Sochurek test still governs pre-2005 Virgin Islands residency claims

Plain-English summary

Chief Counsel advised that the 11-factor Sochurek facts-and-circumstances test remained the proper standard for evaluating bona fide U.S. Virgin Islands residence for tax years 2002 through 2004. The Third Circuit's Vento decision did not change that test because the Vento parents' facts differed from the arrangements described in Notice 2004-45. Examiners should compare each applicable factor, especially intent, home, physical presence, economic ties, family residence, employment, and good faith. They also should not concede a limitations-period issue until first determining that the taxpayer was a bona fide Virgin Islands resident. If the taxpayer was not a bona fide resident, filing a return with the Virgin Islands tax authority did not start the federal assessment period.

Ruling snapshot

• Question: How should the IRS evaluate pre-2005 bona fide Virgin Islands residence claims after Vento?
• Outcome: Advice given to continue applying the 11-factor Sochurek test
• Key authorities: IRC §§ 932, 934, and 6501; Notice 2004-45; Sochurek v. Commissioner, 300 F.2d 34; Vento v. Director of Virgin Islands Bureau of Internal Revenue, 715 F.3d 455

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       memorandum
       Number: 201503012
       Release Date: 1/16/2015
       CC:INTL:B07:JRussin
       POSTS-124550-14

UILC: 932.02-00

date: November 26, 2014

 to:   Nancy B. Romano
       Area Counsel
       (Small Business/Self-Employed)

from: Ricardo Cadenas
Chief, Branch 7
Associate Chief Counsel (International)

subject: Litigation of USVI Economic Development Program Cases, TYs 2002 to 2004

       This responds to your request concerning the impact of Vento v. Director of Virgin
       Islands Bureau of Internal Revenue & United States, 715 F.3d 455 (3d Cir. 2013), aff’g
       in part and rev’g in part 107 A.F.T.R.2d 2011-951 (D.V.I. 2011), on cases involving
       taxpayers who appear to have participated in an arrangement described in Notice 2004-
       45, 2004-2 C.B. 33, Meritless Filing Position Based on Sections 932(c) and 934(b).
       This memorandum should not be used or cited as precedent.

       ISSUE

       After the Vento decision, what factors should be applied to evaluate a claim of bona fide
       residence in the U.S. Virgin Islands (“USVI”) in cases that factually are substantially
       similar to those described in Notice 2004-45 (“Notice 2004-45 cases”) for taxable years
       2002 to 2004?

       CONCLUSION

       The 11-factor facts-and-circumstances test set forth in Sochurek v. Commissioner, 300
       F.2d 34 (7th Cir. 1962), continues to provide the proper standard for evaluating a claim
       of bona fide residence in the USVI for taxable years 2002 to 2004 in a case described in
       Notice 2004-45. The Vento decision did not alter this standard. The facts of the Vento
       parents are distinguishable from the facts in most Notice 2004-45 cases.

POSTS-124550-14 2

FACTS DESCRIBED BY NOTICE 2004-45

Notice 2004-45 describes a scheme in which a taxpayer living and working in the United
States undertakes to “(i) purport to become a USVI resident by establishing certain
contacts with the USVI, (ii) purport to terminate his or her existing employment
relationship with his or her employer . . . and (iii) purport to become a partner of a Virgin
Islands limited liability partnership . . . that is treated as a partnership for U.S. tax
purposes.” The taxpayer continues to provide substantially the same services to his or
her former employer as before, but the former employer makes payments to the USVI
partnership, which then passes the money to the taxpayer. The USVI partnership either
has already secured or then secures a reduction, up to 90%, in USVI income tax liability
under the USVI’s Economic Development Program (“EDP”). The taxpayer claims to be
a bona fide resident of the USVI, as required for the EDP, and claims an EDP reduction
in income tax liability on his or her USVI individual income tax return. The taxpayer
claims that, for purposes of computing his or her U.S. income tax liability, the income is
excluded under section 932(c)(4). Notice 2004-45 states that the tax positions taken
are “highly questionable, and in most cases meritless,” further stating that “a claim of
USVI residency for income tax purposes may be considered without merit or fraudulent
when the taxpayer continues to live and work in the United States.”

