flags of Canada and U.S.

Heading south

Understanding U.S. tax residency & the Substantial Presence Test

High on the list for many Canadians (including snowbirds) who are preparing to spend extended periods of time in the U.S., is making sure they look like they’re home when they’re not. Arrangements to have mail collected, gardens tended, and, in the winter, snow shovelled and ice scraped away is important to ensure your primary home in Canada is taken care of while you’re enjoying warmer weather. 

But beyond housekeeping matters, there are other critical tasks on the to-do list – among them is keeping track of the number of days you spend in the U.S.

Why it’s important

Being meticulous about logging your time spent out of the country is important because under U.S. federal income tax law, a person that is physically present in the U.S. for a certain number of days is deemed to have tax residency in the United States under the Substantial Presence Test. This may mean you are required to file a U.S. federal income tax return and pay tax. 

Here’s how it works

The Substantial Presence Test calculates the person’s deemed tax residency in the current year, as follows:

  • Days present in U.S. in current year, plus
  • 1/3 of days present in U.S. in preceding year, plus
  • 1/6 of days present in U.S. in second preceding year.

Note: partial days count as whole days in this test.

If the above total is 183 days or more, and you are present in the U.S. for at least 31 days in the current year, you are deemed a resident for U.S. federal income tax purposes in the current year.

While this is commonly referred to as the “183-day rule,” you should note that the calculation in the test occurs over a three-year period. Therefore, you may be a deemed resident of the U.S. even if you are present in the U.S. for less than 183 days in each calendar year of the test.

Two ways to overcome deemed residency 

Fortunately, the U.S. tax code and the Canada–U.S. Tax Treaty offer a couple of ways you can overcome your deemed residency for U.S. federal income tax purposes under the Substantial Presence Test.

  1. Closer Connection ExceptionThe first way to overcome the Substantial Presence Test is to establish a closer connection to another country for tax residency purposes. You can do this by completing and filing Form 8840, “Closer Connection Exception Statement for Aliens,” with the Internal Revenue Service.  
  2. Canada – U.S. Tax Treaty ProvisionsIf you’re unable to claim the closer connection exception, the other way for you to overcome being a deemed resident of the U.S. is to rely on the residency tie-breaker provisions of the Canada–U.S. Tax Treaty. These treaty provisions apply where the laws of Canada and the U.S. both say a person is a tax resident and will deem the person to be a tax resident of one country and a non-resident of the other. Most commonly, from a Canadian viewpoint, these provisions are used where a person can establish a closer connection to Canada but has stayed in the U.S. for more than 183 days in the current year.

State tax residency rules may be different

Importantly, the Substantial Presence Test, the closer connection exception, and the treaty provisions outlined above apply only for purposes of U.S. federal income tax. Each U.S. state has their own income tax residency rules that apply separately. That means you could potentially be a non-resident of the U.S. for federal income tax purposes and a resident for state tax purposes. It’s important to get professional advice regarding the residency rules for the state(s) in which you spend time.

If you need advice on preserving your retirement plan while supporting adult children, speak to a Richardson Wealth Investment Advisor.

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