COVID-19 Tax Relief for Nonresident Alien Individuals and U.S. Persons Living Abroad
The Internal Revenue Service (IRS) has provided guidance in Revenue Procedure 2020-20 related to nonresident alien individuals and their ability to claim a medical condition travel exception to the substantial presence test. This is critically important because the substantial presence test controls how nonresident aliens are taxed (as either a resident or nonresident of the United States) in many situations. Additionally, the IRS has provided guidance in Revenue Procedure 2020-27 to U.S. persons living abroad related to the physical presence test and the impact on the foreign earned income exclusion calculation.
Revenue Procedure 2020-20: Defining Resident and Nonresident Status
As background, Internal Revenue Code (IRC) section 7701(b) defines resident and nonresident alien individuals for purposes of the IRC and the applicable taxation treatment. Unless an exception applies, alien individuals who are not lawful permanent residents (i.e., green card holders) and who meet the substantial presence test for a given calendar year are generally treated as U.S. residents for that year and taxed on their worldwide income (versus taxed on only their U.S. source income as a nonresident).
The substantial presence test is met if:
- The individual is present in the U.S. on at least 31 days during the calendar year, and
- If the sum of the following exceeds 183 days:
- The number of days of presence in the current year,
- 1/3 of the number of days of presence in the preceding calendar year, and
- 1/6 of the number of days of presence in the second preceding calendar year.
With the national state of emergency that President Trump declared on March 13, 2020, many individuals are subject to travel restrictions on travel to and from the U.S. As a result, they may end up staying more days in the U.S. than they previously intended, which may trigger the substantial presence test leading to a determination that they are a U.S. resident for 2020.
Understanding the Medical Condition Exemption
However, when applying the substantial presence test, an alien individual may exclude certain days of presence in the U.S., including if the individual qualified for the Medical Condition Exception (MCE). The MCE provides that an alien individual is not treated as present in the U.S. on days when the individual was unable to leave the U.S. as a result of a medical condition that arose while the individual was present in the U.S. A medical condition will not be considered to arise while the individual is present in the U.S. if the condition or problem existed before the individual’s arrival in the U.S. and the individual was aware of the condition or problem.
The IRS provided much needed guidance related to the MCE in Revenue Procedure 2020-20. The revenue procedure applies to eligible individuals who would not have been in the U.S. long enough during 2020 to be considered a resident alien under the substantial presence test or to be ineligible for treaty benefits on services income if the COVID-19 emergency had not happened. Eligible individuals do not have to be diagnosed with the COVID-19 virus to take advantage of this relief.
This leads into some necessary definitions:
- Eligible individual – any individual who is
- Not a U.S. resident at the close of the 2019 tax year;
- Not a lawful permanent resident at any point in 2020;
- Is present in the U.S. on each of the days of the individual’s COVID-19 Emergency Period; and
- Does not become a U.S. resident in 2020 due to days of presence in the U.S. outside of the individual’s COVID-19 emergency period.
- COVID-19 Emergency Period – a single period of up to 60 consecutive calendar days selected by the individual starting on or after Feb. 1, 2020 and on or before April 1, 2020, during which the individual was physically present in the U.S. on each day.
How to Qualify for the Medical Condition Exemption
In essence, the IRS is giving nonresident alien individuals an extra 60 days of physical presence in the U.S. to exclude from the substantial presence calculation pursuant to the MCE. However, in order to get the MCE, individuals must file Form 8843 – Statement for Exempt Individuals and Individuals with a Medical Condition and attach it to their Form 1040-NR, by the due date (including extensions) for filing Form 1040-NR. If Form 1040-NR is not required to be filed, the individuals are not required to File Form 8843. However, they must retain all relevant records and be prepared to produce the records and complete Form 8843 if requested to do so.
It is also important to note that consistent with the MCE, days spent in the U.S. due to an illness that prevents an individual from timely leaving the country are not taken into account in determining the availability of treaty benefits with respect to income from dependent personal services performed in the U.S.
