Are you moving to the US Virgin Islands in 2017 and looking for that exciting 2016 year-end tax strategy? There are many tax advantages of claiming to the IRS that you are a bona fide resident of the US Virgin Islands including you receiving tax free income. While you’re there, structure a Virgin Island replacement investment section 1031 tax free exchange. But be wary of dangerous landmines ahead which will explode into an IRS US Virgin Bona Fide Resident Audit that will take all the joy out of you and your family living in paradise. Indeed the IRS is just waiting sometimes until after you die as happened to the late Travis L Sanders to audit your estate tax returns arguing that you (now deceased) were never a “Bona Fide Resident” and therefore were not entitled to all that tax free living over the years. So if you are interested in moving to the US Virgin Islands to take advantage of all that tax free income you can earn over there, stay tuned to TaxView with Chris Moss CPA Tax Attorney, to find out you can obtain that coveted bona fide resident status and at the same time bullet proof your tax returns when the IRS commences its dreaded US Virgin Island Bona Fide Resident Audit.
In order to understand how difficult it is to become a US Virgin Island Bona Fide Resident, let’s jump right into a recent US Tax Court case Travis L Sanders vs IRS, 144 T.C. No. 5 US Tax Court January 2015. The facts are complex. Sanders became a partner in 2002 of a limited partnership Madison, a designated service business in the US Virgin Islands providing scientific, electronic, investment, economic and management consulting to businesses in the United States. Section 934(b)(1) of the IRS Code allows for tax free income from sources within the Virgin Islands provided that the owners of the company maintain residency there.
During 2003 and 2004 Sanders through various trusts, LLCs and other businesses, and claimed residence on a yacht in the Virgin Islands. Tax returns were filed with the Virgin Island Internal Revenue Department (VIBIR) for tax years 2002 2003 and 2004. On each tax return Sanders reported his home to the Virgin Islands and claimed an Ecomonic Development Commission credit claiming that his interest in Madison allowed him to “reduce his income tax liability by 90% of the income tax attributable to Madison”. Simultaneous to Sanders personal tax return filings, Madison filed partnership returns with VIBIR for the same years listing Sanders as a partner.
On November 30, 2010 the IRS issued a tax bill to Sanders for almost $1M claiming he was not a bona fide resident of the USVI for the years 2002-2003 and 2004. Sanders appealed to US Tax Court in Sanders vs IRS 144 T.C. No 5 (2015). The IRS in Court claimed that all transactions of Madison lacked economic purpose and substance and therefore Sanders was not entitled to tax free recognition during those years. More importantly the Government claimed Sanders was not entitled to file tax returns with VIBIR but instead Sanders had to file his tax returns with the IRS in Philadelphia. Sanders claimed the statute of limitations had run citing IRS Code Section 6501. But the IRS reasoned to the Court that the statute of limitations had not run because no tax returns were ever filed citing that same section 6501. Judge Kerrigan of the US Tax Court was therefore faced with two key sequential questions presented to the Court: Whether Section 6501 period of limitations expired before the US IRS mailed its tax bill to Sanders and as a logical second follow up question whether Sanders filed a tax return.
The Court acknowledged that under Section 932(c) a bonafide resident is only required to file his tax returns with VIBIR and such a filing starts the statute of limitations running citing Senate Finance Committee report stating that all bona fide Virgin island residents will file their returns with VIBIR quoting from within the S.Report No 99-313 (1986).
Judge Kerrigan then reviews 11 factors that determine whether a taxpayer’s claimed residency in any foreign country is “bona fide citing Sochurek v Commissioner, 300 F.2d 34 (7th Cir 1962). The 11 factors are 1. Intention of the taxpayer, 2. Establishment of a home in the foreign county, 3. Participation in activities, 4. Physical presence in the foreign country, 5. Nature, extent, and reasons for absences from temporary foreign home, 6. Assumption of economic burdens and payment of taxes to the foreign county, 7. Status of resident contrasted to transient or sojourner, 8. Treatment accorded his income tax status of 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 are then grouped into various broad categories, intent, physical presence, social, family and professional relationships and the taxpayers owns representations, citing Ventro v VIBIR 715 F.3d 455 (3rd Cir. 2013).
The Court then in a surprise ending- in just a few paragraphs no less- and without any substantial analysis of the facts, indicates that the majority of the 11 factors were favorable to Sanders, that Sanders was a bona fide resident of the USVI for tax years 2002-04, that Sanders properly filed his tax returns with the VIBIR and indeed Section 6501 statute of limitations had run its course and therefore the IRS was out of time to audit Sanders. Sanders wins IRS loses.
But the story does not end here. because the Government appealed. Sure enough the Tax court decision was overturned and remanded back to the US Tax Court for further consideration by the 11th Circuit in Commissioner v. Estate of Travis Sanders, No. 15-12582 (Aug. 24, 2016) with the 11th Circuit noting that “the facts relied upon the Tax Court were insufficient as a matter of law to establish that Sanders was a bona fide resident….”
The 11th Circuit through an Opinion, written by Circuit Judges Jordan and Anderson and District Judge Dalton, gives examples of how the US Tax Court on remand should inquire about the 11 factors. For example, the Circuit Court said, it is true as the US Tax Court pointed out that Sanders had a physical presence in the US Virgin Islands. However, “physical presence” is an especially important factor to conside and the Tax Court should have spent more time on it as it specifically had related to Sanders. The 11th Circuit goes on to say that the US Tax Court did not address the “nature and extent” of Sander’s physical presence and therefore could not have properly weighed the physical presence factor. The Court instructed the US Tax Court on remand to determine how much time Sanders spent in the US Virgin Islands and when, if ever, his contacts with the island became sufficient to make him a bona fide US Virgin Island resident.
The 11th Circuit then went on to give one example after another of how the US Tax Court in fact failed to properly analyze all 11 factors and then vacated the Tax Court’s Opinion entirely. The Circuit Court directed the Tax Court on remand to make factual findings regarding the amount of time Sanders spent in the US Virgin Islands during each of those years, which would be critical in determining the extent of Sanders physical presence. Also important the 11th Circuit says to the Tax Court, would be factual findings regarding the nature of the time Sanders spent in the US Virgin Islands, including the nature of Sanders’s relationship with Madison (For example, Madison’s economic substance and business purpose, or lack thereof).”
What does this mean for any of you who are planning to move the US Virgin Islands in 2017? In my view this is great news coming from the 11th Circuit. Because as a result of this heightened scrutiny on US citizens claiming bona fide residency in the US Virgin Islands we now have specific guidelines strong enough to hold up in any court proceeding. How? With the help of your Tax Attorney you can easily use the 11th Circuit Opinion to create the evidence you now need in 2017 to prove years later when the IRS Virgin Island Bona Fide Audit will surely commence possible many years later.
Finally, include the 11th Circuit Opinion and future cases that support your bona fide residency in the Virgin Islands as the foundation upon which to build all your business structures and tax free income, having your tax attorney in detail apply each of the 11 factors one by one in your income tax return until you have bullet proofed your coveted bona fide residency prior to filing your return. You all can now relax perhaps at the Old Stone Farmhouse, knowing that your tax returns are bulletproofed from the dreaded IRS US Virgin Island Bona Fide Residence Audit.
Thanks for joining us for 2016 year-end tax planning on TaxView with Chris Moss CPA Tax Attorney.
Happy New Year!
See you next time in 2017 on TaxView.
Chris Moss CPA Tax Attorney.