Fundamental Issues In U.S. Taxation of Foreign Entertainers and Athletes

Citizens

A basic principle of U.S. federal income taxation is that U.S. citizens are taxable in the United States on their worldwide income, a principle that distinguishes the U.S. from almost all other countries, and not in a good way. Tax regulations define “citizen” to include “every person born or naturalized in the United States and subject to its jurisdiction.” Treas. Reg. '1.1-1(c). The same regulation cross-references the Immigration and Nationality Act for additional definitions of “citizen.”

This rule seems like it is not worth even mentioning in an article on “foreign” entertainers and athletes, but our experience suggests otherwise.

For example, we have a client who was born in the United States and shortly after birth was whisked away by his parents to Northern Europe, where he has resided for all of his 37 years. He became a moderately successful European actor. When he began to try to leverage his European successes into a U.S. film career, he learned that the fact that he was a U.S. citizen meant that he had been obligated to file and pay tax to the United States ever since he began earning money, even though he had never set foot in the United States.

This is a topical issue because it has been reported that nonresident citizens are giving up their U.S. citizenship in record numbers, largely to put a stop to this very issue.

Resident Aliens ' In General

Similarly, and more logically, resident aliens are taxed in the United States on their worldwide income, while nonresident aliens are not. Obviously, it is important to be able to tell a resident alien from a nonresident alien.

Residency issues tend not to be important for most athletes or entertainers who perform or compete in the U.S. and then go back home. They typically are not in the United States long enough to become resident aliens. U.S. tax residence is primarily determined based on spending many days in the United States. (See below).

More and more, though, our foreign entertainment and music clients are staying in the United States longer and longer. They feel that they need to be here in order to develop relationships and obtain employment in their particular fields. This raises the specter of tax residency.

Resident Aliens ' Green Card Test

One way of being treated as a tax resident of the United States having nothing to do with counting days is the green card test, which treats an individual as a resident alien if at any time during the year the individual is “a lawful permanent resident of the United States.” I.R.C. '7701(b)(1)(A)(i). For most tax purposes, a green card holder is treated exactly the same as a citizen; in particular, green card holders are taxed in the United States on their worldwide income.

But even a green card holder can be treated as a nonresident alien if under a tax treaty with another country the holder is treated as a resident of that country. (More on treaties in Part Two of this article.) While in appropriate circumstances this is perfectly legitimate, taking the tax position that a green card holder is a nonresident alien under a tax treaty gives the immigration lawyers fits because this position might cause the U.S. Customs and Immigration Service to conclude that the individual does not have the proper “immigrant intent” necessary to maintain a green card. Immigration lawyers worry that the tax position may put the green card at risk.

Resident Aliens ' Counting Days ' The 'Substantial Presence Test'

The substantial presence test (I.R.C. '7701(b)(3)(A)) is the day-counting test that is the guts of tax residency determinations. Under this test, an individual is a resident alien in a year if he or she is present in the United States on at least 31 days in that year, and if the sum of: 1) the number of days the individual is present in the United States in that year, plus 2) one-third of the number of days the individual is present in the first preceding year, plus 3) one-sixth of the number of days the individual is present in the second preceding year, equals or exceeds 183. In general, an individual is present in the United States on a day if he or she is physically present in the country at any time during such day, no matter how briefly.

Here is an example:

Suppose T was in the United States 142 days in 2016, 90 days in 2015, and 60 days in 2014. Is T a U.S. resident in 2016? Well, 142 + (1/3 of 90) + (1/6 of 60) = 142+30+10 = 182, so T would not be a resident alien in 2016.

If T stayed in the United States for one more day in 2016, for a total of 143 days, the three-year weighted total would be 183 and he would be a resident alien in the United States in 2016. This highlights how critical it is to obtain an accurate day count.

Counting days is not always easy. In times past, we had interesting conversations with our clients about the number of days they were in the United States in the years pertinent to the substantial presence test. We'd ask the clients to provide their day counts; they'd consult their calendars, their travel receipts, their managers ' and come back to us with numbers that we had no easy way to verify.

