Because of travel restrictions, such as canceled flights and stay-at-home orders, the COVID-19 pandemic may have significantly limited a nonresident alien’s ability to leave the United States, regardless of whether the individual contracted the COVID-19 virus. An unexpected extended stay in the United States, however, could affect an individual’s tax residency classification or eligibility for certain tax treaty benefits. The Internal Revenue Service (IRS) recently released Revenue Procedure 2020-20 to address the potential tax consequences for eligible individuals impacted by the COVID-19 travel restrictions.
Substantial Presence Test for Tax Residency
An individual who is not a United States citizen (i.e., a foreign individual) may be classified as a resident alien or nonresident alien for federal income tax purposes. In general, if a foreign individual is classified as a resident alien, the individual’s worldwide income is subject to federal income tax. However, if the foreign individual is classified as a nonresident alien, only the individual’s U.S. source income is subject to federal income tax. Therefore, a foreign individual’s classification for tax purposes can have a major effect on the individual’s tax liability.
A foreign individual may be classified as a resident alien for federal income tax purposes if the individual meets the “substantial presence test.” An individual satisfies this test if he or she is physically present in the United States for at least 31 days in the current year and 183 days or more during the current and preceding 2 calendar years as determined under a special lookback formula. However, depending on the facts and circumstances, an individual may be able to exclude the days that he or she intended to leave the United States but was unable to do so because of an unforeseeable medical condition that arose while in the United States. There are additional exclusions from the substantial presence test, including for certain statutorily exempt individuals that are beyond the scope of this article.
To claim the medical condition exception under the substantial presence test, the individual must file IRS Form 8843, Statement for Exempt Individuals and Individuals with a Medical Condition, which requires a description of the medical condition and a physician’s statement. Because of the IRS’s narrow interpretation of the rules, it may be challenging for an individual to qualify for the medical condition exception.
Tax Treaty Benefits
The United States has bilateral income tax treaties with other countries that may modify the general federal income tax rules for nonresident aliens employed in the United States. Under many tax treaties, a nonresident alien may be able to exclude income earned from personal services performed in the United States if, among other requirements, the nonresident alien is present in the United States no more than 183 days during a 12-month period. Similar to the medical condition exception for the substantial presence test, the nonresident alien can exclude days on which a medical condition prevented the individual from leaving the United States.
Revenue Procedure 2020-20
Medical Condition Travel Exception
The IRS issued Revenue Procedure 2020-20 (and a list of frequently asked questions) to provide a new exception for certain nonresident aliens remaining in the United States due to COVID-19–related travel restrictions. In accordance with the revenue procedure, an eligible nonresident alien may be able to claim a COVID-19 medical condition travel exception (COVID-19 Exception) for a period of up to 60 consecutive days starting on or after February 1, 2020, and on or before April 1, 2020 (COVID-19 Period). During this period, the individual’s presence in the United States may be excluded for purposes of applying the substantial presence test and for purposes of determining tax treaty benefits with respect to dependent personal services income.
Under the COVID-19 Exception, the eligible nonresident alien is not required to have contracted the virus and is presumed to have intended to leave the United States during the COVID-19 Period, unless the individual has taken steps to become a permanent resident. All other exceptions to the substantial presence test also remain available to the individual if the requirements of an exception are met. For example, if an individual develops a medical problem related to the virus, the individual may be able to claim a medical condition exception for the days not covered by the COVID-19 Exception.
Procedures to Claim the COVID-19 Exception
To claim the COVID-19 Exception, nonresident aliens with a filing requirement must complete and attach the Form 8843 to their Form 1040-NR, U.S. Nonresident Alien Income Tax Return, and file it by the due date of the return (including extensions). Generally, nonresident aliens must file a Form 1040-NR if they are engaged in a trade or business.
Nonresident aliens without a Form 1040-NR filing obligation may claim the COVID-19 Exception without filing a Form 8843. However, as instructed by Revenue Procedure 2020-20, they should retain records used to substantiate their claim, including those necessary to complete a Form 8843 in the event the documents are requested later by the IRS.
A nonresident alien required to file a Form 8843 for the COVID-19 Exception must follow the special instructions provided in Revenue Procedure 2020-20. These special instructions alert the IRS that the nonresident alien is claiming the COVID-19 Exception. If the nonresident alien fails to timely file a Form 8843, the individual may still be able to take advantage of the COVID-19 Exception if the IRS grants relief for the late filing.
Nonresident aliens can certify that income from dependent personal services is exempt from withholding of income tax under the provisions of a U.S. income tax treaty by providing their employer or other withholding agent with a Form 8233, Exemption From Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Nonresident Alien Individual, in accordance with the revenue procedure.
Revenue Procedure 2020-20 may provide significant tax relief for nonresident aliens stranded in the United States due to pandemic-related travel restrictions. However, the revenue procedure is limited in scope, and nonresident aliens may need to rely on other exceptions instead of, or in addition to, the COVID-19 Exception for maximum tax relief.