U.S. Tax Residence for Foreign Nationals Stranded in the United States due to COVID-19
The U.S. federal income tax rules treat U.S. citizens and those holding a "green card" (known as "permanent residents") as U.S. tax residents regardless of whether such individuals live in the United States. U.S. tax residents are taxable on their worldwide income and also are subject to extensive information reporting requirements with respect to foreign assets. A foreign individual who is neither a U.S. citizen nor a permanent resident may also become a U.S. tax resident by meeting a "substantial presence test." This formulaic test requires physical presence in the United States for at least 183 days, calculated under a day count formula that includes U.S. days in the current year, plus 1/3 of U.S. days in the prior year, plus 1/6 of U.S. days in the year prior to that (i.e., a 2 year look back). A foreign individual who achieves U.S. tax residence by substantial presence must file the same tax forms and pay tax on a worldwide basis, just as their U.S. citizen and permanent resident counterparts.
A few exceptions from the substantial presence test exist. The first allows a foreign individual who stays for less than 183 days in the current year to submit a claim to the IRS of 'closer connection' to the home country, thereby escaping U.S. tax residence for that year. The second exception permits a claim to excuse U.S. days resulting from an unforeseen medical emergency for the individual arising while the individual is in the United States. Both exceptions require affirmative, and timely, filing with the IRS. In addition, the U.S./France double tax treaty (the "Treaty") permits any individual classified as a tax resident under the domestic rules of both France and the United States to rely on the "treaty tie breaker" provision to assert the primacy of French tax residence, generally based on such factors as location of permanent home, center of vital interest, and habitual abode in France, or otherwise based on French nationality. Such a Treaty claim must also be submitted to the IRS and, unlike the other exceptions, does not fully excuse such an individual from the foreign asset information reporting requirements.
Even without achieving U.S. tax residence, foreign individuals who work in the United States are generally taxed on their income from "personal services" performed in the United States based on the number of U.S. days worked; this income is treated as "U.S. source" income and can trigger a requirement to file a non-resident U.S. tax return to pay tax on such income. The Treaty may provide relief to non-residents eligible for Treaty benefits by excusing such income from taxation where the individuals spends no more than 183 days in the United States during the relevant 12 month period.
A foreign individual stranded in the United States due to COVID-19 may be at risk of becoming a U.S. tax resident in 2020 under the substantial presence test, or becoming subject to U.S. tax on income from work conducted in the United States. On April 21, 2020 the United States released Revenue Procedure 2020-20 providing that, under certain circumstances, up to 60 consecutive calendar days of U.S. presence that are presumed to arise from travel disruptions caused by the COVID-19 emergency will not be counted for purposes of determining U.S. tax residency under the substantial presence test, and for purposes of determining whether an individual qualifies for tax treaty benefits for income from personal services performed in the United States. This relief appears in keeping with the standard adopted recently in several other countries, including Singapore and the United Kingdom. Presumably, if the COVID-19 situation does not improve to permit travel after 60 days has passed, a follow on Revenue Procedure extending the number of excepted days could be issued.
To benefit from the new exception, stranded individuals can claim a new "COVID-19 Medical Condition Travel Exception". Provided the individual was not a U.S. tax resident at the close of 2019 and is not a permanent resident in 2020, he or she may disregard up to 60 consecutive U.S. days starting on or after February 1, 2020 and on or before April 1, 2020 (the "COVID-19 Emergency Period"). This approach will similarly apply for purposes of determining eligibility for Treaty benefits for income earned from conducting personal services in the United States. The relief is framed to presume entitlement, and does not require foreign individuals to affirmatively claim the exception by filing a Form 8843 with the IRS, unless such individual already has a non-resident U.S. return filing obligation. However, foreign individuals are advised to retain all relevant records in case the IRS requests a Form 8843 in the future. In addition, the IRS clarifies that individuals may benefit from the COVID-19 Medical Condition while also claiming any other exceptions for which they are eligible, such as the closer connection exception or the traditional medical condition exception.
