This simple question is the starting point for many of our client relationships. The answer drives tax advice and choices with wide-ranging impact on work and economic life. Since we deal mostly with clients who live in Switzerland and the United States, we will highlight the rules for those two places.
RESIDENCY FOR TAX PURPOSES IN SWITZERLAND
An individual is a Swiss resident for tax purposes if one of these conditions is met:
- He or she maintains a tax domicilein Switzerland, or
- He or she has a tax residencein Switzerland.
A domicile is defined as a place where the person lives and plans to stay permanently. It is about more than taxes and work; the person maintains relationships and spends their non-working hours there. They have friendships and perhaps family ties in the area.
A tax residence has a more practical definition. If a person has a place of abode where they stay for a minimum of 30 days, irrespective of short interruptions, and combine that stay with gainful activity, or they stay a minimum of 90 days without gainful activity.
Taxable persons in Switzerland include legal entities, or companies. (This includes stock companies, limited liability companies, stock companies with unlimited partners, cooperatives, associations and foundations, investment companies with fixed capital, and collective investment schemes with a direct investment in real estate). These entities are residents for tax purposes in Switzerland if their legal domicile is in Switzerland, which means the place of effective management is in Switzerland, and if it is formally incorporated in Switzerland and it is registered in a commercial registry. “Place of anagement” means Switzerland is where important company decisions are made and the manager of the company resides, or the major shareholder resides in Switzerland and is actively involved in decision-making at the company.
RESIDENCY STATUS AND TAX IMPLICATIONS IN THE UNITED STATES
Why does it matter how many days I spend in the United States if I am an alien, not a US citizen and not green card holder?
A US resident alien is taxed exactly as a United States citizen is taxed: all income is taxed. However, a nonresident alien is taxed only on certain income. [See the information on the differences in tax liability between these groups below.]
Any green card holder is automatically given resident status and taxed as a US citizen would be.
Who is and is not a nonresident alien is determined by IRS rules. Several spell out just how long a nonresident can be in the US before triggering a change in residency status and becoming a resident alien – and being taxed on all income.
The Substantial Presence formula
To be considered a resident for tax purposes, an alien must be present in the United States, including territorial waters, for:
- 31 days during the current year, and
- 183 days during the 3-year period that includes the current year and the 2 years immediately before that, counting:
- All the days you were present in the current year, and
- 1/3 of the days you were present in the first year before the current year, and
- 1/6 of the days you were present in the second year before the current year.
To make it easier, we developed an example to help you understand residency status for tax purposes. You can use the example to determine your status by figuring out your resident days, multiplying each year by the factor amount, then adding up each factored year:
|Second previous year
|Total resident days
|If Total Resident Days is less than 183, you are not considered by the IRS to be a resident alien for tax purposes.
What are the specific US tax liabilities you will incur if you are designated a resident for tax purposes or a nonresident?
If an alien is deemed a U.S. resident for income tax purposes:
(1) Taxpayer pays U.S. income tax at regular rates on all of worldwide income, but the taxpayer may be entitled to a foreign tax credit for foreign taxes paid on his foreign-source income.
(2) Pays tax on all interest income, whether derived from U.S. banks and savings institutions, from Eurodollar bonds or otherwise. The taxpayer can, however, obtain tax-free interest from U.S. municipal bonds.
(3) Pays U.S. income tax on capital gains derived from anywhere in the world. Gain is determined by reference to a historic cost basis in U.S. dollars, even if the property was acquired many years before becoming a U.S. resident.
(4) Owning shares in a foreign corporation may subject the taxpayer to current U.S. tax on his pro-rata share of the corporation’s undistributed earnings if the foreign corporation is a controlled foreign corporation (CFC) or a passive foreign investment company (PFIC).
(5) Transfers of appreciated property to a foreign corporation or a foreign partnership are subject to the same rules that apply to a U.S. citizen who
makes those transfers.
(6) Taxpayer becomes subject to the net investment income tax (“NIIT”).
(7) The taxpayer is required to file a FinCEN Form 114 (what, at one time, was the Form TD F 90-22.1)—that is, the FBAR form—when holding the appropriate bank or securities account.
(8) Taxpayer is required to file Form 8938 if his “specified foreign assets” meet the required threshold.
(9) Taxpayer is not necessarily a resident of the United States for estate and gift tax purposes. That would depend on a separate determination of his domicile under a different set of rules.
If the alien is nonresident, the individual is subject to a substantially different tax regime:
(1) Does not pay any U.S. income tax on his foreign-source income except under very limited circumstances.
(2) Pays U.S. income tax at regular rates on any income that is effectively connected with the conduct of a U.S. trade or business.
(3) Pays a maximum 30-percent U.S. withholding tax on dividends, some interest, and other investment income that he derives from U.S. sources. The 30-percent U.S. tax rate may be reduced or eliminated by favorable income tax treaty provisions. However, anti-treaty-shopping rules may restrict the non-resident’s ability to use third-country treaties.
(4) Interest income derived by the non-resident’s from U.S. banks and savings institutions or from Eurodollar bonds is tax free.
(5) Pays U.S. income tax on his capital gains from the sale of U.S. real property interests, but does not pay any U.S. tax on most other capital gains from U.S. or foreign sources.