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Residency and its effect on taxes

Texas, Florida, Nevada and Wyoming are a few of the states that have no state income tax. U.S. territories also have different tax policies. A long-standing agreement between the Virgin Islands and the U.S. allows territory residents to pay their taxes to the Islands.

As retirees know when they split time between Texas and California, residency rules need to be followed closely. A case pending in the U.S. Tax Courts looks at what it means to be a "bona fide" resident of the U.S. Virgin Islands.

Residency is at the heart of a dispute because it qualified the taxpayer for a significantly reduced income tax rate. The Tampa Bay Times reported that between 2002 and 2004, two Florida business partners formed a company and claimed residency in the U.S. Virgin Islands. Transactions of more than $50 million were routed through the company avoiding U.S. federal income taxation.

Documenting residency status

The men claim they were physically present in the U.S. Virgin Islands consistent (with) their employment." They also have asserted that any failure to pay taxes was due to "reasonable cause" rather than "willful negligence." This difference could mean the difference in the size of penalties and whether criminal charges are added.

In a similar case, the taxpayer showed access to a condo, a checking account registered to a U.S. Virgin Islands address and purchase of a car on the Island. The IRS, however, cited credit card receipts which indicated the taxpayer was only on the Island for 8 days during one year.

The American Job Creation Act of 2004 broadened out the residency requirement and many business operations on the Island apparently ceased the next year.

Homestead exemptions

One important factor in any dispute over residency is the homestead exemption. One of the taxpayers in the current case secured an exemption for a Florida property affirming to be a permanent resident of Florida. He also ran a Florida business. These details could pose problems for the taxpayer in the pending litigation.

Could foreign account reporting also be an issue?

If you frequently vacation in the U.S. Virgin Islands, you may have a bank or investment account on the Island. Would you need to report it on Form 114, Report of Foreign Bank and Financial Accounts (FBARs)?

FBARs are required if you are:

  • A U.S. person;
  • With a financial interest or signature authority over a financial account;
  • Located in a foreign country; and
  • The aggregate amount in the account(s) valued in U.S. dollars was $10,000 or more at any point in the calendar year.

The U.S. Virgin Islands is included in the definition of United States, because it is a U.S. territory. This means that the answer is a qualified no.

Each situation is unique, so speak with a qualified tax attorney. Whether concerned about residency or FBAR reporting requirements, getting the right answers can mitigate litigation risks along with the potential for steep penalties.

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