After nearly 20 years of waiting after Congress directed the Treasury Department to promulgate residency rules for the U.S. territories in the Tax Reform Act of 1986, in 2005 the IRS finally promulgated rules setting forth three tests for territorial residency. The tests include the presence test, the tax home test, and the closer connection test.
Widely considered the toughest test to meet by those who only spend a portion of their time in a U.S. territory, and who also spend substantial time in the United States, is the physical presence test. There are several ways to meet that test, but the one that is most important to these types of taxpayers requires that the taxpayer spend at least 183 days in a taxable year in the territory in question.
Since the rules were first promulgated in 2005, three different U.S. Virgin Islands governors have lobbied the IRS and Congress to ease the rules — with little success. While a minor change in the rules allowed averaging of the 183-day requirement over 3 years, the main USVI proposal, to change the 183-day requirement to 120 or 122 days, fell on deaf ears in Washington. A more recent and more modest proposal, to treat up to thirty days per year spent out of both the territories and the United States, as constructive days in the territory was recently promulgated as a proposed rule published in the Federal Register on August 27, 2015. See, Prop. Treas. Reg. §1.937-1(c)(3)(i)(D), REG-109813-11 August 27, 2015.
But the rule is disappointing and not nearly as helpful as had been hoped since for most taxpayers it makes only a very modest dent in the number of days required to be spent in a territory. The first sentence of the proposed rule starts out well enough by seemingly allowing 30 days spent outside of the territory to count as days in the territory so long as the days are not spent in the United States. But the next sentence delivers the “zinger” – for the 30-day break to be applicable, the taxpayer still must spend more actual days in the territory than in the United States (not counting the constructive days).
Let’s do the math on a few of examples – examples, by the way, that we as international tax attorneys think are much more realistic than the ones published with the proposed rule:
- M, a U.S. citizen, owns a home in St. Thomas where he owns and operates a financial service business. He also owns a condominium in New York City and a vacation home in Vermont. He runs a Virgin Islands-based service business that requires him to spend about five months a year in New York City and up to 45 days in Europe. In 2016 he stays in his New York condo for 155 days and he spends part of the month of January (21 days) at his home in Vermont where he enjoys skiing. He also spends 30 days in London and 15 days in Paris on business and the remaining 145 days in St. Thomas. Of his 45 days abroad, 30 may be constructively considered to be in the USVI, for a total 175 days there. Since he does not have 183 days in the USVI, in 2016 he fails the presence test.
- In 2017 M spends 30 days in London, no days in Paris, 155 days in New York, 21 days in Vermont and the remaining 159 days in St. Thomas. He still does not meet the presence test because even though the 30 days in London may be added to his time in St. Thomas for a total of 189 days, the total days spent in the United States (which equals 176) are greater than the 159 days actually spent in St. Thomas and this makes M fail the test.
- Having failed the test in 2016 and 2017, M is determined to meet it in 2018 and decides to cut back on his skiing, reduce his business time in New York, and spend some extra time in the Virgin Islands. So in 2018 he spends 150 days in New York, 18 days in Vermont, 30 days in London, and the remaining 167 days in St. Thomas. Unfortunately, M still fails the test since the 30 days of constructive time in the USVI as a result of the London visit do not matter since M’s actual time in the USVI, 167 days, is less than his actual time in the United States, 168 days.
- Now desperate to meet the test, M tries even harder in 2019. That year he spends 155 days in New York, only 12 days skiing in Vermont, the same 30 days in London, and the remaining 168 days in St. Thomas. In 2019, M finally meets the test since the 30 days in London added to his actual time in St. Thomas totals more than 183 days and his actual time in St. Thomas, 168 days, exceeds his time in the United States of 167 days.
While these examples admittedly nibble at the very edges of day counting scheme, the IRS has been far from generous by requiring the actual days in the territory to exceed the days in the United States. For the business person travelling internationally who also needs to spend substantial time in the States, the relief is truly only about 15 days as is seen in Example D where M still had to spend 168 days in St. Thomas rather than the 183 under the existing rule.
Two more quick points:
First, a September 1, 2015 letter announcing the new regulation to tax beneficiaries of the USVI Economic Development Program, touts the 30 days of constructive presence as a boon for that Program and concludes that a taxpayer can spend as few as 153 days in a year in the territory and still meet the test. While this is technically true, if that is all the time the taxpayer does spend in the USVI, he or she had better not spend more than 152 days in the United States during that year (ignoring, for now, the averaging test), which leaves 60 days in the year — all of which the taxpayer needs to spend abroad! In fact, most taxpayers in this category who are seeking to maintain USVI residency undoubtedly would like to spend the extra days in the United States, which the new rule would not allow. Our conclusion is that while the new rule helps, it only helps a very small bit and does not materially ease the burdens of Virgin Islanders, at least those who are not prepared to spend as much as 60 days abroad. And we doubt that that this change, without more, will allow the Territory to attract new businesses and investment.
Second, it is important to note that the proposed rule only becomes effective starting in the year after the regulation is finalized. Therefore, the proposed rule would only be effective for the 2016 tax year at the earliest.