Understanding US individual federal taxation begins with one critical concept: tax residency status. Unlike many countries that tax individuals primarily based on citizenship or physical domicile, the United States applies a unique hybrid approach. For individuals earning income connected to the US—whether citizens, green card holders, foreign professionals, investors, or students—residency status determines what income is taxable, which forms must be filed, and what compliance risks exist.
Many taxpayers assume that simply living outside the US exempts them from US tax obligations. In reality, the IRS focuses on residency classification, not just location. A person living abroad may still be treated as a US resident for tax purposes, while someone physically present in the US for months may remain a non-resident depending on technical rules. This distinction can significantly affect tax rates, deductions, reporting obligations, treaty benefits, and exposure to penalties. This article breaks down the residency framework, explains its tax implications, and highlights why professional guidance is often necessary to remain compliant while optimising tax outcomes.
What Determines US Tax Residency?
The United States classifies individuals for federal tax purposes as either resident aliens or non-resident aliens. This classification is independent of immigration status and is determined using two primary tests.
The Green Card Test
An individual is considered a US tax resident if they hold a valid US permanent resident card (green card) at any point during the tax year. Once this status applies, the individual is taxed similarly to a US citizen unless formal abandonment procedures are completed.
The Substantial Presence Test (SPT)
If an individual does not have a green card, residency may still arise under the Substantial Presence Test. This test considers:
- Days present in the current year
- One-third of the days present in the prior year
- One-sixth of the days present two years prior
If the total equals or exceeds 183 days, the individual is generally treated as a US tax resident.
Certain visa categories, short-term visitors, and students may qualify for exemptions, but these are highly technical and time-limited.
Tax Obligations of US Tax Residents
Once classified as a US tax resident, an individual is subject to worldwide income taxation.
Scope of Taxable Income
US residents must report:
- US and foreign employment income
- Global investment income
- Foreign rental income
- Business profits earned abroad
This applies regardless of where the income is earned or where the individual resides physically.
Filing Requirements
Residents generally file Form 1040 and may be required to submit additional disclosures, such as:
- Foreign bank account reporting
- Foreign asset disclosures
- International information returns for businesses or trusts
Deductions and Credits
Residents can typically access:
- Standard or itemised deductions
- Child and education credits
- Foreign tax credits
- Retirement contribution benefits
While these benefits can reduce tax liability, they also increase reporting complexity.
Tax Obligations of Non-Resident Aliens
Non-resident aliens are taxed under a much narrower framework.
US-Sourced Income Only
Non-residents are taxed only on income that is:
- Fixed, determinable, annual, or periodic US income (such as interest or dividends)
Foreign income remains outside the US tax net.
Withholding Structure
Most US-source income paid to non-residents is subject to flat withholding, often at 30%, unless reduced by a tax treaty.
Filing Forms
Non-residents typically file Form 1040-NR, which offers limited deductions and no access to most credits available to residents.
Dual-Status Taxpayers: A Transitional Category
Some individuals change residency status mid-year—for example, moving to or leaving the US.
How Dual-Status Works
In such cases:
- Income earned while a non-resident is taxed under non-resident rules
- Income earned as a resident is taxed on a worldwide basis
Dual-status returns are complex and restrict access to many deductions and credits.
Role of Tax Treaties in Residency-Based Taxation
Treaty Tie-Breaker Rules
When an individual qualifies as a tax resident of both the US and another country, treaties apply tie-breaker tests based on:
- Permanent home
- Centre of vital interests
- Habitual abode
- Citizenship
Correct treaty application can override domestic residency rules, but incorrect claims may trigger penalties.
Compliance Risks of Misclassifying Residency
Residency errors can result in:
- Underreporting global income
- Incorrect withholding rates
- Missed disclosures
- Civil penalties and interest
- Increased audit exposure
The complexity of US residency rules means self-classification without professional support often leads to costly mistakes.
Why Professional Guidance Matters
US individual taxation—especially involving cross-border income—is governed by detailed statutes, evolving IRS interpretations, and treaty provisions. The Internal Revenue Service applies strict documentation and disclosure standards, leaving little room for error.
Professional advisors help:
- Accurately determine residency status
- Optimise treaty benefits
- Ensure correct form selection
- Maintain long-term compliance strategies
This is particularly critical for expatriates, foreign nationals working in the US, remote workers, and international investors.
End Words
Residency status is the foundation of US individual federal tax obligations. Whether an individual is taxed on worldwide income or only US-sourced earnings depends entirely on how residency rules apply—not on assumptions, visas, or physical location alone.
Given the financial and legal consequences of misclassification, proactive planning and expert interpretation are essential. If you are navigating US tax residency, international income reporting, or treaty considerations, Pravega Business Consultants offers specialised expertise in cross-border US taxation.
