For many years, the IRS has been aggressively auditing taxpayers who have filed income tax returns with the U.S. Virgin Islands (USVI) Bureau of Internal Revenue (VIBIR), claiming a 90% tax credit under the USVI Economic Development Program (EDP). The IRS has long believed that individuals are falsely claiming to be “bona fide” USVI residents to obtain the tax credit, and the IRS identified such false claims to be an abusive tax shelter way back in 2004. Notice 2004-45, 2004-2 C.B. 33. Likewise concerned, Congress amended the law in 2004 to make it clear that the term “bona fide resident” requires one to be physically present in the USVI for at least 183 days during a calendar year. I.R.C. § 937(a). For years prior to that law change (many of which are still working their way through the courts), a less precise facts-and-circumstances test must be used to determine bona fide residency.
If one is, in fact, a bona fide resident of the USVI, one need only file an annual tax return with the VIBIR and need not file one with the IRS. Thus, if an individual incorrectly determines that he/she is a bona fide resident of the USVI and does not file a U.S. tax return, such person not only would lose the valuable 90% credit, but might also lose his/her ability to rely on the statute of limitations for filing returns under the Internal Revenue Code (which does not begin to run if a tax return has not been filed by a taxpayer). The potential liability, accordingly, can be enormous.
In Estate of Travis L. Sanders & the Government of the USVI, Intervenor v. Commissioner, 144 T.C. 63 (2015), the U.S. Tax Court rejected the IRS’s assertion that Mr. Sanders was not a bona fide USVI resident. Unfortunately for the late Mr. Sanders, the Eleventh Circuit has now reversed and remanded the case to the Tax Court. Comm’r v. Estate of Travis L. Sanders & Gov’t of the USVI, 2016 WL 4447257 (11th Cir. Aug. 24, 2016). In its opinion, the Eleventh Circuit decided two contentious issues – (i) when the U.S. statute of limitations runs in cases such as this and (ii) what are the appropriate factors to consider in determining bona fide residency status.
First, in the case, the government of the USVI argued that the U.S. statute of limitations ought to run if a taxpayer filed a return with the VIBIR, but not the IRS, in the good faith belief that he/she was a USVI resident. The Eleventh Circuit was not convinced, holding that a taxpayer’s mere good faith belief regarding his/her USVI residency is insufficient to cause a return filed with the VIBIR to start the statute of limitations period. The unfortunate result of this ruling is that all past years, for which a person incorrectly determined himself or herself to be a USVI resident, would be open to audit by the IRS. Vast amounts of U.S. taxes and hefty penalties could easily be the result.
Second, the Eleventh Circuit held that in determining residency, the eleven factors identified by the Seventh Circuit in the case of Sochurek v. Commissioner, 300 F.2d 34, 38 (7th Cir. 1962), as grouped together into “four broad categories” by the Third Circuit in the case of Vento v. Director of Virgin Islands Bureau of Internal Revenue, 715 F.3d 455, 466–68 (3d Cir. 2013), provide appropriate guidance. The Eleventh Circuit stressed, however, that the most important factor is a taxpayer’s physical presence (which is consistent with Congress’s law change in 2004 requiring one to be physically present in the USVI for at least 183 days during a calendar year to be a bona fide resident).
The case has now been remanded to the U.S. Tax Court for an evaluation of Sanders’s residency, using the appropriate factors. Whether his estate will benefit from the protection of the statute of limitations now depends wholly on that decision.
Posted by Matthew Gries.