In a previous post, we provided an overview
for determining a person's U.S. income tax residency status
under the substantial presence test (the "SPT"), a test
which relies on a mathematical formula for computing an
individual's days of physical presence in the U.S. But for
certain "students" (a term which is defined not only by
U.S. tax law, but relies on U.S. immigration law as well), there is
a major benefit – their days of presence in the U.S. while
they remain on a student visa are generally not "counted"
when applying the SPT.1 This article provides an
overview of the student visa exception and highlights some
potential traps for the unwary.
For tax purposes, a "student" is defined as an individual who is temporarily present in the U.S. under the appropriate visa and who substantially complies with the terms and requirements of that visa. Most commonly for students, the appropriate visa is an "F" visa. The individual who is going to school will receive an F-1 visa, and certain immediate family members of the individual can receive derivative status through an F-2 visa.2
The ability of a student to exclude days of presence in the U.S. has its obvious benefits, but this exception is not unlimited. In general, a student can only exclude days under the student visa exception for five years, with any portion of a year counting as a full year for this purpose.3 After the five-year threshold is crossed, a student can no longer exclude days of presence in the U.S., unless further action is taken. The following simple example illustrates these basic rules:
- Mr. Z arrives in the U.S. for the first time on December 30, 2017, on an F-1 visa, to begin a course of study. 2017 counts as one full year toward the five-year threshold.
- Mr. Z remains in the U.S. through the end of 2021 and complies with the terms of his student visa. 2021 will count as Mr. Z's fifth year of student status.
- Mr. Z's days of presence in the U.S. from December 30, 2017 through December 31, 2021, are not "counted" for purposes of applying the SPT.
- Mr. Z decides to continue his course of study in the U.S. into 2022 and obtains the appropriate immigration law approvals to remain in the U.S. in 2022 on his student visa.
- Absent further action, Mr. Z's status as a "student" will generally terminate on January 1, 2022, and Mr. Z must begin counting his days of presence in the U.S.
In order to extend student status beyond the fifth year, the individual must establish that he or she does not intend to reside permanently in the U.S. and that the individual has substantially complied with his or her student visa requirements.4 The facts and circumstances to be considered in determining if an individual has demonstrated the requisite "intent" include, but are not limited to: (i) whether such individual has maintained a closer connection with a foreign country; and (ii) whether the individual has taken affirmative steps to change the individual's status to that of a permanent lawful resident (i.e., a green card holder).5
It might seem that for a student whose days of presence in the
U.S. are not counted for purposes of the SPT, there are no U.S.
income tax issues that the student need worry about; however, this
would be a dangerous assumption to make. For starters, like any
other nonresident alien, a student will still be subject to U.S.
income tax on his or her taxable U.S. source income (e.g., a
dividend paid by a U.S. corporation).6 Additionally,
although capital gains are generally not subject to U.S. income tax
in the case of a nonresident alien individual (except for U.S. real
estate related gains and certain U.S. trade or business related
gains), an often-forgotten rule lurks in the shadows.
For nonresident aliens who are physically present in the U.S. for 183 days or more in the taxable year, there is a 30% tax imposed on U.S.-source capital gains.7 This rule has very limited application, because for most individuals, if they are present in the U.S. for 183 days or more, they are likely considered a U.S. income tax resident, subject to U.S. income tax under the normal rules that apply to all U.S. taxpayers. Students, however, are one of the few categories of people to whom this rule applies.
The source of capital gains for these students is usually determined by reference to the location of their "tax home." For these purposes, tax home generally means the person's principal place of business, of if the person has no principal place of business, then the person's regular place of abode in a real and substantial sense (i.e., where the person spends most of his or her time). Determining the location of an individual's tax home can be difficult and often requires analysis of subjective elements. Although not binding law, the IRS addresses the issue and provides some guidance on its website (Nonresident Alien Students and the Tax Home Concept and The Taxation of Capital Gains of Nonresident Alien Students, Scholars and Employees of Foreign Governments).
Clients and their advisors need to remember that just because an individual's days of presence in the U.S. do not count for purposes of the SPT, it does not mean that U.S. tax issues can be forgotten. This can be particularly important in a pre-immigration planning setting, where an individual is going to school in the U.S. with the intent to remain on a more permanent basis after finishing his or her course of study. Traditional pre-immigration planning techniques in this setting could have disastrous U.S. tax outcomes by triggering large amounts of capital gain that, as a result of the individual having a U.S. tax home, are subject to U.S. federal income tax.9 It should also be considered what effect spending that much time in the U.S. will have on the person's domicile status for U.S. gift and estate tax purposes.10
Additionally, it is important to remember that while classification as a student has important tax consequences, the starting point for the analysis is a matter of immigration law. In order to receive any of the tax benefits of being a student, the person must be in compliance with the terms of his or her student visa. Accordingly, immigration counsel should always be consulted to address these issues.
1 See generally, Code §§ 7701(b)(3) and
7701(b)(5), and Treas. Reg. § 301.7701-3. The student visa
exception is claimed by filing IRS Form 8843, Statement for
Exempt Individuals and Individuals with a Medical
2 See Treas. Reg. § 301.7701(b)-3(b)(8).
3 A transition rule in the Treasury regulations provides that the five year limitation applies only for those stated periods that occur after 1984. See Treas. Reg. § 301.7701(b)-3(b)(7)(iv). As an example: "an alien who is present as a student during the calendar years 1982-1990 will not be subject to the five year rule for students until 1990." Id.
4 In order to do this, the individual would file IRS Form 8843 and attach a statement explaining the situation. See IRS Form 8843, Line 12.
5 A number of facts and circumstances are analyzed in determining whether or not a "closer connection" to a foreign country exists. Such factors include, but are not limited to: (i) the location of the individual's permanent home; (ii) the location of the individual's family; and (iii) the location of personal belongings, such as automobiles, furniture, clothing and jewelry owned by the individual and his or her family. See Treas. Reg. § 301.7701(b)-2(d).
6 Compensation from the performance of services in the U.S. may also be taxable; however, individuals on a student visa should review the terms of their visa regarding what type of work is and is not prohibited while studying in the U.S.
7 See Code § 871(a)(2).
8 And further, there may not be an available offsetting foreign tax credit.
9 "Domicile" is a determination separate from an individual's "residency" status for U.S. income tax purposes. Although one might think that qualifying as a "student" is indicative of non-U.S. domiciliary status, it is far from definitive, and it could very well be that a foreign student studying in the U.S. is considered to be a U.S. domiciliary based on the facts and circumstances.
10 Status as a U.S. domiciliary would pose challenges for clients who intended to make gifts prior to moving to the U.S.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.