Tax Court Holds That Virgin Islands Tax Return Did Not Trigger Statute of Limitations

(Parker Tax Publishing May 2023)

The Tax Court held a U.S. citizen who was not a bona fide resident of the U.S. Virgin Islands did not trigger the three-year statute of limitations on assessments under Code Sec. 6501(a) by filing tax returns only with the Virgin Islands Bureau of Internal Revenue (VIBIR). According to the court, as a U.S. citizen "other than a bona fide resident of the Virgin Islands " under Code Sec. 932(a), the taxpayer was required to file returns with both the United States and the Virgin Islands, and as a result of his failure to do so, the IRS could issue a notice of deficiency at any time under Code Sec. 6501(c)(3). Tice v. Comm'r, 160 T.C. No. 8 (2023).

Background

David Tice, a U.S. citizen, filed income tax returns for 2002 and 2003 with the Virgin Islands Bureau of Internal Service (VIBIR). On each return, Tice claimed residency in the U.S. Virgin Islands (USVI). The IRS determined that Tice was not "a bona fide resident of the Virgin Islands" under Code Sec. 932(c) but rather a U.S. citizen "other than a bona fide resident of the Virgin Islands" under Code Sec. 932(a) and therefore was required to file income tax returns "with both the United States and the Virgin Islands," as mandated by that subsection. The IRS determined deficiencies, additions to tax, and a penalty for the years in issue and in 2015 issued a notice of deficiency. Tice challenged the notice of deficiency in the Tax Court.

Code Sec. 6501(a) generally requires that income tax be assessed within three years after the taxpayer's return was filed. It defines "return" as the "return required to be filed by the taxpayer." Under Code Sec. 6501(c)(3), if the filing requirement is not satisfied, then the statute of limitations is not triggered, and the tax may be assessed "at any time."

The USVI generally is not a part of the United States for tax purposes. Originally, U.S. citizens permanently residing in the USVI who had both U.S.-source and USVI-source income were required to file returns and pay taxes to both jurisdictions. In 1954, Congress established an "inhabitant rule" that treated these individuals as having satisfied their U.S. tax obligation by paying tax directly to the USVI. In 1986, Congress repealed the "inhabitant rule" and enacted Code Sec. 932 to coordinate the U.S. and USVI tax systems.

Under Code Sec. 932, the filing requirement for a taxpayer with USVI-source income depends on the taxpayer's residency. Code Sec. 932(a) applies to an individual for the tax year if the individual is a citizen or resident of the United States (other than a bona fide resident of the Virgin Islands at the close of the tax year) and has income derived from sources within the Virgin Islands for the taxable year. Code Sec. 932(c) applies to an individual for the tax year if the individual is a bona fide resident of the Virgin Islands at the close of the tax year.

Code Sec. 932 then provides different filing requirements depending on which mutually exclusive subsection applies. Under Code Sec. 932(a)(2), "each individual to whom" Code Sec. 932(a) applies - i.e., a U.S. citizen or resident with USVI-source income who is not a USVI resident - is required to file his income tax return for the tax year with both the United States and the Virgin Islands. By contrast, "each individual to whom" Code Sec. 932(c) applies - i.e., a bona fide resident of the Virgin Islands - must file an income tax return for the tax year with the Virgin Islands.

In 2008, the IRS issued Reg. Sec. 1.932-1(c)(2)(ii), which provides that for purposes of Code Sec. 6501(a), an income tax return filed with the USVI by an individual who takes the position that he or she is a bona fide USVI resident will be deemed a U.S. income tax return, provided that the United States and the USVI have entered into an agreement for the routine exchange of income tax information. The regulation applied prospectively to tax years ending after April 9, 2008. Taxpayers also could elect to apply to open tax years ending on or after December 31, 2006.

In a motion for summary judgment, Tice argued that the three-year period of limitations under Code Sec. 6501(a) began to run upon his filing of returns with the VIBIR for 2002 and 2003 in 2003 and 2004, respectively, making the 2015 notice of deficiency untimely. Tice contended that whether he actually was a bona fide resident of the USVI for the years at issue was immaterial because he claimed to be one in his VIBIR returns, and merely claiming to be one was sufficient to qualify him for the single-filing regime under Code Sec. 932(c).

Analysis

The Tax Court held that taxpayers who filed a return only with the VIBIR for tax years ending before December 31, 2006, do not trigger the statute of limitations under Code Sec. 6501(a) unless they are bona fide residents of the USVI to whom Code Sec. 932(c) applies. The court held further that, as a taxpayer "other than a bona fide resident of the Virgin Islands" to whom Code Sec. 932(a) applies, Tice's filing of returns only with the VIBIR did not trigger the statute of limitations under Code Sec. 6501(a) and therefore, the notice of deficiency could be issued at any time under Cod Sec. 6501(c)(3).

The court found that, for the years in issue, Tice was required by Code Sec. 932(a)(2) to file his income tax returns "with both the United States and the Virgin Islands," because he was a U.S. citizen with USVI-source income who was not a bona fide USVI resident. Because he was not a bona fide USVI resident, the court found that he was not subject to the "filing requirement" under Code Sec. 932(c)(2), which requires bona fide USVI residents to file solely "with the Virgin Islands." The court also found that Tice could not elect to apply the rule in Reg. Sec. 1.932-1(c)(2)(ii) because the tax years at issue ended before December 31, 2006.

The court explained that filing with the VIBIR is not filing with the IRS. The court reasoned that if a taxpayer were deemed to have filed "with both the United States and the Virgin Islands" by virtue of filing "with the Virgin Islands," then Code Sec. 932(a)(2) would be meaningless. Therefore, the court concluded that taxpayers who file a return only with the VIBIR for the years in issue do not trigger the statute of limitations under Code Sec. 6501(a) unless they are bona fide residents of the USVI to whom Code Sec. 932(c) applies. As a taxpayer other than a bona fide USVI resident to whom Code Sec. 932(a) applies, Tice did not trigger the statute of limitations under Code Sec. 6501(a) by filing returns only with the VIBIR; therefore, the notice of deficiency could be issued "at any time" under Code Sec. 6501(c)(3).

The court rejected Tice's argument that whether he was bona fide resident of USVI for the years at issue was immaterial because he claimed to be one in his VIBIR returns. The court noted that taxpayers raised the same argument before the Eleventh Circuit in Comm'r v. Estate of Sanders, 2016 PTC 322 (11th Cir. 2016). The Eleventh Circuit rejected that argument, holding that a taxpayer who files a return only with the VIBIR does not trigger the statute of limitations unless the taxpayer is actually a bona fide resident of the USVI. According to the Eleventh Circuit, the language and structure of Code Sec. 932 are clearly inconsistent with the taxpayers' invitation to imply a good faith exception to the requirement be filed in the proper place. The court also noted that in Coffey v. Comm'r, 2021 PTC 43 (8th Cir. 2021), the Eighth Circuit reversed the Tax Court and that a USVI nonresident's sole filing with the VIBIR does not begin the running of the three-year period of limitations. The Tax Court noted that this case was appealable to the Fifth Circuit, where there was no binding precedent, but the court found the reasoning of the Eighth and Eleventh Circuits persuasive.

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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