Three Notable Changes to Cross-Border Taxation in Response to the COVID-19 Pandemic
The U.S. government’s economic response to the COVID-19 pandemic has taken a number of forms, including stimulus payments to individuals, economic relief for small businesses, extended reporting deadlines, and many other efforts.
As a part of these efforts, the IRS has now even taken aim at softening some of the cross-border taxation rules. While these changes may seem somewhat minor at first blush, they are worth paying attention to as they could have a significant impact for both US expats living abroad and non-US individuals connected to the US during the 2020 year.
In this blog, we highlight three notable changes to the cross-border tax rules recently announced by the IRS:
Change #1 – COVID-19 and US Tax Residency
The tax residency of non-U.S. citizens (referred to in the tax world as “aliens”) greatly affects the extent to which U.S. tax filings are required. While resident aliens, like citizens, report worldwide income on a Form 1040, nonresident aliens basically only report US source income and income generated from a U.S. trade or business on the more condensed Form 1040-NR (Nonresident Alien Income Tax Return).
A non-citizen will be considered a U.S. tax resident if he or she meets one of two tests: (1) the “lawful permanent residence” or green card test or (2) the “substantial presence” test.
Under the substantial presence test, an individual will be considered a U.S. resident for tax purposes if he or she is physically present in the United States on at least: (a) 31 days during the current calendar year; and (b) A total of 183 days during the current year and the 2 preceding years, counting all the days of physical presence in the current year, but only one-third the number of days of presence in the first preceding year, and only one-sixth the number of days in the second preceding year.
For purposes of the substantial presence test, the IRS has announced, in response to the COVID-19 pandemic, up to 60 consecutive calendar days of U.S. presence that are presumed to arise from travel disruptions caused by the COVID-19 emergency will not be counted for purposes of determining U.S. tax residency.
The 60-day reprieve also applies for purposes of determining whether an individual qualifies for tax treaty benefits for income from personal services performed in the United States.
Change # 2 – COVID-19 and US Economic Nexus
Similar to individuals, foreign corporations can be taxed in the U.S. depending on the extent of their economic nexus to the United States.
In this regard, the IRS has announced, in response to the COVID-19 pandemic, that certain U.S. business activities conducted by a foreign corporation (or nonresident alien) will not be counted for up to 60 consecutive calendar days in determining whether the individual or entity is engaged in a U.S. trade or business or has a U.S. permanent establishment, but only if those activities would not have been conducted in the United States but for travel disruptions arising from the COVID-19 emergency.
The IRS has also provided reporting relief to U.S. persons that temporarily did business in foreign countries because of travel disruptions. Specifically, temporary activities will not trigger an obligation to file (1) Form 8858 with respect to foreign disregarded entities and foreign branches, or (2) Form 8865 with respect to a controlled foreign partnership.
Change #3 – COVID-19 and the Foreign Earned Income Exclusion
The rule change that is most relevant for U.S. citizens living abroad relates to the Foreign Earned Income Exclusion, an expat tax basic concept.
If you can establish that your tax home is outside the U.S. (which includes the requirement that you do not have an abode in the U.S.) and can satisfy either the “bona fide residence” test or the “physical presence” test, you can exclude your foreign income from U.S. tax. The latter test is passed if you are present in a foreign country for 330 full days during a period of 12 consecutive months.
In response to the COVID-19 emergency, the IRS has announced that qualification for the foreign earned income exclusion will not be impacted as a result of days spent away from a foreign country due to the COVID-19 emergency based on certain departure dates (for countries other than China, the exemption currently applies from February 1 through July 15).
The IRS gives the following example to illustrate how the exemption works:
An individual who was present in the United Kingdom on January 1 through March 1, 2020, establishes that he or she reasonably expected to work in the United Kingdom for the entire calendar year, but departed the United Kingdom on March 2, 2020, due to the COVID-19 Emergency, and returns to the United Kingdom on August 25, 2020, for the remainder of the calendar year, would be a qualified individual for 2020 with respect to the period between January 1 through March 1, 2020, and August 25 through December 31, 2020, assuming the individual has met the other requirements for qualification under section 911.
Expat tax filers who have had travel plans affected by COVID-19 should store this away as an important rule change to keep in mind when filing next year.