Tax Court Rules that U.S. Virgin Islands Partnerships are Corporations under “Check the Box” Regulations

Mar 21, 2012   

On March 19, 2012, Judge Jacobs in speaking for the Unitd States Tax Court ruled that a United States Virgin Islands (USVI) limited liability company (LLC) is treated under the “check the box” regulations as a foreign corporation and that the unified audit provisions of the Internal Revenue Code, commonly referred to as the TEFRA provisions, do not apply.  As a result, the Tax Court did have jurisdiction over the notice of deficiency that the IRS issued, and the taxpayers motion to dismiss was denied.

The facts of the case summarized as follows:

The taxpayer filed income tax returns with the USVI Bureau of Internal Revenue (BIR) for 2002, 2003, and 2004. During those years the taxpayer was a member of NASCO, LLC a USVI Economic Development Commission (EDC) approved beneficiary.  The IRS claimed that the taxpayers was only involved with NASCO as a tax avoidance scheme in order to claim a tax credit under Internal Revenue Code (IRC) section 932.

Joseph A. DiRuzzo, III, a senior tax associate at Fuerst Ittleman, moved to dismiss the case on the grounds that the Tax Court lacked the jurisdiction necessary to adjudicate a notice of deficiency issued to an individual taxpayer that attempted to adjust partnership items.  The taxpayer argued that (1) NASCO was a valid LLC organized under the laws of the Virgin Islands, was recognized as such by the BIR, and should be respected for Federal tax purposes, and (2) this case involves a partnership item and hence the IRS should have issued an Final Partnership Administrative Adjustment (FPAA) to the Tax Matters Partner (TMP) of NASCO pursuant to the procedural rules of TEFRA, as opposed to a notice of deficiency.   

The Tax Court held as follows:

Business entities are generally classified for Federal tax purposes by section 7701 and the “check-the-box” regulations of sections 301.7701-1 through 301.7701-5, Proced. & Admin. Regs.8 The Virgin Islands, and the businesses established therein, are generally considered foreign for purposes of the Code because the Virgin Islands is not one of the 50 States or the District of Columbia. See sec. 7701(a)(4), (5), (9).

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To conclude, because NASCO did not file a Federal partnership return and because NASCO is classified as a foreign corporation for Federal tax purposes, the TEFRA procedural rules do not apply. Consequently, we hold that (1) respondent was not required to issue an FPAA, and (2) respondent issued a valid notice of deficiency.

A full copy of the opinion can be found here

The opinion presents some interesting opportunities for taxpayers litigating against the IRS.  Because a USVI partnership is treated as a corporation (absent an affirmative election under the check the box regulations), and assuming that the USVI partnership is not a controlled foreign corporation (CFC) with Subpart F income, if the USVI partnership is found to be a valid business entity, any tax liability will be the liability of the USVI partnership and not of its members.  It is thus critical that the issue as to the validity of the USVI entity be properly litigated and tried.

The attorneys at Fuerst Ittleman have extensive experience litigating against the IRS before the Tax Court, the District Courts, the Court of Federal Claims, and the U.S. Circuit Courts.  Joseph A. DiRuzzo, III, is licensed to practice in a host of jurisdictions including the USVI and actively litigates and tries a wide variety of cases there.  You can contact an attorney by calling us at 305.350.5690 or by emailing us at contact@fidjlaw.com.