The notices of deficiency in these cases typically conclude that the taxpayer has
entered into an abusive tax avoidance scheme as described in Notice 2004-45. This
advice is provided based on the typical and shared elements in these cases.

LAW AND ANALYSIS

In Vento, the U.S. Court of Appeals for the Third Circuit applied the 11-factor standard
set forth in Sochurek v. Commissioner, 300 F.2d 34 (7th Cir. 1962),1 and held that the
Vento parents were bona fide residents of the USVI as of December 31, 2001, but that
the three Vento daughters were not.
1
The Third Circuit stated that “[t]he District Court . . . applied Sochurek to this dispute, and we will do so
as well.” Vento at 466. The 11 factors are:
“(1) intention of the taxpayer;
(2) establishment of his home temporarily in the foreign country for an indefinite period;
(3) participation in the activities of his chosen community on social and cultural levels,
identification with the daily lives of the people and, in general, assimilation into the foreign
environment;
(4) physical presence in the foreign country consistent with his employment;
(5) nature, extent and reasons for temporary absences from his temporary foreign home;
(6) assumption of economic burdens and payment of taxes to the foreign country;
(7) status of resident contrasted to that of transient or sojourner;
(8) treatment accorded his income tax status by his employer;
(9) marital status and residence of his family;
(10) nature and duration of his employment; whether his assignment abroad could be promptly
accomplished within a definite or specified time;
(11) good faith in making his trip abroad; whether for purpose of tax evasion.”
Vento at 466-67 (quoting Sochurek at 38).
POSTS-124550-14 3

When the Third Circuit’s factual findings with respect to the Vento parents are compared
with Notice 2004-45, it is clear that Vento is distinguishable from the typical Notice
2004-45 case. Of particular significance, the tax abuse in which the Ventos had
engaged was not with respect to rules exclusive to the USVI but rather involved a “Son
of BOSS” tax shelter.2 The typical Notice 2004-45 case, in contrast, involves a direct
abuse of a tax benefit available solely through a USVI entity and expressly conditioned
on bona fide residence in the USVI. Furthermore, the court’s specific factual findings
with respect to the situation of the parents in Vento are distinguishable from the typical
Notice 2004-45 case in many ways relevant to the Sochurek standard. The following
discussion considers each of the relevant factors in turn.

THE 11-FACTOR TEST

As noted in both Sochurek and Vento,3 while not all Sochurek factors will be present in
every situation, consideration and weight should be given to each factor that is
applicable. Facts distinguishing the parents in Vento from Notice 2004-45 cases are
expected to arise in consideration of factors (1), (2), (4), (6), (9), (10), and (11).

(1) Intention of the taxpayer. The Vento court found that the Vento parents “certainly
decided to move to the Virgin Islands.” Vento at 473. In contrast, the promotional
materials described in Notice 2004-45 falsely advised that participants could “continue
to live and work in the United States and, nevertheless, be a bona fide resident of the
USVI.”

(2) Establishment of his home. The Third Circuit found that the house in the USVI the
Ventos purchased and were renovating was “not unlivable.” Vento at 476 n. 21.
“Establishment of a home” should take into consideration the type of property, amount
expended, and type of accommodation; by contrast to the Ventos, many Notice 2004-45
taxpayers had only shared or short-term accommodations in the USVI.

