E-2 Visa and U.S Tax Implications
Recently, I received this question:
“Hello. I am a German citizen and 100% owner of a U.S. company (“U.S. Co”).
I lived in the United States (“U.S.”) for 30 days in 2019 and 45 days in 2020. I returned to the U.S. on July 21, 2021, with an E-2 Visa, and I will remain in the U.S. until December 31, 2021.
During the 2021 tax year, I’ve received management and director fees from U.S. Co, and all the work I did for those fees was performed here in the U.S.
I understand that U.S. Co must file Form 1120, to report and pay taxes on worldwide income. However, I’m not sure whether I need to file Form 1040 or Form 1040NR for my personal tax return. Can you enlighten me?”
Great question! Let’s dive right in.
Understanding Forms 1040 and 1040NR
U.S. Treasury Regulation Section §1.6012-1(a)(6), (b)(l)(i) states that:
- A U.S. Citizen must file their tax return using Form 1040
- Likewise, a U.S. Resident Alien must file their tax return using Form 1040
- In contrast, a Non-Resident Alien must file their tax return using Form 1040NR
Since we’re dealing with a question from someone who isn’t a U.S. citizen, we need to determine whether they are a U.S. Resident Alien or Non-Resident Alien.
U.S. Resident Aliens vs. Non-Resident Aliens
Section 7701(b) of the Internal Revenue Code (“IRC”) defines a Resident Alien as someone who meets at least one of the three following qualifications:
- They have been lawfully admitted for permanent residence in the United States and granted a Green Card
- They meet the Substantial Presence Test (“SPT”)
- They have made a first-year election to be treated as a Resident Alien
If any of these three conditions applies to an individual who is not a U.S. Citizen, then the IRS will consider them to be a U.S. Resident Alien. If none of these conditions apply, the IRS will consider the individual a Non-Resident Alien.
Note: As stated in IRC Section 864(b), the IRS still taxes Non-Resident Aliens if they have income effectively connected to a U.S. trade or business (“USTB”), or receive U.S.-source “fixed, determinable, annual, or periodic” – FDAP income.
Now, let’s turn our attention to the person who asked the question at the start of this article. Are they a U.S. Resident Alien or a Non-Resident Alien?
In this case, because the taxpayer hasn’t been granted a Green Card or invoked the first-year election to be treated as a Resident Alien, it will come down to the second qualification. Do they meet the Substantial Presence Test?
How the Substantial Presence Test Works
The SPT is based on how many days a person has spent in the U.S over a 3-year time period. You meet the SPT if BOTH of these conditions apply:
- You spent at least 31 days in the U.S. during the current year (2021, for this taxpayer)
- You spent a combined total of at least 183 days in the U.S. over the current year (2021) and the two previous years (2019 and 2020).
However, not all days spent in the U.S. count for this. It’s calculated on a weighted system. To figure out your “official” number of days spent in the U.S., you have to multiply the actual days spent in the U.S. as follows:
- 2nd preceding year (2019) – ⅙
- 1st preceding year (2020) – ⅓
- Current year (2021) – 1
Let’s look at the details of the taxpayer’s question again.
- In 2019, he spent 30 days in the U.S.
- In 2020, he spent 45 days in the U.S.
- In the current year (2021) he will be spending 163 days in the U.S. (July 21–December 31)
Using the weighted system mentioned above, our calculations would be:
Because the taxpayer will spend at least 31 days in the U.S. this year and will have spent at least 183 over the past three years by the end of 2021, they do meet the SPT standards. That means that the IRS will classify them as a Resident Alien for part of the 2021 tax year.
But what about the other part of the year?
Dual Status Alien Status
The taxpayers U.S. residency will be considered to have officially begun on July 21, 2021. Because it didn’t begin on January 1, he will be treated as a Dual-Status Alien for tax year 2021.
This means that he will be taxed as a Non-Resident Alien for U.S source income earned before July 21 and taxed as a Resident Alien for any income they earned on or after July 21. They will then be subsequently taxed as a Resident Alien until they leave the U.S. and establish a closer connection with a foreign country other than the U.S.
