Tax Resident in Two Countries? How Treaty Tie-Breaker Rules Work — and Their Hidden Costs

When the tie-breaker applies

The tie-breaker applies only when an individual is a resident of both countries under each country's domestic law and the countries have an income tax treaty with a residence article. The United States has comprehensive income tax treaties with many countries in Europe and Asia, Canada, and in Latin America with Mexico, Venezuela and Chile. Residents of countries without a treaty — including Colombia, Argentina, Brazil and Peru — cannot use a treaty tie-breaker at all.

The usual sequence of tests

• Permanent home: where the individual has a permanent home available
• Center of vital interests: where personal and economic relations are closer, if there is a permanent home in both or neither
• Habitual abode: where the individual lives more regularly
• Nationality: the country of which the individual is a citizen
• Mutual agreement: the tax authorities of the two countries decide if the earlier tests do not resolve it

The wording differs among treaties, and the specific treaty governs. The analysis is factual and should be documented with evidence such as leases, property ownership, family location, employment and bank relationships.

What changes — and what does not

Under the regulations, an individual who is a U.S. resident under domestic law but a resident of the other country under the treaty is treated as a nonresident alien for purposes of computing U.S. income tax liability. The individual generally files Form 1040-NR. For other purposes of the Code, however, the individual can continue to be treated as a U.S. resident. That distinction matters for information reporting, such as whether the individual is a U.S. shareholder of a foreign corporation for Form 5471 purposes, and the interaction with FBAR obligations should be reviewed specifically.

Disclosure on Form 8833

An individual who takes the position that a treaty overrides U.S. residency generally must disclose it on Form 8833 attached to the return. The penalty for failing to disclose a treaty-based return position is $1,000 for an individual for each failure. The disclosure should explain the facts supporting the treaty residence claim.

The green card risk

A green card holder who has held lawful permanent resident status in at least eight of the prior 15 years is a long-term resident. If a long-term resident commences to be treated as a resident of a treaty country under a tie-breaker, does not waive treaty benefits, and notifies the IRS, that can be treated as an expatriation for tax purposes. The individual may then be subject to the expatriation rules, including potential exit tax as a covered expatriate. Separately, claiming nonresident status for tax purposes can be viewed as evidence of abandoning permanent residence for immigration purposes. Green card holders should consult both a tax adviser and an immigration attorney before claiming a tie-breaker.

When a tie-breaker makes sense

• An individual temporarily present in the United States who meets the substantial presence test but clearly maintains a home and family abroad
• A treaty-country resident with a U.S. presence that is significant but secondary
• Situations where the foreign country's tax on worldwide income is comparable and double taxation would otherwise be difficult to relieve

Alternatives to consider

The closer connection exception may allow an individual who meets the substantial presence test to be treated as a nonresident without relying on a treaty, if present fewer than 183 days in the current year and able to show a closer connection to a foreign tax home, by filing Form 8840. It is not available to green card holders or to anyone who has applied for one. Foreign tax credits may also relieve double taxation even where both countries treat the individual as a resident.

Sources and official references

• IRS — Claiming tax treaty benefits
• IRS — Instructions for Form 8833
• IRS — Publication 519, U.S. Tax Guide for Aliens
• IRS — Closer connection exception to the substantial presence test
• IRS — Instructions for Form 8854 (long-term residents)