The United States Virgin Islands (“USVI”) is an unincorporated territory of the United States.[1] But that doesn’t mean that they’re subject to exactly the same laws as in the United States—especially when it comes to taxes.
The Mirror Code
As a territory, the U.S. Congress is empowered to “make all needful Rules and Regulations respecting” the USVI.[2] As far as taxes go, Congress requires that the USVI impose an income tax that “mirrors” the U.S. federal income tax found in United States Code, Title 26 (also known as the “Internal Revenue Code” or “IRC”).[3] Because of this requirement, USVI’s income tax law is commonly called a “mirror code.” One of the basic principles used in the application of the “mirror code” is the substitution principle, according to which “Virgin Islands” generally is substituted for “United States” wherever that phrase appears in the IRC.[4]
Under the IRC, the United States taxes citizens and residents on their worldwide income and nonresident aliens on income from sources within the United States or that is effectively connected with the conduct of a United States trade or business.[5] For these purposes, the United States includes only the States and the District of Columbia.[6]
The USVI applies similar rules to its residents and nonresident aliens under the mirror code.[7]
Non-Bona Fide Residents
A U.S. citizen or resident who isn’t a bona fide resident of the USVI during the entire taxable year and who has income derived from USVI sources or effectively connected with a trade or business within the USVI is required to file income tax returns in the taxable years with both the United States and the USVI.[8] The income taxes that such a person is required to pay to the USVI is determined by multiplying the income taxes imposed under the IRC by the “applicable percentage,” which means the percentage that USVI adjusted gross income bears to adjusted gross income.[9] USVI gross income is adjusted gross income determined by only taking into account income from USVI sources and deductions allocable to that income.[10]
Bona Fide Residents
If a person is a bona fide resident of the USVI during the entire taxable year, reports income from all sources on their income tax return to the USVI and identifies the source of each item of income on such return, and full pays their tax liability to the USVI with respect to such income, then for purposes of calculating income tax liability to the United States, the gross income for purposes of calculating federal income tax does not include any amount included in gross income on such return, and allocable deductions and credits shall not be taken into account.[11]
Who’s a Bona Fide Resident?
According to the IRC, an individual is a bona fide resident of the USVI if they are physically present in the USVI for at least 183 days during the taxable year and does not have a tax home outside of the USVI during the taxable year and don’t have a closer connection to the United States of a foreign country than to the USVI.[12] Treasury Regulations modify and elaborate on these conditions.[13]
The Physical Presence Test
Thus, a U.S. citizen or resident meets the physical presence test if they:
- were present in the USVI for at least 183 days during the taxable year;
- were present in the USVI for at least 549 days during the three-year period consisting of the taxable year and the two immediately preceding taxable years and at least 60 days during each taxable year of the period;
- were present in the United States for no more than 90 days during the taxable year;
- during the taxable year had earned income in the United States, if any, not exceeding $3,000 and was present for more days in the USVI than in the United States; or
- had no significant connection to the United States during the taxable year.[14]
A nonresident alien individual meets the physical presence test if they are present in the USVI for at least 31 days in the current taxable year and a total of at least 183 days in the current taxable year and the preceding two taxable years after multiplying the number of days in each year by the applicable multiplier (the applicable multipliers are 1 for the current year, 1/3 for the first preceding tax year, and 1/6 for the second preceding tax year).[15]
The Significant Connection Test
