The Oxford English Dictionary defines residency as “the fact of living in a place.” As simple as this definition may be, the concept of residency as applied to financial planning is notably more nuanced. When working with expatriates in particular, conflicting types of residency can be a major source of confusion.
It is important to understand the varying definitions of residency in legal, tax and estate contexts for more sound financial planning. Contrary to what one may expect, the meaning and determination of residency differ across these separate realms.
To begin with, it’s worth noting the distinction between residency and domicile, another concept often used to describe one’s home. Though similar in meaning, these two terms cannot be used interchangeably for there are important differences with regards to tax, immigration and estate planning.
A residence is a home where someone may live for a temporary period. A domicile, on the other hand, is a concept used to describe where an individual intends to be their permanent home. In this way, domicile is subjective; it is predicated on one’s intent to return to and remain in a location. While you can have multiple residences, you cannot have multiple domiciles.
Given that states and countries abide by different laws, determining your residence(s) and domicile is important for identifying what tax obligations and judicial orders you must follow.
From a legal standpoint, U.S. residency can be attained temporarily or permanently through bureaucratic procedure and is often discussed in the context of immigration. Several avenues exist, such as issuance of a permanent resident card (or “green card”), and certain work and student visas.
In the lenses of U.S. tax law, legal residence does not necessarily determine who owes state and federal taxes—though lawful permanent residence through a green card can indeed qualify an individual as a tax resident. However, it is also possible for someone to reside illegally in the U.S. and yet owe state and federal income taxes.
How is this possible? Apart from the green card test, an individual may also qualify as a resident for tax purposes based on physical presence. Using a calculation known as the “substantial presence” test, tax residency requires:
Federal estate taxation uses yet another way of determining residency—one based on domicile rather than presence. In the context of estate planning, domicile determines where one’s will is probated as well as whether property ownership is shared with a spouse. An unclear domicile may lead to estate taxes from multiple jurisdictions and complicate details like the size of one’s estate left to heirs.
Given that domicile reflects a state of mind, how does one go about proving their intent to live somewhere long-term? Declaring one’s intention to live somewhere is not enough; if this were the case, many people would claim a home with the fewest tax liabilities as their domicile. Rather, to determine domiciliary intention, authorities look at criteria like:
The concepts of residency and domicile have major ramifications for tax and estate planning. Only when an individual understands their tax residence can they begin financial planning. After all, without full awareness of one’s tax liabilities, creating a financial strategy would be fruitless.
Of course, taxpayers who move in and out of the country may find themselves in a precarious financial position.
The U.S. is the only developed country that practices citizenship based on taxation; that is, American citizens and permanent residents living overseas are subject to U.S. taxation on their worldwide income no matter where they are based. Stated differently, while a U.S. citizen or permanent resident may be living overseas and therefore be a tax resident of that foreign country, they are also tax residents of the U.S. This does not apply in reverse, however.
Thus, Non-Resident Aliens’ (NRAs) only U.S. tax obligation is for income determined to be from a U.S. source (aka U.S. situs income). Yet it is possible for an individual to be a “dual-status alien,” a designation that refers not to citizenship but rather, resident status for tax purposes. In this case, dual-status taxpayers were both resident aliens and nonresident aliens in a single tax year—and as a result, generally require two returns based on their different sources of income.
Complicating matters further, individuals that earned income abroad may qualify for exclusions like the foreign earned income exclusion and foreign housing expenses exclusion. However, the exact stipulations of tax treatment vary between states; some states, like California and New Jersey, do not allow the foreign earned income exclusion when determining taxable income.
Depending on their residency and domicile then, expatriates in the U.S. and American taxpayers face several challenges when trying to plan their finances. The complexity of the U.S.’s tax code speaks volumes to the value of having a qualified expert help navigate domestic and multinational planning.
To learn more about how to better serve cross-border clients, consider signing up for our Global Financial Planning Master Class.
The CPA Journal. “U.S. Tax Residency.”
Deloitte. “Taxation of foreign nationals by the US—2016.”
International Tax Blog. “U.S. ‘State’ Tax Residency (Domicile).”
KPMG. “U.S. taxation of Americans abroad.”
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