Taxpayer Was a Bona Fide Resident of U.S. Virgin Islands

By James A. Beavers, J.D., LL.M., CPA, CGMA

Procedure & Administration

The Tax Court held that a taxpayer, who had filed tax returns with the U.S. Virgin Islands Bureau of Internal Revenue (VIBIR) for 2002-2004, was a bona fide resident of the U.S. Virgin Islands for those years, and thus the statute of limitation on assessment had expired on the U.S. returns for those years for which the IRS had issued a notice of deficiency.

Background

Travis Sanders was a U.S. citizen who built his own company in the United States to manufacture and distribute surge suppression devices. In 2002, he signed an employment agreement to work for Madison Associates, a limited partnership organized in the U.S. Virgin Islands, a territory of the United States, as a professional consultant. The employment agreement required Sanders to become a resident of the U.S. Virgin Islands. Sanders also signed an agreement making him a limited partner of Madison. Under that agreement, he was required to provide an opinion letter from a law or accounting firm stating that he would qualify as a resident of the U.S. Virgin Islands and provide any documentation required in the future by Madison to prove his continued residence in the territory.

For the years at issue, 2002-2004, Sanders actually lived in the U.S. Virgin Islands. In 2002, he stayed at a condominium in its capital, St. Thomas, and in 2003 and 2004 lived on a yacht moored in a harbor in St. Thomas. From 2002-2004, Sanders' checks for his bank accounts reflected a U.S. Virgin Islands address. In addition, he was married in June 2003 and listed St. Thomas as his place of residence on the marriage license.

Taking the position that he was a bona fide resident of the U.S. Virgin ­Islands, pursuant to Sec. 932(c)(2), Sanders filed Forms 1040, U.S. Individual Income Tax Return, with the VIBIR for tax years 2002, 2003, and 2004. Because he was filing his returns with the VIBIR, he did not file returns with the IRS, in accordance with IRS Publication 570, Tax Guide for Individuals With Income From U.S. Possessions.

More than three years after Sanders filed Forms 1040 with the VIBIR, the IRS mailed him a notice of deficiency determining that he was not a bona fide resident of the U.S. Virgin Islands for tax years 2002-2004 and treating him as a nonfiler for U.S. tax purposes. In the notice of deficiency, the IRS also asserted, among other things, that Sanders (1) was not a bona fide resident of the U.S. Virgin Islands for tax years 2002-2004; (2) was not entitled to the gross income exclusion under Sec 932(c)(4), which allows an exclusion on the U.S. income tax return of a bona fide U.S. Virgin Islands resident for income properly reported on the taxpayer's U.S. Virgin Islands tax return for tax years 2002-2004; (3) and was required to file a Form 1040 for each of the tax years 2002-2004 with the IRS (i.e., he was required to file a U.S. income tax return for those years).

Sanders filed a petition in Tax Court in response to the notice of deficiency. He contended that filing his return with the VIBIR started the running of the statute of limitation on his U.S. return for each year, and thus the limitation period for assessment for the years 2002-2004 had run, and the IRS could not assess deficiencies related to those years. After filing the petition, in November 2012 Sanders died, but the case was continued by his estate.

The Tax Court's Decision

The Tax Court held that Sanders' estate had proved that the statute of limitation on assessment for the years 2002-2004 had expired before the IRS issued its notice of deficiency. The court found that under the ­Sochurek test, Sanders had been a bona fide resident of the U.S. Virgin Islands during the years at issue, and, therefore, under Sec. 932(c), his filing of returns for those years with the VIBIR satisfied his U.S. filing requirement. Therefore, the statute of limitation on a U.S. return for Sanders for 2002-2004 began when he filed his returns with the VIBIR.

