IRS Continues to Issue Guidance for International Taxpayers in Light of COVID-19
As COVID-19 continues to impact daily life, the IRS has published guidance to address the tax consequences for certain international taxpayers. Recent travel restrictions could require individuals to remain in locations longer than expected, resulting in a changed tax status. In order to mitigate this result, the IRS provided relief provisions to put certain affected persons in the same U.S. tax position they would have been in, but for the COVID-19 crisis.
The new guidance issued on April 21, 2020 addresses (i) non-resident aliens (“NRAs”) who are unable to leave the United States as a result of coronavirus measures; (ii) U.S. persons living abroad and intending to claim the foreign earned income exclusion; and (iii) certain business activity that may be granted relief from meeting the U.S. trade or business (USTB) taxability threshold.
Furthermore, as a result of the recent CARES Act modifications to the net operating losses (“NOLs”) rules, the IRS issued Frequently Asked Questions regarding NOL carrybacks for taxpayers who have had IRC sec. 965 “transition tax” inclusions.
I. Relief for Non-Resident Aliens Stranded in the United States
A foreign individual is considered a “non-resident alien” for U.S. tax purposes if such individual does not exceed the “substantial presence test” threshold provided under IRC sec. 7701(b)(3). An individual will be deemed to have met the substantial presence test threshold if:
- such individual was present in the United States on at least 31 days during the calendar year; and
- the sum of (i) the number of days the individual was present in the United States during the calendar year; (ii) one-third of the number of days the individual was present in the United States during preceding calendar year; and (iii) one-sixth of the number of days the individual was present in the United States during the second preceding calendar year totals 183 or more.
When applying the substantial presence test, individuals are permitted to exclude certain days on which they were physically present in the United States if the individual intended to leave the United States, but was unable to do so because of a medical condition that arose while the individual was present in the United States (the so-called “Medical Condition Exception).[1] On April 21, 2020, the IRS issued Rev. Proc. 2020-20 which allows “eligible individuals” to claim the COVID-19 emergency as a Medical Condition Exception.
An “eligible individual” is a foreign person who intended to leave the United States during the “COVID-19 Emergency Period” but was unable to do so because of the travel restrictions and disruptions put in place as a result of the COVID-19 crisis. The IRS provided that an individual’s “COVID-19 Emergency Period” is a single period of up to 60 consecutive days selected by an individual (1) which starts on or after February 1, 2020, and on or before April 1, 2020; and (2) where such individual was physically present in the United States on each day. Eligible individuals will be presumed to have intended to leave the United States on any day during their Emergency Period, but were unable to leave, unless the individual has taken steps to become a lawful permanent U.S. resident (e.g. applying for a green card).
These provisions also apply to individuals hoping to claim benefits under an applicable U.S. income tax treaty. That is, with respect to income from personal services performed in the United States, the eligible individual will be presumed to be unable to leave the United States on any day during their emergency period, and all such days will not count when determining an individual’s presence in the United States.
II. Foreign Earned Income Exclusion Relief for U.S. Persons Living Abroad
The IRS also issued Rev. Proc. 2020-27 providing relief with respect to the IRC sec. 911 foreign earned income exclusion, to certain U.S. citizens and residents living abroad.
IRC sec. 911(a) allows “qualified individuals” to exclude their foreign source income and cost of foreign housing from gross income. Under IRC sec. 911(d)(1) a “qualified individual” is an individual whose tax home[2] is a foreign country and who is (A) a citizen of the United States and has been a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire taxable year; or (B) a citizen or resident of the United States who, during any period of 12 consecutive months, is present in a foreign country or countries during at least 330 full days.
Rev. Proc. 2020-27 provides that a U.S. person who reasonably expected to become a “qualified individual” under IRC sec. 911(a) but left the foreign country due to the COVID-19 travel restrictions, will not have the resulting days spent away from their tax home count against such individual. For U.S. persons living in China, the relief period began on December 1, 2019; for U.S. persons living in all other countries, the relief period begins on February 1, 2020. Currently, the relief period will end on July 15, 2020 though the IRS may later choose to extend it.
III. IRS FAQs on Relief Regarding U.S. Trade or Business Status
The IRS also published answers to frequently asked questions regarding the U.S. activities of non-resident aliens and foreign corporations during the COVID-19 travel disruptions.
Generally, if a U.S. income tax treaty applies, non-resident aliens and foreign corporations will not be subject to U.S. tax on their business profits from the conduct of a U.S. trade or business (“USTB”), unless the business is conducted through a U.S. permanent establishment (“PE”).
