Avoiding Canadian winters by heading to the warmer climate of the southern United States has long been a common goal for Canadian retirees. These snowbirds look to enjoy the warm weather while maintaining their Canadian ties. For many it's a great way to spend a part of their retirement, as long as they are aware of the potential tax consequences.
Many of them are just like the parents of my friends, a healthy sun-seeking couple named Mary and James. They're well-to-do and readily able to afford a few months in Florida's warmth, and they think they have all the knowledge they need to avoid any tax or financial pitfalls that may be caused by their extended time in the U.S. At a gathering recently, James confidently told me he and Mary have no fears that their sojourn down south will cause them to be considered as U.S. residents for tax purposes. He and his wife hold to the conventional wisdom that says if you spend fewer than 183 days in the U.S., the Internal Revenue Service will leave you alone.
He seemed a bit surprised when I told him that he had fallen into a common misconception about U.S. residency requirements. The reality is more complicated than staying under the 183 day barrier. U.S. visitors like James are subjected to what the IRS calls a 'substantial presence' test to see if they will be deemed to be U.S. residents for tax purposes. Indeed, you may well have clients just like James, people in need of some useful advice about the intricacies of U.S. residency requirements before they head for the border.
What makes a U.S. resident?
Anyone who meets the IRS's substantial presence test will be considered a U.S. resident and will therefore have to comply with certain U.S. tax laws. That's the simple reality. The test itself, however, is a little more complicated, making it essential that Canadians who plan to stay in the U.S. for extended periods count their days carefully to ensure they don't go over the threshold.
The first thing your clients need to know is that the IRS has its own definition of what constitutes a day, and it isn't necessarily 24 hours. For the purpose of calculating residency, a day can be any part of a 24-hour-period in which an individual is physically on U.S. soil. So, for example, an early morning trip to the airport for a flight back to Canada would count as a full day (not a partial day) in the calculation.
Given this caveat, the IRS imposes its substantial presence test this way: you qualify as an U.S. resident for tax purposes if you have been physically present in the U.S. for 31 days during the current year, and for 183 days on a weighted average basis in the three years that include the current year and the two preceding years.
Here's where the calculation becomes a bit more complicated for your clients (and allows a bit of leniency for taxpayers). To arrive at that three-year total, the IRS allows them to add the number of days they were in the U.S. during the current year to one third of their total U.S. days in the previous year and one sixth of their U.S. days the year before that. If the total is less than 183 days, generally residency isn't established. If it's 183 days or more, your clients could have a problem.
As an example, let's assume that James will spend 120 days in the U.S. this year, and that he spent the same number of days there in each of the preceding two years. His calculation under the substantial presence test for the three years will then be 120 plus 40 (1/3 of 120) plus 20 (1/6th of 120) for a total of 180 days. He won't qualify as a U.S. resident. Of course, had James spent an extra 10 days in the U.S. last year, he would have incurred an extra three days under the formula. That would have pushed him to the 183-day threshold, making him a U.S. resident for tax purposes.