The United States taxes individuals primarily on citizenship rather than on residence. This “U.S. person‑based” regime means that U.S. citizens, lawful permanent residents (green‑card holders), and certain foreign nationals who satisfy the substantial presence test are subject to U.S. tax on worldwide income and must file specific forms, even if they live abroad.
The substantial presence test
To be treated as a U.S. tax resident for a calendar year, a person must:
- Be physically present in the United States for at least 31 days during the current year, and
- Accumulate 183 days over the current year and the two preceding years, using the weighted formula:
| Year | Weight | Days counted |
|---|---|---|
| Current year | 1 | Full days |
| Prior year | 1/3 | One‑third of days |
| Two years ago | 1/6 | One‑sixth of days |
Example – 120 days present in each of 2020, 2021, 2022:
2022 = 120 days (full)
2021 = 120 × 1/3 = 40 days
2020 = 120 × 1/6 = 20 days
Total = 180 days → below the 183‑day threshold, so no residency for 2022.
Practical tip: Keep a detailed travel log and ensure total weighted days stay under 183 to avoid automatic residency.
U.S.–situs assets
U.S. tax law treats certain assets as “U.S.–situs,” subjecting them to U.S. estate and income tax regardless of the owner’s residence. These include:
- Real estate and other tangible personal property located in the U.S.
- Business assets physically situated in the U.S.
- Stock or ownership interests in U.S. corporations (public or private) and U.S. partnerships
- Loans from U.S. persons or companies
Exempt from the definition are Treasury bills, U.S. government bonds, and other sovereign securities.
Implication: Owning any of the above triggers U.S. tax obligations. Tax treaties—currently ranging from 18 % to 40 % on certain income—may reduce the effective rate, but the assets remain taxable.
Strategies for U.S.–situs assets
- Foreign trust: Placing U.S.–situs assets into a foreign trust can provide asset protection, succession planning, and some mitigation of litigation risk. The trade‑off is reduced direct control over the assets.
- Foreign corporation: For many individuals whose primary goal is to avoid U.S. estate tax, holding assets through a foreign corporation may be sufficient, without the complexity of a trust.
U.S. source income categories
FDAP (Fixed, Determinable, Annual, Periodic) income
- Includes passive income such as dividends, interest, and rent.
- Generally subject to a 30 % withholding tax on non‑resident aliens, unless a tax treaty provides a lower rate or exemption.
- Capital gains on U.S. assets are usually exempt for non‑resident aliens.
ECI (Effectively Connected Income)
- Income that is “effectively connected” with a U.S. trade or business (e.g., business profits, certain rental income elected as ECI).
- Allows deduction of related expenses (maintenance, depreciation, commissions, etc.).
- Taxed at the same progressive rates that apply to U.S. residents.
Key distinction: FDAP income is taxed at a flat withholding rate with limited deductions, while ECI permits expense deductions and is taxed on a graduated scale.
Practical considerations
- Early assessment: Review travel patterns, asset holdings, and income sources well before relocating or acquiring U.S. assets.
- Treaty analysis: Identify applicable tax treaties to potentially lower FDAP withholding or avoid double taxation.
- Entity selection: Choose between a foreign trust, foreign corporation, or other structure based on the complexity of the estate, litigation exposure, and succession goals.
- Compliance: Even if you avoid residency, filing requirements (e.g., Form 8840 for “Closer Connection” or Form 8938 for foreign assets) may still apply.
By understanding the substantial presence test, the scope of U.S.–situs assets, and the differences between FDAP and ECI, high‑net‑worth individuals can structure their affairs to minimize unintended U.S. tax exposure.