Finally, Revenue Procedure 2020-20 includes specific instructions for claiming an exemption from tax on income from dependent personal services under a U.S. income tax treaty. For example, many U.S. income tax treaties exempt income from employment (or other dependent personal services) if the recipient is present in the U.S. for no more than 183 days in any 12-month period that begins or ends in the relevant tax year. For purposes of computing days of presence in the U.S. under this type of test, days on which an illness prevented the individual from leaving the U.S. are not counted.
Revenue Procedure 2020-27: Ability to Elect the Foreign Earned Income Exclusion Without Meeting the Normally Required Tests
The IRS has provided a waiver of the time requirements found in IRC section 911(d)(1). In order to understand this waiver, it is important to walk through IRC section 911 with a focus on the intent and audience for this specific section. Specifically, IRC section 911 relates to qualified individuals that live outside the U.S. and the ability to elect to exclude from gross income the individual’s foreign earned income and housing expenses.
As always, we need to start with a definition – a “qualified individual” (as defined in IRC section 911(d)(1)) is an individual whose tax home is a foreign country and who is:
- A citizen of the U.S. and establishes that they are bona fide (focused on the intent of the individual) resident of a foreign country or countries for an uninterrupted period that includes an entire taxable year, or
- A citizen or resident of the U.S. who, during any period of 12 consecutive months, is present in a foreign country or countries for at least 330 full days.
Additionally, IRC section 911(d)(4) provides that an individual will be treated as a qualified individual with respect to a period in which the individual was a bona fide resident of or was present in a foreign country if the individual left the country as a result of being required to leave because of war, civil unrest, or similar adverse conditions that precluded the normal conduct of business. An individual must be able to establish that, but for these conditions, they could have reasonably expected to meet the eligibility requirements. Previously, the IRS had listed countries for 2019 in which the waiver would apply.
However, in 2019 and 2020, Revenue Procedure 2020-27 provides some much needed relief. Revenue Procedure 2020-27 states that for purposes of IRC section 911(d)(4), the COVID-19 emergency is an adverse condition that precluded the normal conduct of business as follows:
- In the People’s Republic of China (excluding Hong Kong and Macau) as of Dec. 31, 2019, and
- Globally as of Feb. 1, 2020.
The period covered by the revenue procedure ends on July 15, 2020, unless specifically extended.
Thus, for purposes of IRC section 911, an individual who left China on or after Dec. 1, 2019 or another foreign country on or after Feb. 1, 2020 but before July 15, 2020, will be treated as a qualified individual with respect to the period during which that individual was present in, or was a bona fide resident of, that foreign country if the individual establishes a reasonable expectation that he or she would have met the requirement of IRC section 911(d)(1) but for the COVID-19 emergency. In order to qualify for this relief, an individual must have established residency or been physically present in the foreign country on or before the applicable date (Dec. 1, 2019 for China and Feb. 1, 2020 for all other foreign countries).
It is important to note that an individual may be able to use the excluded days in determining if the individual met the 330-day rule under the physical presence test for the foreign earned income exclusion. However, the individual must reduce the maximum foreign earned income exclusion amount by the days present in the U.S. regardless of the days being used in the physical presence calculation.
For example, an individual who arrived in China on Sept. 1, 2019 and establishes that he is reasonably expected to work in China until Sept. 1, 2020, but departed China on Jan. 19, 2020 due to the COVID-19 emergency. This individual would be a “qualified individual” for the period from Sept. 1, 2019 – Dec. 31, 2019 and for the period from Jan. 1, 2020 – Jan. 19, 2020 for purposes of the calculation. Another example included in the revenue procedure is that an individual who was present in the United Kingdom on Jan. 1, 2020 – 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 returned to the U.S. Then, on Aug. 25, 2020, she returned to the United Kingdom for the remainder of the calendar year. She would be a “qualified individual” for 2020 with respect to the period from Jan. 1, 2020 – March 1, 2020 and Aug. 25, 2020 – Dec. 31, 2020.
Revenue Procedures 2020-20 and 2020-27 provide some much needed relief from the substantial presence and physical presence rules. As with all IRS calculations, it is critically important that taxpayers keep contemporaneous records and support for any position taken on a tax return, in order to ensure that they can accurately defend their positions.
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