Virgin Islands Tax Return Triggered Statute of Limitations When Forwarded to the IRS

(Parker Tax Publishing February 2018)

The Tax Court held that a nonresident of the Virgin Islands (VI) who filed a VI tax return but did not file a return with the IRS was protected by the statute of limitations from assessment by the IRS because the VI forwarded the first two pages of the VI returns to the IRS under an information sharing agreement. According to the Tax Court, the portion of the return the IRS received qualified as a return and started the running of the statute of limitations period, notwithstanding that the taxpayer filed nothing with the IRS and was not aware that the partial VI return was forwarded to the IRS. Coffey v. Comm'r, 150 T.C. No. 4 (2018).

Judith Coffey had a successful career in scholastic publishing. In 1985, she and her husband formed Rainbow Educational Concepts, Inc., a publisher's development company that focused on editorial design and production of textbooks. Coffey was president of Rainbow until 2003 and had income of over $1 million in 2003 and 2004.

In 2003, Coffey learned of the advantages of the Virgin Islands (VI) tax system, which offers incentives to bring companies to the VI. Coffey ended her relationship with Rainbow and became a partner in a VI partnership called StoneTree. She bought a house and two cars in the VI, got a VI driver's license and became a VI registered voter.

Coffey thought she was a bona fide VI resident and believed she was required to file a return only with the VI Bureau of Internal Revenue (VIBIR) and not with the IRS. VI residents and nonresidents use the same Form 1040 that is filed with the IRS. Coffey timely filed Forms 1040 with the VIBIR for 2003 and 2004, the years at issue. The returns were complete and accepted by the VIBIR. Coffey's returns were complex and she filed numerous schedules in addition to the Form 1040.

Under an information sharing agreement, the VIBIR sends copies of VI returns to the IRS in some instances. For example, when the VIBIR receives a return from a bona fide VI resident who had taxes withheld in the U.S., the VIBIR sends a copy of the return (or parts of it) to the IRS in order to collect the withheld funds. In this case, the VIBIR electronically sent photocopies of the first two pages of Coffey's Forms 1040 to the IRS along with copies of her Forms W-2. The VIBIR did not send any of the schedules that Coffey filed with her returns.

The IRS extracted some information from the returns. Its records reflected that Coffey claimed two exemptions and showed withholding credits from non-VI sources. The IRS initially recorded Coffey's adjusted gross income as zero for both years. Her VIBIR returns were later selected for audit and a notice of deficiency was sent in September 2009. Coffey challenged the notice in the Tax Court and the VI intervened.

Under Beard v. Comm'r, 82 T.C. 766 (1984), a filing is treated as a return and starts the running of the statute of limitations period if it (1) contains enough information to calculate the tax, (2) purports to be a return, (3) is an honest and reasonable attempt to comply with the law, and (4) is signed under penalties of perjury.

Coffey argued in a motion for summary judgment that what the IRS received from the VIBIR constituted returns under Beard. Coffey argued that the IRS got enough information from the VIBIR and that it could have requested any missing data under the information sharing agreement. She reasoned that her VIBIR filing purported to be a return because it was the same Form 1040 that would have been filed with the IRS. Coffey said that because she believed she was required to file only in the VI, her VI returns were therefore an honest and reasonable attempt to comply with the tax laws. Finally, Coffey contended that although the returns the IRS received did not have original signatures, a return need not be perfect to start the statute of the limitations, and the IRS routinely accepts nonoriginal signatures.

The IRS argued that what it received from the VIBIR did not disclose information in such a way that the returns could be readily verified. The IRS said that the returns did not purport to be returns because they were territorial filings, not federal filings. Nor were the returns an honest and reasonable attempt to comply with the law, in the IRS's view; if Coffey believed she had no U.S. taxable income, the only return consistent with her position would have been a protective all zero return. Finally, the IRS said the returns it received did not contain original signatures, so they were not executed under penalties of perjury.

Observation: IRS Notice 2007-31 states that, if a taxpayer claims to be bona fide resident of VI and files a tax return there, the VI return starts the statute of limitations in the U.S. Regulations issued under Code Sec. 932 in 2008 mirror the position taken in the notice. Neither the notice nor the regulations applied retroactively, so the Tax Court looked to the common law rules in this case.

The Tax Court found that the information the IRS received qualified as returns under Beard. First, the Tax Court reasoned that the IRS had enough information to create a transcript of account, albeit one with zeroes on almost every line. But that was precisely what the IRS said Coffey should have filed if she was unsure whether she was a U.S. resident. The Tax Court pointed out that the IRS actually received more information than it would have from a zero return. The missing schedules, in the court's view, did not prevent the computation of Coffey's tax liability. The court added that the computation need not be accurate for purposes of the statute of limitations.

Coffey's returns purported to be returns because Coffey filed the same Forms 1040 used by the IRS. The Tax Court reasoned that the filing of a VI return is part of the federal filing obligation for a taxpayer with VI source income. The court further reasoned that, in the criminal context, a person who files a fraudulent VI return is charged with filing a fraudulent federal return. The facts showed, in the court's view, that the IRS stamped Coffey's returns as received, summarized the contents in its files and opened an audit, but ultimately failed to issue the notice of deficiency in time.

The court also found that Coffey made an honest and reasonable attempt to satisfy the law. It rejected the IRS's argument that Coffey should have filed a protective zero return because it found this argument was based on Coffey's subjective beliefs about her obligations, which were irrelevant under Beard. The court reasoned that this element of the test was intended to distinguish tax protester returns from honest attempts to comply and saw Coffey's returns as the latter rather than the former.

Finally, the Tax Court held that the signed returns Coffey filed with the VIBIR satisfied the signature requirement under Beard. The court reasoned that nothing in the Code or regulations explicitly calls for an original signature. Moreover, the IRS accepts some returns with facsimile signatures. The court acknowledged that the IRS usually requires authenticating safeguards when nonoriginal signatures are accepted, but reasoned that the IRS received the forms from the VIBIR, the official revenue agency of a U.S. possession and one with which the IRS has a longstanding information sharing agreement. The Tax Court was careful not to hold that a photocopied signature is always sufficient to make a return valid, but found that Coffey's signature was valid under the circumstances.

A concurring opinion contended that the limitations period began not with what the VIBIR sent to the IRS but with the returns Coffey filed with the VIBIR. A dissenting opinion reasoned that, for purposes of the limitations period, the filing of a valid federal income tax return requires an intentional act by the taxpayer, and there was none here.

For a discussion of the return filing requirements and the statute of limitations, see Parker Tax ¶260,130. For a discussion of the return filing requirements for taxpayers with income from U.S. possessions, see Parker Tax ¶10,125.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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