174 days in 2021 and 264 days in 2020. 

The general guidelines are:

The person must be physically present in the United States on at least: 31 days during the current calendar year, and a minimum of 183 days during the applicable three year period that includes the current year and the two years directly before the current, including: 

• All of the days the person was present in the current calendar year, as well as
• One-third of the days the person was present in the first preceding calendar year, as well as
• One-sixth of the days the person was present in the second preceding calendar year 

Example: An individual is present in the U.S. for 82 days in 2022, 174 days in 2021 and 264 days in 2020. 

Current year: 2022

Number of days in US: 82

82 x 1 = 82

1st preceding year: 2021

Number of days in US: 174

174 x ⅓ = 58

2nd preceding year: 2020

Number of days in US: 264

264 x ⅙ = 44

Total days: 184 (showing residency)

In the above example, the person was a resident during 2021, because the total number of days in the US is greater than 183 days.

Need help with determining your residency status? Reach out today!