Corporate Income Tax Residence and Permanent Establishment
Under the U.S. federal income tax rules, corporations organized under U.S. domestic law are U.S. tax resident and subject to U.S. tax on their worldwide income, while corporations organized under a foreign country's laws are not considered U.S. tax resident. There is no "place of effective management" test as may exist in other countries. However, under U.S. domestic rules a foreign corporation may become subject to U.S. tax on income earned in connection with a trade or business conducted in the United States, such as through a U.S. branch activity. Under the Treaty, the level of activity required for a foreign corporation to create such a U.S. taxable nexus is higher, and more specific, than under domestic rules, generally referred to under the Treaty as a "permanent establishment" ("PE").
While the Covid-19 situation will not impact U.S. corporate tax residence determinations, it could result in unintended U.S. activity by employees of foreign companies who are stranded, and working for the foreign employer, while in the United States. That U.S. employee activity could, in some cases, suffice to create a U.S. taxable branch or PE for the foreign corporation if the regular activity standards are applied, triggering tax and filing requirements for the foreign employer. Under the Treaty, an employee is generally characterized as a "dependent agent" of the employer and, if the employee has, and habitually exercises within the United States, an authority to conclude contracts in the name of the employer (e.g., signing contracts), that activity normally should suffice to create a U.S. PE for the foreign employer. (Less specific U.S. employee activity may suffice to create a taxable branch activity under domestic rules, known as a "U.S. trade or business").
On April 21, 2020, the IRS released an FAQ specifically addressing these questions. Specifically, a foreign corporation may choose an uninterrupted period of up to 60 days during the COVID-19 Emergency Period during which activities conducted in the United States will be disregarded in determining taxable U.S. business activity (i.e., a PE), provided the activity is performed in the United States solely due to the COVID-19 situation. This exception extends to work conducted in the United States by U.S. citizens or permanent residents who had a tax home outside the United States in 2019 and reasonably expect to have that tax home in 2020 (i.e., U.S. persons normally living abroad now stranded in the United States). On a similar basis, for Treaty purposes, any U.S. activity occurring during this COVID-19 Emergency Period that would not otherwise have occurred will not be taken into account to determine whether a PE has been established.
Foreign individuals and companies are advised to retain contemporaneous documentation to establish the COVID-19 Emergency Period and that the relevant business activities undertaken during that time would not have been undertaken in the United States but for the COVID-19 situation. In addition, the FAQ confirms that foreign individuals and companies may make protective filings of their annual U.S. tax returns, even if they believe they are not required to file a 2020 return because U.S. activity should be excused, in order to avail themselves of the benefits and protections that arise from such filings, including deductions, statutes of limitations, and generally claiming tax treaty-based relief.
Taxation and Tax Residence in the 50 U.S. States
A separate issue somewhat unique to the United States is that each State applies its own rules, separate and apart from the federal tax rules, to determine the tax residence of individuals and the income taxation (and sales tax obligations) of foreign corporate activities in the State. As a result, activity and presence that may escape federal taxation could still create tax residence and nexus for State tax purposes. State taxation is not covered by U.S. tax treaties, so any relief thereunder is simply not relevant to State taxation. As a result, foreign individuals stranded in the United States, and the foreign corporations that employ them, must understand the rules, and any relief, offered by the State in which any employee may be residing and/or working during the COVID-19 crisis. A few States, including New Jersey, already have released limited guidance indicating they will not assert tax jurisdiction over companies that employ individuals who are compelled by the COVID-19 crisis to work from home in that State. Presumably foreign companies may benefit from such directives; however, thus far, the State directives are not clear regarding the tax residence status for foreign individuals who are stranded in that State (and thus are not "working from home").
Gide is monitoring the developments in the United States and is available to discuss any particular U.S. tax questions.
This legal update is not intended to be and should not be construed as providing legal advice. The addressee is solely liable for any use of the information contained herein and the Law Firm shall not be held responsible for any damages, direct, indirect or otherwise, arising from the use of the information by the addressee.
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