Home News Local news Report: IRS Adopts Alternative Means to Determine Residency

Report: IRS Adopts Alternative Means to Determine Residency

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Nov. 14, 2006 — On Nov. 13, 2006, the Internal Revenue Service issued final regulations (TD 9297) providing an alternative method for meeting the physical presence test in the rules for determining bona fide residency in U.S. possessions, including the U.S. Virgin Islands, effective November 14, 2006.
This test supplements the physical presence tests set out in the 2004 Jobs Act, the proposed and temporary regulations issued effective April 11, 2005, and the final regulations issued effective Jan. 31, 2006.
There are now five alternative ways that a person can meet the physical presence component of the bona fide residency test for U.S. possessions:
A person is present in a possession for at least 183 days during a tax year. To meet this test, presence in a possession for any part of a day counts towards the 183 days. For example, if a person traveled from the U.S. Virgin Islands to Miami on Monday and returned on Tuesday, both days would "count" towards the 183 days. Moreover, certain types of days spent outside the U.S. Virgin Islands count as being in the U.S. Virgin Islands, such as days spent receiving medical care requiring hospitalization and medically necessary time immediately before and after the hospitalization.
A person spends no more than 90 days in the United States during the tax year. Days spent in Puerto Rico dont count as being in the United States, nor do periods of time spent in the United States in transit of fewer than 24 hours.
A person has no significant connection to the United States during the tax year, meaning no permanent home, no voter registration, no spouse, and no minor children (with exceptions for legal separation agreements and noncustodial parents).
A person has no more than $3,000 of earned income from U.S. sources and is present for more days in the territory than in the United States during the tax year.
And, effective Nov. 14, a person is present in the possession (i.e., territory) for a simple, nonweighted three-year average of 183 days per year, provided that a minimum of 60 days of presence is met in each of those three years. Accordingly, an individual will satisfy the presence test if he or she is present in the U.S. Virgin Islands for at least 549 days during the three-year period that includes the current tax year and the two preceding tax years as long as she or he was present in the U.S. Virgin Islands for at least 60 days in each year during the three-year period.
What is interesting, and is made clear by the example contained in the final regulations, is that a person does not have to have been a resident for the preceding one or two years to have the days in the years "count" towards current year residence.
For example, a person could spend 60 days in the U.S. Virgin Islands on vacation in 2004 and file his or her return with the United States, then spend 330 days in 2005 and 159 in 2006 and he would satisfy the physical presence test for 2005 by spending more than 183 days in the U.S. Virgin Islands and in 2006 by meeting the three-year averaging test. A taxpayer can rely on different physical presence tests for different years.
The Internal Revenue Service now requires that Form 8898 Statement for Individuals Who Begin or End Bona Fide Residence in U.S. Possession be filed by persons moving to or from a possession for the year of move. The IRS will be revising this form to accommodate the 183-day averaging test.
However, the physical presence test regardless of which of the five methods is used to meet it is only one prong of the three-part residency prong. A "bona fide resident" of a possession must also not have a tax home outside of such possession for the taxable year (the "tax home test"); and not have a closer connection to the United States or a foreign country than to such possession (the "closer connection test").
A tax home is a person's regular or principal place of business or, if the individual has no regular or principal place of business, then his or her regular abode.
To meet the closer connection test a person must have a closer connection to the U.S. Virgin Islands than anywhere else, looking to such factors as the location of the persons home or homes, location of the persons family and personal belongings, social, political, cultural, and religious organizations in which the person participates, location of personal bank account, drivers license, place of residency indicated on forms and documents, and where the person votes.
These tests are unchanged by todays final regulations. Accordingly, they continue to be determined on a year-by-year basis.
The Internal Revenue Service issued the new final regulations after receiving additional comments after the Jan. 31, 2006 final regulations from various persons. The background that accompanied the final regulations discusses other suggested changes to the final regulations and why they were rejected.
The Internal Revenue Service indicated that it was sympathetic to the concern that the realities of life in the territories might require periodic temporary absences from the territories, but found that suggestions that days spent outside of a territory for nonmedical family emergencies, charitable pursuits or business travel would have been very difficult to implement and monitor administratively. However, the IRS does not indicate why such exceptions would have been more difficult to administer than the current five alternative physical presence tests. In essence, every U.S. Virgin Islands taxpayer relying on a physical presence test other than the "no significant connection" test must now keep a daily diary where he or she is and the incorporation of additional exceptions would not create any additional administrative burdens on the taxpayers than exist already.
Further, the Internal Revenue Service indicated that it considered a request that up to 30 days or business or personal travel outside the United States and the territory be treated as days of presence in a territory, but again concluded that such a rule would be administratively difficult to implement and monitor. Such an exception, however, would have been particularly appropriate for the insular territories because many residents have close family and professional ties to other islands especially in light of the increasing and already high cost of air travel. It is also difficult to understand why such a test would have been difficult to monitor.
The Internal Revenue Service also considered providing that outpatient care be added to the permitted types of qualifying medical treatment but decided that the 183-day rule in combination with the alternative physical presence tests provided sufficient flexibility to accommodate outpatient care. It did not address the fact that insurance companies and the medical establishment in general now promote (or require) outpatient care whenever possible in lieu of hospitalization for an expanding number of procedures, nor the fact that many illnesses and infections are tied to overnight hospital stays and can be minimized through outpatient treatment.
The IRS indicated that it added the 183-day average test because it believed that it was administrable and achieved the additional flexibility required for nonmedical family emergencies, charitable pursuits, business travel, international travel and outpatient care. The IRS indicated, however, that it believes the next three-year averaging alternative, together with the existing available alternatives, provide individuals with sufficient flexibility in applying the presence test and thus that no further amendments will be made to the bona fide residency rules via the regulatory process. It appears that any further changes in the possession residency rules, therefore, would require statutory amendments by the U.S. Congress.
The final regulations apply generally to tax years ending after Jan. 31, 2006. Taxpayers may also technically choose to apply Treasury Regulation 1.937-1 in its entirety to all tax years ending after Oct.
22, 2004, for which the statute of limitations is open (generally three years from filing).
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