Treas. Reg. §1.871-13 instructs Dual-Status Aliens to:
File Form 1040 for any periods after you become a Resident Alien, reporting all income during that time—including sources of income outside or completely unconnected to the U.S.
There are also additional requirements for U.S. citizens and Resident Aliens to file the following forms (If Applicable):
- Report of Foreign Bank and Financial Accounts (FBAR)
- Form 8938, Statement of Specified Foreign Financial Assets
- Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts
- Form 3520-A, Annual Information Return of Foreign Trust with a U.S. Owner
- Form 5471, Information Return of U.S. Persons with Respect To Certain Foreign Corporations
- Form 8865, Return of U.S. Persons with Respect to Certain Foreign Partnerships
- Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation
- Attach Form 1040NR as a schedule, or as an information return, reporting U.S.-source income earned before becoming a Resident Alien—without needing to report income from non-U.S. or foreign sources.
But in the case of this taxpayer, there’s room for flexibility…
The Treaty Tie-Breaker Rules: How to Avoid U.S. Tax Residency
In cases where a German citizen qualifies as a resident of both the U.S. and Germany, the tie-breaker rules of Article 4 of the United States-Germany Tax Treaty state that the IRS must continue to treat you as a Non-Resident Alien.
In order to qualify as a resident of Germany, you must be liable to tax in Germany by reason of your domicile, residence, place of management, place of incorporation, or similar criteria. If the taxpayer can show that he is a tax resident of Germany under German law, they may be able to use the tie-breaker rules to shield themselves from the worldwide taxation regime applicable to U.S Citizens and Resident Aliens.
These rules also apply to citizens or residents of other countries that the U.S. has tax treaties with, as well.
You must have strong proof of tax residency in another country such as the location of your:
- Permanent home and family;
- Personal belongings, such as automobiles, furniture, clothing and jewelry owned by you and your family;
- Of social, political, cultural or religious organizations with which you have a current relationship;
- Where you conduct your routine personal banking activities;
- Where you conduct business activities (other than those that constitute your tax home);
- Of the jurisdiction in which you holds a driver’s license, votes etc.;
- Country of residence designated by you on forms and documents; and
- The types of official forms and documents filed by you, such as Form W-8 (Certificate of Foreign Status) or Form W-9 (Payer’s Request for Taxpayer Identification Number).
However. If you are unable to supply enough evidence of your connection to that foreign country, the IRS will conclude that you do not have a residency in a foreign country for income tax purposes and will subject you to worldwide taxation regime applicable to U.S Citizens and Resident Aliens.
According to Treas. Reg. 301.7701(b)-7, a U.S. Resident Alien who is claiming foreign residency under a treaty’s tie-breaker rules must file Form 1040NR with an attached Form 8833 in a timely manner. You can find further information throughout sections 6114 and 7701(b).
CAUTION: Invoking the treaty tie-breaker rule does not completely exempt you from U.S. income Tax. You will still have tax obligations as a Non-Resident Alien, but solely on income effectively connected to USTB, as well as FDAP income from U.S sources
Also, even if you are classified as a Non-Resident Alien on your income tax return by virtue of the tax treaty provision, you will still be treated as a Resident Alien for other tax and information filing requirements, such as Form 5471, FBAR, etc.
Under Section 6038D-2(e)(2), those invoking the treaty tie-breaker rules are exempt from filing Form 8938, as long as the individual properly discloses the treaty position on 1040NR and 8833.
Section 1.1298-1(c)(5)(ii) also provides exemption from filing form 8621, once again, the 1040NR and form 8833 must be timely filed.
Need Some More Help?
Hopefully, this article has helped clear up when individuals should file forms 1040 or 1040NR. But if you still have questions, I’d be happy to answer them!
I’m a licensed CPA with years of experience helping foreign business owners with their taxes. Just contact me, and I’ll be happy to answer all of your questions.
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- Gather all the necessary documents
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***Disclaimer: This communication is not intended as tax advice, and no tax accountant -client relationship results**