By William Blum
On January 29, 2015, the United States Tax Court, in Estate of Sanders v. Commissioner (Docket No. 4614-11, 144 T.C. 5) sided with a taxpayer who argued that because he filed his return with the USVI as a bona fide resident, the statute of limitations on assessments had run and the IRS could not assess additional tax liability or penalties against him.
This is the most recent in a series of cases relating to the USVI residency issue and the IRS’s largely unsuccessful efforts to attack the USVI Economic Development Commission (EDC) tax incentives authorized by Congress in the 1960’s. Code section 934 effectively gives the USVI the authority to reduce the federal tax liability of USVI taxpayers with respect to USVI source (or effectively connected) income. The Territory has, for decades, used this authority by providing tax incentives for individuals and companies who engage in appropriate businesses, usually those that export goods or services, and who hire the requisite number of local employees, usually 5 to 10. For an individual to be eligible for the incentives, which provide a 90% income tax exemption among other benefits, the individual must be a “bona fide” resident of the USVI.
Beginning in the early 2000’s the IRS perceived that the incentives were being abused and began a program of audits of persons claiming USVI residency. As it turned out, the great majority of these taxpayers were “bona fide residents” of the USVI and were therefore entitled to pay their federal tax to the USVI minus any applicable EDC credits. But the IRS nevertheless challenged taxpayers in hundreds of cases, mostly for tax years 2001 through 2005. And for reasons that are unclear, the IRS failed to seek extensions of the statute of limitations while conducting its audits of these taxpayers. Instead the Service relied on the idea that if the taxpayers did not file US returns with the IRS, there would be no applicable statute of limitation even though the taxpayers had filed their returns with the USVI as directed by various IRS publications and pronouncements.
In the Sanders case, the Tax Court found that the taxpayer had made a legitimate effort to establish residency in the USVI before the end of 2002 and was therefore a bona fide resident of the USVI in that year and subsequent years. As a result, his filing of a tax return with the USVI was sufficient to start the running of the statute of limitations. Because that return was filed in 2003, the usual 3-year or 6-year statute had already run by the time the IRS made an assessment in 2010 – thus handing a victory to the taxpayer.
The Court analyzed Mr. Sanders’ facts in the context of rules set forth in previous cases on this subject, primarily, the Sochurek, Vento, and Appleton cases. Both Vento and Appleton were recent USVI cases also decided in favor of the taxpayer. The difference in Sanders, however, is that unlike earlier cases such as Appleton where the IRS had stipulated to the taxpayer’s residency, in Sanders the taxpayer’s claim of residency was disputed.
The Sanders court followed Vento in analyzing the factors to determine a bona fide residency claim. These 11 factors, first set forth in Sochurek, are divided into four groups under Vento: taxpayer intent; taxpayer physical presence; social, family, and professional relationships; and taxpayer’s own representations. Finding that the taxpayer met all of these four groups of factors, the Sanders court declared that the taxpayer “was a bona fide resident of the USVI for tax years 2002-04 and he properly filed tax returns with the VI [Bureau of Internal Revenue] for those years.” As a result the court found that the Code section 6501 period of limitations has expired before the IRS mailed its notice of deficiency.
There are still several more cases with similar fact patterns yet to be decided by the Tax Court, and many more that have not yet even been filed. After Sanders, it will be interesting to see how many new the cases the IRS will decide to pursue with vigor. So stay tuned . . . .