On April 21, 2020, the IRS issued FAQs #1 and #2 (“Information for Nonresident Aliens and Foreign Businesses Impacted by COVID-19 Travel Disruptions”), which provide that a nonresident alien or foreign corporation may choose an uninterrupted 60-day period beginning on or after February 1, 2020 and on or before April 1, 2020, during which any activities conducted in the United States will not be taken into account when determining if such nonresident alien or foreign corporation is engaged in a USTB. In order to be eligible for this relief, (1) such activities must be performed by one or more individuals temporarily present in the United States; and (2) the activities undertaken would not have been performed in the United States but for the COVID-19 travel restrictions. Additionally, such services will not be taken into account to determine whether the nonresident alien or foreign corporation has a “permanent establishment” in the United States.
Finally, the IRS encourages nonresident aliens and foreign corporations to protectively file U.S. tax returns for the 2020 taxable year even if they believe they are not required to file for 2020 because they were not engaged in a USTB.
IV. CARES Act Provisions Regarding NOL Carrybacks and IRC sec. 965 Inclusions
Under the 2017 Tax Cuts and Jobs Act (“TCJA”), NOLs arising in taxable years beginning after December 31, 2017 could not be carried back to prior years, but could be carried forward indefinitely. Additionally, the NOL deduction was limited to 80-percent of taxable income. The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) repealed the 80-percent income limitation for tax years beginning before January 1, 2021. The Act also amended IRC sec. 172 to temporarily reverse the TCJA provision prohibiting carrybacks of NOLs.
Under the CARES Act, amended IRC sec. 172(b)(1) allows for NOLs arising in a taxable year beginning after December 31, 2017 and before January 1, 2021 to be carried back for up to five taxable years. Taxpayers should bear in mind that the CARES Act provides special rules for NOL carrybacks to taxable years with IRC sec. 965(a) inclusions.
Under the CARES Act, a taxpayer with a NOL arising in a 2018, 2019, or 2020 taxable year must carry that loss back to each of the five preceding years unless the taxpayer makes a timely election under (1) IRC sec. 172(b)(3) to waive the entire five-year carryback period; or (2) IRC sec. 172(b)(1)(D)(v)(I) to exclude from the five-year carryback period, all of the taxable years in which the taxpayer had a IRC sec. 965(a) inclusion.
It is important to note that an election to exclude IRC sec. 965(a) inclusion years will not result in an extension of the five-year carryback period; rather, the electing taxpayer is permitted to use the NOL to offset income in a subsequent year in the carryback period. In its April 23, 2020 description of tax provisions of the CARES Act, the Joint Committee on Taxation published an example illustrating an IRC sec. 172(b)(1)(D)(v)(I) election:
Suppose, in 2020, a calendar-year taxpayer has a $120 loss. Because the provision (pursuant to section 172(b)(1)(D)) allows a special five-year carryback period in the case of NOLs arising in a taxable year beginning after December 31, 2017, and before January 1, 2021, the taxpayer may carry the $120 NOL from 2020 to the five taxable years preceding the taxable year of such loss. For an NOL arising in 2020, the relevant taxable years within the relevant five-year carryback period are 2015, 2016, 2017, 2018, and 2019. If the taxpayer had $20 of taxable income in 2015 and $30 of taxable income in 2016 (both without regard to any NOL deduction), then the taxpayer is entitled to a $20 NOL deduction in 2015 and a $30 NOL deduction in 2016. The remaining unused portion of the 2020 NOL (i.e., the remaining $70 of the $120 NOL carryback) may be applied to the taxpayer’s 2017 taxable year and, to the extent allowed under section 172(b), to each subsequent year.
If, in 2017, the taxpayer had a section 965(a) inclusion (net of the section 965(c) deduction), which the taxpayer elected under section 965(h) to pay in installments, and other taxable income (before any NOL deduction), the taxpayer has two options: (1) apply the provision’s default rule, which deems the taxpayer to have made an election under section 965(n) not to apply the NOL to such taxpayer’s section 965(a) inclusion amount net of the section 965(c) deduction; or (2) elect to exclude 2017, the taxpayer’s section 965(a) inclusion year, from the five-year carryback period (i.e., carry back the 2020 NOL only to 2015, 2016, 2018 and 2019, before carrying forward).[3]
With the battle against COVID-19 continuing, it is possible that these timeframes for international taxpayers may be altered through future legislation or IRS guidance. If you have questions regarding the CARES Act or other COVID-19 relief options, Kostelanetz & Fink is here to help. Please contact Robert Russell or Yoram Keinan.
[1] IRC sec. 7701(b)(3)(C); Treas. Reg. 301.7701(b)-3(c)(1).
[2] See IRC sec. 911(d)(3) (“The term ‘tax home’ means, with respect to any individual, such individual’s home for purposes of IRC sec. 162(a)(2) (relating to traveling expenses while away from home). An individual shall not be treated as having a tax home in a foreign country for any period for which his abode is within the United States, unless such individual is serving in an area designated by the President of the United States by Executive order as a combat zone for purposes of IRC sec. 112 in support of the Armed Forces of the United States.”).
[3] JCX-12R-20, Description of the Tax Provisions of public Law 116-136, The Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, Joint Committee on Taxation, at 53 (Apr. 23, 2020).