An individual generally is considered to have a significant connection to the United States if they have a permanent home in the United States, are currently registered to vote in any political subdivision of the United States, or have a spouse or minor child whose principal place of abode in the United States.[16] In this context, a permanent means a dwelling that is available at all times and solely for short stays, but doesn’t include a property that is rented to another person during the taxable year unless the taxpayer uses it as a residence at any time during the taxable year.[17] A child who is in the United States because the child is living with a custodial parent under a custodial decree or multiple support agreement or a child who is in the United States as a student does not constitute a significant connection to the United States.[18]
The Tax Home Test
An individual meets the tax home test if their regular place of business is not located outside of the USVI.[19] An individual meets the closer connection test if the individual did not have a closer connection to the United States or another country than to the USVI during the taxable year.[20] Factors relevant in determining whether the individual has a closer connection include:
- The location of the individual’s permanent home;
- The location of the individual’s family;
- The location of personal belongings, such as automobiles, furniture, clothing, and jewelry owned by the individual and his or her family;
- The location of social, political, cultural, or religious organizations with which the individual has a current relationship;
- The location where the individual conducts his or her routine personal banking activities;
- The location where the individual conducts business activities (other than those that constitute the individual’s tax home);
- The location of the jurisdiction in which the individual holds a driver’s license;
- The location of the jurisdiction in which the individual votes;
- The country of residence designated by the individual on forms and documents; and
- The types of official forms and documents filed by the individual, such as Form 1078 (Certificate of Alien Claiming Residence in the United States), Form W-8 (Certificate of Foreign Status) or Form W-9 (Payer’s Request for Taxpayer Identification Number).[21]
Year-of-Move
Special rules apply for the taxable year in which an individual changes residence to the USVI. When an individual moves to the USVI, the tax home and closer connection tests are met if:
- For each of the three taxable years immediately preceding the taxable year of the change of residence, the individual is not a bona fide resident of the USVI;
- For each of the last 183 days of the taxable year of the change of residence, the individual does not have a tax home outside the relevant possession or a closer connection to the United States or a foreign country than to the USVI; and
- For each of the 3 taxable years immediately following the taxable year of the change of residence, the individual is a bona fide resident of the USVI.[22]
Take-Away Thoughts
While taxation in the USVI ostensibly is supposed to “mirror” the federal income tax, certain provisions in the Internal Revenue Code that limit who is bona fide resident of the USVI make the process much more complicated. If you’re in a situation where you may or may not be a bona fide resident of the USVI, it may be a good idea to consult a tax professional to make sure that you get it right.
[2] See U.S. Const. art. IV, §3, cl. 2.
[3] 48 U.S.C. § 1397; 26 U.S.C. § 7701(a)(29) (“The term “Internal Revenue Code of 1986” means this title . . . .”); Danbury, Inc. v. Olive, 820 F.2d 618, 620-21 (3d Cir.1987) (“Congress create[d] a separate taxing structure for the Virgin Islands “mirroring” the provisions of the federal tax code except as to those provisions which are incompatible with such a separate tax structure.”)).
[4] Abramson Enters., Inc. v. Gov’t of V.I., 994 F.2d 140, 142 (3d Cir.), cert. denied, 510 U.S. 965 (1993).
[5] See 26 U.S.C. §§ 1, 871; 26 C.F.R. §§ 1.1-1(b), 1.871-1(a).
[6] 26 U.S.C. § 7701(a)(9).
[7] See 26 U.S.C. § 1; 48 U.S.C. § 1397.
[8] 26 U.S.C. § 932(a)(1), (2).
[9] 26 U.S.C. § 932(b)(1), (2)(A).
[10] 26 U.S.C. § 932(b)(2)(B).
[11] 26 U.S.C. § 932(c)(4).
[12] 26 U.S.C. § 937(a). Juridical persons, including corporations, partnerships, trusts, and estates, cannot be bona fide residents of the USVI. 26 C.F.R. § 1.937-1(b)(3).
[13] See 26 U.S.C. § 937(a) (stating that the statutory conditions for bona fide residence apply “except as provided in regulations . . . .”).
[14] 26 C.F.R. § 1.937-1(c)(1).
[15] 26 U.S.C. § 7701(b)(3); 26 C.F.R. § 1.937-1(c)(1)(i).
[16] 26 C.F.R. § 1.937-1(c)(5)(i).
[17] See 26 C.F.R. §§ 1.937-1(c)(5)(2), 301.7701(b)-2(d)(2).
[18] 26 C.F.R. § 1.937-1(c)(5)(i)(C).
[19] 26 C.F.R. § 1.937-1(d)(1).
[20] 26 C.F.R. § 1.937-1(e).
[21] See 26 C.F.R. §§ 1.937-1(e), 301.7701-2(d)(1).
[22] 26 C.F.R. § 1.937-1(f)(1).
