Virgin Islands Economic Development Program Update: Tax Court: Statute of Limitations Triggered by Filing Tax Return with Virgin Islands Bureau of Internal Revenue

May 24, 2013   

On May 22, 2013, Judge Jacobs writing for the United States Tax Court ruled against the IRS which had taken the position that the statute of limitations did not apply to Virgin Islands taxpayers who filed an income tax return with the Virgin Islands Bureau of Internal Revenue (VIBIR). The case is Appleton and the Government of the United States Virgin Islands v. Commissioner of Internal Revenue, 140 T.C. No. 14, which may be read here. For a background discussion of taxation in the U.S. Virgin Islands, including the Virgin Islands Economic Development Program(EDP) and the ongoing litigation between the IRS and the myriad taxpayers who have availed themselves of the EDP, please see our prior blog posts on these issues  here, here, here, here and here.

The facts of the case are fairly straightforward. The taxpayer, Arthur Appleton, is a United States citizen who resided on the U.S. Virgin Islands and was a bona fide resident under Section 932 of the Internal Revenue Code. The taxpayer claimed an EDP tax credit.  The IRS received copies of the taxpayer’s 2002, 2003, and 2004 returns from the VIBIR, and both the VIBIR and the IRS examined the taxpayer’s income tax returns. The VIBIR proposed no adjustments, but the IRS did, determining that the taxpayer did not qualify for the section 932(c)(4) gross income exclusion. Treating the taxpayer as a nonfiler, on November 25, 2009, the IRS issued the taxpayer a statutory notice of deficiency.

In the Tax Court’s discussion, it observed that Section 7654(e) of the Internal Revenue Code required the Secretary to draft whatever regulations necessary to carry out the provisions of section 932, including prescribing the information which individuals to whom section 932 applies must furnish to the Secretary. The Secretary did not, however, promulgate regulations for the years at issue.

The court also recognized that the instructions to Form 1040 stated that that “permanent residents of the Virgin Islands should use: V.I. Bureau of Internal Revenue, 9601 Estate Thomas, Charlotte Amalie, St. Thomas, VI 00802” when filing their Form 1040 individual income tax returns.  The court noted that the IRS “concedes that the Forms 1040 petitioner filed with the VIBIR are returns within the meaning of section 6501(a)(1), sufficient to trigger the running of the period of limitations if properly filed.”  The court then went on to state that “[t]he Secretary, using the authority expressly granted to him by section 6091(b)(1)(B), promulgated section 1.6091-3(c), Income Tax Regs., which requires taxpayers like petitioner, residing in a possession of the United States, to file their tax returns as designated on the return forms or in the instructions issued with respect to those forms. The instructions to Form 1040 are explicit: The form is to be filed with the VIBIR.”

In dispensing with the argument that an income tax return filed with VIBIR cannot be an IRS return, the court recognized that the IRS’s position (i.e., that petitioner should have filed two returns–one with the VIBIR and one with the IRS) was undermined by its position that bona fide residents of the Virgin Islands who earn less than $75,000 may satisfy their Federal filing requirements by the single filing of a return with the VIBIR. Thus, even before the start of the Appleton case, IRS had accepted Mr. Appleton’s argument that a return filed with the VIBIR may be both a Federal return and a territorial return.

The Court concluded that the taxpayer proved that the section 6501(a) period of limitations expired before the date the IRS mailed the taxpayer the notice of deficiency.

The implications of the decision are far reaching, and it appears that the IRS’s ability to audit VI taxpayers indefinitely has been seriously undercut by the Tax Court.  We anticipate that the IRS will have to change its litigation position and that a good majority of the cases currently pending in the Tax Court will also be subject to dismissal based on the statute of limitations defense.  However, only time will tell how the IRS will respond and if the IRS will attempt to seek reconsideration and/or appeal.

Additionally, as we previously blogged, the U.S. Court of Appeals for the Third Circuit in the Vento case established the legal test for those who claim to be bona fide USVI residents under IRC section 932 (2004).  The implication of Appleton and Vento decisions working in tandem is that USVI residency is a low threshold to meet, and once one is a USVI resident the statute of limitation should prevent the IRS from assessing additional tax, penalties and interest.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive civil and criminal tax litigation experience and are currently litigating a large number of Virgin Islands tax cases before the Tax Court.  You can reach at attorney by calling us at 305.350.5690 or by emailing us at: