Closer connection exception
Even if James meets the substantial presence test, he can still avoid being labeled a U.S. resident by filing a Form 8840 with the IRS. This form has the coldly cumbersome name “Closer Connection Exception Statement For Aliens.” James can complete this form if he was present in the U.S. for fewer than 183 days in the current year, can establish a tax home in Canada in the current year, and can establish a closer connection to the tax home in Canada than to the U.S. By filing this form, James would still be considered a non-resident of the U.S.
Read: Tax cheats beware
Form 8840 asks James a barrage of questions to support his claims that his personal, social and economic ties in the latest tax year are closer to Canada than to the US. The IRS wants to know the location of his permanent home, where his family resides, where his automobile is registered, and where he keeps his personal belongings. Among other things, the form also asks where he conducts his banking relationships, where his driver’s license was issued, where he is registered to vote, and the locations of personal, financial and legal documents. The form even requests the location of investments and whether James qualifies for any type of national health plan sponsored by a foreign government. About the only thing it doesn’t want to know about is information about his birthmarks.
As intrusive as it may sound, Form 8840 has to be filed with the IRS by June 15 in the year following the year in which the substantial presence test is met. If James doesn’t file on time, he may not be eligible to claim the closer connection exception and may be treated as a U.S. resident. As well, he could also face other penalties.
The tax treaty ‘tie breaker’
If James spent 183 days or more in the US then he cannot complete Form 8840, however, James may still be able to avoid being considered a U.S. resident under the Canada – U.S. Tax Treaty. To avail himself of what is commonly known as the ‘tie breaker’ rule under the treaty, James will have to fill out IRS Form 8833, “Treaty-Based Return Position Disclosure.” The disclosure required in this case is much more rigorous and complicated than on the ‘Closer Connection’ form. In fact, James would be well advised to seek out a tax expert who specializes in this area. Like the ‘Closer Connection’ form, the ‘Treaty Position’ form must be filed with the IRS by June 15 in the year following. Failure to file on time could make James ineligible to claim the treaty position and he might then be treated as a U.S. resident. And again, other penalties could be assessed.
Read: Common U.S. tax troubles
As you and your clients are no doubt aware, there have been numerous stories in recent months about the efforts of the IRS to have delinquent U.S. tax filers get their returns up to date. Against the backdrop of U.S. deficit and public debt woes, the IRS naturally is seeking to expand tax revenues wherever possible. That makes it imperative that your clients stay within the residency rules.
Many clients will benefit
It’s very likely that there are many James’ in your client lists. As an advisor, you can be of great assistance by making them aware of U.S. residency requirements for tax purposes and, above all, explaining them to ensure that they don’t inadvertently fall offside. Once they understand the potential pitfalls, they’ll be grateful that they’ve avoided a US tax filing, or worse, a US tax liability.