Feb. 28, 2007 — A new tax notice issued last week by the Internal Revenue Service has caused confusion and concern among residents with gross incomes higher than $75,000 a year, and spawned efforts by top officials to change the federal government's position.
Those officials include Gov. John deJongh Jr. and Delegate Donna M. Christensen. Even the chairman of the House Ways and Means Committee has gotten involved, writing a letter to the national taxpayer advocate in September.
"The situation involves the imposition of retroactive tax liabilities on individual taxpayers who, in good faith, paid the correct amount of tax but potentially to the wrong government," wrote Democratic Rep. Charles B. Rangel of New York, a frequent visitor to the territory. "After reading the recitation of facts provided below, I am hopeful that you will agree that the situation is patently unfair to the taxpayers affected and that some manner of relief should be provided to them with the assistance of your office."
At the time he wrote the letter, Rangel was ranking minority member of the committee.
At issue is Notice 2007-19, issued by the IRS Feb. 21. Since 1987, an implementation agreement between the IRS and the V.I. Bureau of Internal Revenue (BIR) has provided for taxpayers to pay income tax directly to the territorial government, with no provision for paying taxes directly to the federal government. But with this notice, estimated to affect approximately 8,500 residents, taxpayers will have to file mostly blank 1040 forms and offer proof that they reside primarily in the territory.
As of yet, the IRS has issued no form to provide it with that proof. Instead, residents must attach a statement to Form 1040 labeled "Bona Fide Resident-Return Position," according to information prepared by the Marjorie Rawls Roberts law firm in Charlotte Amalie:
(1) the taxpayers name, social security number and address;
(2) a statement affirming the facts upon which the taxpayers bona fide residence is based as defined in Treas. Reg. Section 1.937-1(b);
(3) an affirmation that the taxpayer has properly filed a USVI individual income tax return (generally Form 1040), a statement of total tax liability reported on the USVI Form 1040 and the amount of gross income reported in such return; and
(4) a declaration under penalties of perjury that the taxpayer has examined the statement and attachments and that they are true and correct to the best of the taxpayers knowledge.
(For a detailed summary of Notice 2007-19 and its impact, prepared by Marjorie Roberts and Erika Kellerhals, please see "IRS Notice Addresses Statutes of Limitation on Assessment, Gross Income.")
The paperwork will take each resident approximately five hours to complete, according to IRS estimates.
Failure to do so may result in a $1,000 penalty from the IRS. Additionally, the notice raises questions about previous year's returns for taxpayers with annual gross incomes higher than $75,000. As a general rule, the IRS may conduct an audit of tax returns dating back three years, so tax advisors recommend keeping documentation for that period. Under a 2006 IRS ruling, however, local taxpayers may face questions about their legal residency dating back more than three years, meaning residents affected by the notice may not have kept the necessary documentation.
"The IRS memorandum sets a three-year limit on audits of upper-income residents who immediately provide federal tax returns for the past 20 years," said a Government House news release issued Tuesday.
Christensen testified about the tax issues before the House Ways and Means Committee in September. She argued that people taking legitimate advantage of tax breaks provided by the territory's Economic Development Commission had suddenly and arbitrarily begun to face unfair audits from the IRS.
"Rather than facilitating and ensuring tax compliance and, if the facts warrant, ferreting out wrongdoers, the IRS audits have instead become a vehicle for undermining a congressionally sanctioned and authorized economic-development program through punitive and heavy-handed techniques, including repetitive, intrusive, and burdensome data and document requests," Christensen said. "Unfortunately and unfairly, the IRS audit presumption seems to be that the taxpayer engaged in tax fraud unless he or she can prove otherwise."
The changes began with the 2004 Jobs Act. In a worst-case scenario, officials say, people unable to prove their residency from previous tax years would have to pay their taxes twice.
The IRS, Christensen testified, "can assess full tax and penalties even if the taxpayer has paid the correct amount to the Virgin Islands. Because the Virgin Islands statute of limitations will have run in many of these circumstances, the taxpayer will be precluded from seeking a refund of tax paid to the Virgin Islands, and thus be subject to double taxation."
On Tuesday, deJongh weighed in on the issue while in Washington, D.C., attending the Winter Meeting of the National Governors Association. The governor testified before the House Subcommittee on Insular Affairs, questioning the IRS serving Notice 2007-19 with no local input.
"The issuance of a memorandum last week without the policy input of the local government is a step backwards," deJongh said. According to the news release, "The governor is seeking to clarify that an income tax return filed in good faith by a taxpayer in the Virgin Islands shall be treated as a tax return filed in the U.S. for purposes of the statute of limitations in both jurisdictions."
To start the statute of limitations, the IRS notice requires affected residents to file a Form 1040 with the IRS reporting no gross income and no taxable income.
Several issues related to the IRS notice remain unclear. The IRS has given no indication of when the residency form will become available. The notice also indicates the U.S. Treasury Department and the IRS are looking into exchanging information with the BIR, which could eliminate residency-reporting requirements. But no time frame was given for setting up such an exchange.
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