Now the uncertainty is largely gone (with some exceptions) because of a Department of Homeland Security website that, when certain simple security tests have been passed, provides a detailed list of dates and ports of entry and departure: https://i94.cbp.dhs.gov.

But sometimes a day is not a day. Simply counting days may do a disservice to a client because there are scattershot provisions that allow certain days on which an individual is physically in the U.S. to be ignored.

For example, a day doesn't count if an individual is unable to leave the United States that day because of a medical condition that arose while the individual was present in the country (I.R.C. '7701(b)(3)(D)(ii)). Days in the United States are also not counted for certain foreign government-related individuals, teachers or trainees, students or professional athletes temporarily in the country to compete in certain charitable sports events. (I.R.C. ”7701(b)(3)(D)(i) and 7701(b)(5)). Note that, as is typical with the Internal Revenue Code, many words whose meanings you think you know (such as “student”) have their own definitions that may not comport with yours.

Other days not counted include commuting days to the United States for workers resident in Canada or Mexico, or a day present in the United States if the individual is in transit between two points outside the United States and is physically present in the United States for less than 24 hours. There are additional rules as well.

In many cases, these tweaks to the day-counting rules are not important because the individual's three-year weighted U.S. day count is either significantly over or significantly under 183. But in close cases, these day-count exceptions can make the difference between residency and nonresidency.

The residency test rules are extremely intricate and have numerous exceptions and exceptions to exceptions. Some of these can provide for some unique planning opportunities.

For example, consider the special rule for the first year of U.S. residency for a (formerly) nonresident alien.

As mentioned above, and as will be discussed in Part Two of this article, nonresident aliens are taxed in the United States (primarily) on their U.S. source income. Unlike resident aliens, nonresident aliens are not taxed in the United States on their worldwide (i.e., foreign source in this case) income.

If it appears that a nonresident alien is going to become a resident alien, a useful strategy may be for the individual to generate much of his foreign source income before becoming tax resident in the United States. That income will not be subject to tax in the United States. This makes it extremely important to know the first day on which a nonresident alien will be treated as a resident alien.

In general, an individual whose day count exceeds that required under the substantial presence test begins U.S. tax residency on the first day of the year on which that individual is physically present in the United States. But the law allows the first 10 days to be excluded in determining the residency start date, as long as the individual had a tax home in a foreign country and still maintained a closer connection to that country. Those excluded days are still counted when calculating the substantial presence weighted average.

This test can be critically important, not in determining whether someone is a resident under the substantial presence test, but in determining whether a particular item of non-U.S. source income was earned while a resident or a nonresident.

For example, suppose a musician enters the United States on January 1 of a year that will turn out to be the individual's first year of residence under the substantial presence test. She spends a week skiing in Aspen. On January 8, the musician flies to Monte Carlo, where she gives a concert and is paid $1 million. That fee is not U.S. source income, so it is taxed in the United States only if the musician is a resident on that January 8. If her residency start date is January 1, as it would be in most cases in which the individual is physically present in the United States on January 1, that $1 million will be taxable to her in the United States. But if she can take advantage of the test above to ignore the first week of the year in determining her residency start date, she will be able to exclude the $1 million from U.S. income.

Being aware of and understanding this rule can save clients a fortune in the right circumstances.

Bob Jason is a Principal with Nigro Karlin Segal Feldstein & Bolno LLC. This piece is intended as a broad introduction to key fundamental income tax issues presented when a foreign entertainer or athlete comes to the United States, rather than as a comprehensive analysis. Copyright ' 2016 Robert M. Jason. All rights reserved.

'

SPECIAL OFFER: Twitter, LinkedIn, Facebook and Google+ followers can get an online subscription to Entertainment Law & Finance for only $299. Click here, select Digital Only and use promo code ENTLOL299 at checkout. This offer is valid for new subscribers only.

'