The IRS has been busy, and this time, that is a good thing. Within the past couple weeks, they have released two Revenue Procedures (Rev. Proc.) and one frequently asked questions (FAQ) that explains how treatment of cross-border activities will change in light of the COVID-19 disruptions. Mandated quarantines and travel restrictions can easily affect tax residency tests and international treaties provisions. To provide relief to international business executives and others, the IRS made changes affecting tax residency, claiming benefits under an income tax treaty and excluding foreign income. To help clients, prospects and others, Clayton & McKervey has provided a summary of key changes below.
Determining U.S. Tax Residency
Business travelers were forced to change their plans when airlines began cancelling flights, countries temporarily closed borders, quarantines were mandated, and hospitalizations were required. These obstacles forced many foreign travelers to stay in the U.S. for longer than planned, and some stayed for so long, it inadvertently established U.S. tax residencies. Typically, individuals will be considered U.S. tax residents (and have a U.S. tax filing responsibility) when they meet the following substantial presence test:
- They are in the U.S. for at least 31 days in a year, and
- The sum of the following is at least 183 days:
- Days they were in the U.S. this year
- 1/3 of the days they were in the U.S. last year
- 1/6 of the days they were in the U.S. two years ago
One exception to this rule is when a medical condition exists that prevents a return home trip. Although COVID-19 hospitalizations may fall into this category, flight cancellations or border closures would not – that is, until the IRS published Revenue Procedure 2020-20.
Rev. Proc. 2020-20 expands the medical condition exception to almost all COVID-19 emergencies, medical or procedural. When international travel is suspended or delayed from the coronavirus, a single period of up to 60 consecutive calendar days can be selected by the individuals starting on or after February 1, 2020, and on or before April 1, 2020, to be excluded from these travelers’ U.S. substantial presence tests.
The relief under Rev. Proc. 2020-20 does not change the application of other applicable exceptions to the substantial presence test such as the closer connection exception. Individuals who qualify for other exceptions do not need to claim this COVID-19 exception in order to claim other exceptions; an individual may choose to claim all exception for which they are eligible.
When Inadvertently Engaging in U.S. Activity
Foreign individuals and companies that conduct business in the U.S. are deemed to be operating a U.S. trade or business. Unless a U.S. income tax treaty exception applies, these individuals and companies are generally taxed in the U.S. on the business income connected to the U.S. trade or business. When coronavirus-related flight delays and border closings altered travel plans, some were forced to perform business activities for foreign companies while they remained in the U.S. In a recent FAQ document, the IRS states that the same 60-day exemption period in Rev. Proc. 2020-20 applies to these individuals and companies. If the entity would have otherwise chosen to conduct business from outside of U.S. borders, their activity would not qualify, and they would not be subject to U.S. income tax.
Claiming the COVID-19 Medical Condition Travel Exception
If an individual has a requirement to file a U.S. non-resident Form 1040-NR, a Form 8843, “Statement for Exempt Individuals and Individuals with a Medical Condition,” needs to be attached to the Form 1040-NR to claim the COVID-19 medical condition travel exception. Without a Form 1040-NR filing requirement, an individual must retain relevant records to support reliance on Rev. Proc. 2020-20 and complete Form 8843 only if requested by the IRS.
When Excluding Foreign Earned Income
Under Section 911(d) of the U.S. tax code, U.S. citizens can exclude foreign earned income and certain housing costs from their U.S. tax returns if – among other requirements – they are present in a foreign country for at least 330 full days. During the coronavirus outbreak, many were forced to return home and were therefore unable to meet this 330-day requirement. Fortunately, Revenue Procedure 2020-27 provides temporary relief from this requirement.
If a U.S. citizen would have otherwise established residency in the foreign country but failed to meet the 330-day requirement because of the coronavirus emergency, they can continue to exclude foreign earned income from their U.S. tax returns. The emergency period extends from February 1, 2020, to July 15, 2020, globally, but for citizens working in China, this period begins two months earlier on December 1, 2019.
The economic impact of the COVID-19 emergency continues despite numerous relief efforts from the federal government. The updated rules are designed to help U.S. and international companies manage the tax implications caused by this extraordinary situation. If you have questions about the information outlined above or need assistance with another issue, Clayton & McKervey can help. For additional information call us at 248- 208-8860 or click here to contact us.
The above represents our best understanding and interpretation of the material covered as of the date of this post. Things are moving at a rapid pace, and as such, information is subject to change. This information is provided for informational purposes only and is not intended to be a substitute for obtaining accounting, tax, or financial advice from an accountant.