(4) Physical presence. Mr. Vento was present in the USVI for the entire month of
December 2001, a fact on which the court focused because his bona fide residence was
only at issue for that year. Vento at 474-75. Most Notice 2004-45 cases involve more
than one tax year, and in many cases bona fide residence is at issue for an entire
taxable year.4 Even where a single month is critical, the taxpayer may not be present
for the entire month.
2
See VI Derivatives, LLC v. United States, No. 06-cv-0012-JRS-RM (D.V.I. December 13, 2011) and
VIFX, LLC v. United States, No. 06-cv-0013-JRS-RM (D.V.I. December 13, 2011) (granting Government
motions for partial summary judgment).
3
Sochurek, 300 F.2d at 38; Vento, 715 F.3d at 467.
4
Pursuant to § 908(c)(2) of the American Jobs Creation Act of 2004, P.L. 108-357, the wording in Code
section 932(c)(4)(A) was changed from “at the close of the taxable year” to “during the entire taxable
year,” effective for tax years ending after October 22, 2004.
POSTS-124550-14 4

(6) Assumption of economic burdens. The court found that the Vento parents had
“observed all the legal formalities of residency,” Vento at 477; in many Notice 2004-45
cases, the taxpayers maintain their driver’s licenses, voting, and other registrations in
the United States and not in the USVI.

(9) Marital status and residence of his family. The Third Circuit found that Mr. and Mrs.
Vento lived with one another in the USVI. Vento at 477. Their daughters, who lived
elsewhere, were adults and not dependents of their parents. Id. By contrast, many
taxpayers in Notice 2004-45 cases have spouses or minor children living outside the
USVI.

(10) Nature and duration of his employment. Mr. Vento had sold the company he co-
founded and “began developing professional relationships in the Virgin Islands.” Vento
at 476-77. By contrast, typical Notice 2004-45 participants return to the United States
as part of providing services to their former employers, which do not benefit from the
participants’ time in the USVI.

(11) Good faith. In its application of Sochurek’s “good faith” factor, the Third Circuit
found that two of the three USVI entities formed by the Vento parents were “bona fide
companies with non-tax, business purposes” and that “Richard Vento’s establishment of
business interests in the Virgin Islands supports his claim of bona fide residency.”
Vento at 471. In Sochurek, this factor turned on the absence of a “scheme or
arrangement” relating to taxes. Sochurek at 39. A typical Notice 2004-45 case involves
the use of a USVI partnership, and sometimes additional entities, in an attempt to
convert U.S.-source income into income that is treated as effectively connected with the
conduct of a trade or business in the USVI. Claims of bona fide residence when using
such arrangements, found “highly questionable” by Notice 2004-45, are the clearest
cases when individuals would fail to meet the “good faith” factor.

In sum, when challenging a bona fide USVI residence position in a Notice 2004-45
case, the IRS should carefully distinguish the facts from those involving the Vento
parents with respect to each applicable Sochurek factor, in particular the 11th (“good
faith”) factor, where the direct USVI nexus presented by the abusive tax arrangement in
which the taxpayers participated (e.g., inappropriately claiming the EDP benefit with
respect to activities unconnected to the USVI) is an important difference from Vento.

LIMITATIONS PERIOD ON ASSESSMENT

Finally, we note that it is not appropriate for the IRS to concede automatically the
statute-of-limitations issue often present in Notice 2004-45 cases. Such a concession is
appropriate only after a determination has been made under the Sochurek standard that
a taxpayer is a bona fide USVI resident. It is important to recognize that the holding in
Appleton v. Commissioner, 140 T.C. 273 (2013), is limited to situations in which the
POSTS-124550-14 5

taxpayer is a bona fide resident of the USVI for the tax year in issue.5 In such cases,
the period of limitations on assessment under section 6501(a) begins to run upon the
filing of the taxpayer’s filing of his return with the USVI Bureau of Internal Revenue
(BIR).6 If a taxpayer is not a bona fide resident of the USVI, then the filing of the
taxpayer’s return with the USVI BIR does not start the running of the period of
limitations under section 6501(a), pursuant to sections 932(a) and 6501(c)(3).

Please call Jacob Russin at (202) 317-6941 if you have any further questions.

5
The parties stipulated that Mr. Appleton was a bona fide resident of the USVI for the relevant tax years.
6
If another exception to the running of the statute of limitations under section 6501 applies, then the IRS
should pursue that avenue.