The U.S. Virgin Islands has its own tax system based on the same tax laws and tax rates that apply in the United States. Sec. 932 provides rules that govern the coordination of the U.S. income tax system and the U.S. Virgin Islands income tax system. Sec. 932 establishes two distinct filing regimes: one for bona fide residents of the U.S. Virgin Islands and one for those who are not bona fide residents. Bona fide residents file their tax returns with the VIBIR, and, under Sec. 932(c), this return satisfies the taxpayer's territorial and federal filing obligations. Those who are not bona fide residents must file two income tax returns: one with the IRS and one with the VIBIR.

Finding that Sanders had properly filed Forms 1040 with the VIBIR for tax years 2002-2004, and that the Forms 1040 he filed were valid returns for purposes of starting the running of the statute of limitation under Sec. 6501(a) under the four-part test from Beard, 82 T.C. 766 (1984), aff'd, 793 F.2d 139 (6th Cir. 1986), the only question left was whether Sanders was a bona fide resident of the U.S. Virgin Islands who could take advantage of the rule in Sec. 932(c). To make this determination, the court applied the 11 factors set out in Sochurek, 300 F.2d 34 (7th Cir. 1962).

The 11 factors are (1) intention of the taxpayer; (2) establishment of a home in the foreign country for an indefinite period; (3) participation in activities; (4) physical presence in the foreign country; (5) nature, extent, and reasons for absences from his temporary foreign home; (6) assumption of economic burdens and payment of taxes to the foreign country; (7) status of the resident contrasted to transient or sojourner; (8) treatment accorded his income tax status by his employer; (9) marital status and residence of his family; (10) nature and duration of employment; and (11) good faith in making the trip abroad. The 11 factors can be further grouped into four broad categories: intent; physical presence; social, family, and professional relationships; and the taxpayer's own representations (Vento v. Director of V.I. Bureau of Internal Rev., 715 F.3d 455 (3d Cir. 2013)).

After considering the facts and circumstances and applying the Sochurek factors as grouped in Vento, the court found that Sanders was a bona fide U.S. Virgin Islands resident from 2002-2004. The court came to this conclusion because he had the intent to be a bona fide resident because he intended to remain indefinitely or at least for a substantial period; he had a physical presence in the U.S. Virgin Islands and was employed by a U.S. Virgin Islands partnership and was listed as a partner on its Schedules K-1 for tax years 2002-2004; he conducted banking in the U.S. Virgin Islands and had checks with a U.S. Virgin Islands address; he was married in the U.S. Virgin Islands and reported his address as the U.S. Virgin Islands on his marriage license; and, finally, he identified himself as a resident of the U.S. Virgin Islands and paid U.S. Virgin Islands taxes.

Reflections

The reason the IRS was so interested in proving that Sanders was not a bona fide U.S. Virgin Islands resident was that, as such, Sanders had taken under the Virgin Islands Economic Development Program (EDP), a credit of 90% of his U.S. Virgin Islands tax liability attributable to his portion of the net income derived by Madison. As the IRS described in Notice 2004-45, taxpayers who are not bona fide residents of the U.S. Virgin ­Islands have become partners in partnerships similar to Madison and have fraudulently claimed that they are bona fide residents to avoid tax through an EDP credit. However, regardless of whether it is good policy to give someone this credit when he or she simply runs a U.S. business through a U.S. Virgin Islands partnership, under the law as it stands, if the person does so, lives in the U.S. Virgin Islands, and qualifies as a bona fide resident of the territory, he or she can file a U.S. Virgin Islands return and take the credit.

In Chief Counsel Advice 201503012, released Jan. 16, 2015, in response to the Vento decision, the Office of Chief Counsel advised that the 11-factor test from Sochurek is still the proper standard for analyzing whether a person is a bona fide resident of the U.S. Virgin Islands in cases involving facts that are substantially similar to those in Notice 2004-45 and that the Vento decision did not alter this standard. In Vento, the Third Circuit held, based on the facts, that a husband and wife were bona fide residents of the territory while their three daughters were not.

Estate of Sanders, 144 T.C. No. 5 (2015); Chief Counsel Advice 201503012

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