Kevin. M. Hall is a lawyer based in Holland & Knight's Fort Lauderdale office
HIGHLIGHTS:
- Because of the damage Hurricanes Irma and Maria inflicted on the U.S. Virgin Islands and Puerto Rico, the IRS has relaxed the stringent physical presence requirements that individuals typically must satisfy to qualify as bona fide residents of either possession.
- Although the notice provides welcome relief for individuals affected by the hurricanes, many Puerto Rican residents rely on Puerto Rican tax incentives that require them to satisfy similar presence requirements. Unless Puerto Rico also provides relief, these individuals may lose their Puerto Rican tax benefits if they leave the island.
The U.S. Virgin Islands (USVI) and Puerto Rico offer substantial tax benefits to certain of their residents for income sourced within the island. These benefits result in worldwide tax savings for a U.S. citizen only if the individual is a bona fide permanent resident of the island under U.S. tax rules. An individual must satisfy stringent requirements, which require sustained physical presence on the island, to qualify as a bona fide resident of either the USVI or Puerto Rico. Because of the damage inflicted by Hurricanes Irma and Maria, the IRS published Notice 2017-56 on Oct. 4, 2017. The notice relaxes the physical presence requirements.
Although the notice provides welcome relief for individuals affected by Hurricane Maria, many Puerto Rican residents rely on Puerto Rican tax incentives that require them to satisfy similar presence requirements. Unless Puerto Rico also provides relief, these individuals may lose their Puerto Rican tax benefits unless they return to, or remain in, Puerto Rico.
U.S. Taxation of Bona Fide USVI, Puerto Rican Residents
U.S. citizens and residents are subject to U.S. federal income tax on their worldwide incomes. Section 933 of the U.S. Internal Revenue Code (the Code), however, exempts Puerto Rican-source income earned by individuals who are "bona fide residents" of Puerto Rico from U.S. federal income tax. Section 932 of the Code exempts certain USVI-sourced income earned by individuals who are "bona fide residents" of the USVI.
Bona Fide Residence Requirement
To qualify as a bona fide resident of possession during a taxable year, an individual must 1) satisfy a presence requirement, 2) not have a "tax home" outside of the possession during the taxable year, and 3) not have a "closer connection" to a foreign country or the United States than the possession. The most onerous of these requirements typically is the presence requirement.
The Code provides that an individual satisfies the presence requirement if he or she is present on the respective island (Puerto Rico or the USVI) for at least 183 days during the tax year. The regulations, however, provide alternative tests. Pursuant to the regulations, an individual satisfies the presence requirement if the individual:
- was present on the island for at least 183 days during the taxable year
- was on the island for at least 549 days during the three-year period consisting of the taxable year and the two immediately preceding taxable years, and was present on the island for at least 60 days during each year of such three-year period
- was present in the United States for no more than 90 days during the taxable year
- had no more than $3,000 of U.S.-source income for the taxable year and was present during the taxable year on the island for more days than he or she was present in the United States, or
- had "no significant connection" to the United States
Thus an individual who satisfies any one of these five tests satisfies the presence requirement.
For purposes of these rules, an individual is considered to be present on the island or in the United States for a day if the individual is physically present on the island or in the United States, as the case may be, at any time during that day. The regulations treat up to 14 days spent outside of the island as days spent on the island if a disaster occurs on the island. Specifically, they provide that "[a]ny day that an individual is outside the relevant possession because the individual leaves or is unable to return to the relevant possession during any 14-day period within which a major disaster occurs in the relevant possession for which a Federal Emergency Management Agency Notice of a Presidential declaration of a major disaster is issued in the Federal Register."
Notice 2017-56 extends this 14 day period to 117 days, effective beginning Sept. 6, 2017, and ending Dec. 31, 2017. The notice further provides that "an individual who is outside of an impacted U.S. territory on any day during this 117-day period will be treated as leaving or as being unable to return to the relevant U.S. territory as a result of Hurricane Irma and Hurricane Maria on such day."
Additional Considerations
Under the notice, days spent outside of the island by individuals beginning on Sept. 6, 2017, will count as days spent on the island for purposes of the presence requirement under the Code. But unless Puerto Rico provides similar relief, such days spent outside of Puerto Rico will not qualify for purposes of the Puerto Rico Act 22 physical presence test, which requires 183 days of presences within Puerto Rico. Act 22 exempts certain income – including certain dividends, interest and certain capital gains – from Puerto Rican tax, which otherwise applies at rates reaching 33 percent. Unless Puerto Rico relaxes its presence requirement, U.S. tax residents seeking benefits under Act 22 (coupled with the Section 933 exemption) must decide whether the tax savings justify the hardships of remaining in Puerto Rico.
For more information on how IRS Notice 2017-56 could affect you specifically, contact the author, Kevin Packman or William Sherman.
For more on residency requirements in the USVI and other U.S. possessions, see "Establishing Residency in the U.S. Virgin Islands – A Look at Section 937's Reach."
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
