GEORGE C. HUFF, PETITIONER v. COMMISSIONER
OF INTERNAL REVENUE, RESPONDENT
Docket No. 12942–09. Filed August 17, 2010.
Claiming to be a bona fide resident of the U.S. Virgin
Islands at the close of 2002, 2003, and 2004, and claiming he
was qualified for the gross income tax exclusion provided by
I.R.C. sec. 932(c)(4), P, a U.S. citizen, filed territorial income
tax returns with the Virgin Islands Bureau of Internal Rev-
enue. He did not file Federal income tax returns for those
years. R determined that P was not a bona fide resident of the
Virgin Islands and was not qualified for the gross income tax
exclusion as claimed. Therefore, R issued a notice of deficiency
determining income tax deficiencies and penalties for 2002,
2003, and 2004. For protective reasons, P filed a petition in
this Court but asserts that the deficiency relates to a Virgin
Islands tax matter over which this Court lacks jurisdiction.
Held: Although this case involves putative Virgin Islands
transactions, the notice of deficiency determines deficiencies
in Federal income tax. Whether P satisfies all the require-
ments set forth in I.R.C. sec. 932(c)(4), and thus need not file
a Federal tax return or pay Federal income tax for 2002,
2003, and 2004, is a matter which this Court has jurisdiction
to decide. Held, further, P’s motion to dismiss for lack of juris-
diction will be denied.
222
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(222) HUFF v. COMMISSIONER 223
William M. Sharp, Lawrence R. Kemm, Joseph A. DiRuzzo,
III, and Marjorie Rawls Roberts, for petitioner.
Daniel N. Price and Ladd Christman Brown, Jr., for
respondent.
OPINION
JACOBS, Judge: This case is before the Court on petitioner’s
motion to dismiss for lack of jurisdiction. The specific ques-
tion to be decided is whether this Court has jurisdiction to
redetermine Federal income tax deficiencies and penalties of
a U.S. citizen who claims (1) to be a bona fide resident of the
U.S. Virgin Islands at the close of each of the years at issue
(i.e., 2002, 2003, and 2004), and (2) to be exempt from U.S.
tax filing and payment requirements as a consequence of his
satisfying all the requirements of section 932(c)(4).
All section references are to the Internal Revenue Code
(Code) in effect for the years at issue unless otherwise
indicated.
Background
Petitioner is a U.S. citizen. He resided in Florida when he
filed his petition in this Court on May 28, 2009. Claiming to
be a bona fide resident of the U.S. Virgin Islands (Virgin
Islands) at the close of 2002, 2003, and 2004, petitioner (1)
filed territorial income tax returns with the Virgin Islands
Bureau of Internal Revenue (BIR) for 2002, 2003, and 2004,
and (2) claimed he was qualified for the section 932(c)(4)
gross income exclusion and therefore did not have to file a
Federal income tax return or pay Federal income tax for
those years. Following an audit of petitioner’s 2002, 2003,
and 2004 Virgin Islands income tax returns, on February 27,
2009, respondent issued petitioner a notice of deficiency
determining the following Federal income tax deficiencies
and additions to tax:
Additions to tax
Sec. Sec. Sec.
Year Deficiency 6651(a)(1) 6651(a)(2) 6654
2002 $252,687 $55,431.45 $61,590.50 -0-
2003 88,350 18,586.35 20,651.50 $2,129.22
2004 77,938 17,271.68 17,271.68 2,196.05
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224 135 UNITED STATES TAX COURT REPORTS (222)
Attached to the notice of deficiency was a Form 4549–A,
Income Tax Discrepancy Adjustments, which set forth the
basis for the income tax deficiencies and additions to tax
involved herein:
It is determined that during the taxable years 2002 through 2004 you were
not a bona fide resident of the United States Virgin Islands (USVI). It is
also determined that you participated in a tax avoidance scheme which
involved improperly claiming to be a resident of the USVI and superficially
recasting US-source income as USVI source income in order to inappropri-
ately and invalidly claim a tax credit of 90% under the USVI Economic
Development Program. It has also been determined that all transactions
between NASCO Corporate Finance Consultants, LLC (NASCO) and
American Benefits Institute, Inc. (ABI), Employers International, Inc. (EI),
Professional Advisory Group, Inc. (PAG), and George C. Huff, including
any entity controlled or owned in whole or in part by George C. Huff, are
part of a series of step/sham transactions devoid of economic substance and
will not be recognized for US federal income tax purposes. These step/
sham transactions were part of a larger tax avoidance scheme and were
entered into solely in an attempt to superficially recharacterize US-source
income as USVI-source income in order to inappropriately and invalidly
claim a tax credit of 90% under the USVI Economic Development Program.
See IRS Notice 2004–45.
On May 28, 2009, petitioner filed a petition in this Court.
On April 14, 2010, petitioner filed a complaint petition for
redetermination of income taxes against the Commissioner of
Internal Revenue in the U.S. District Court, District of the
Virgin Islands, St. Thomas and St. John Division (District
Court), case No. 1:10CV00026. On June 1, 2010, petitioner
filed in this Court the motion in question.
Discussion
I. The Virgin Islands
The Virgin Islands are an insular area of the United
States; they are a part of neither one of the 50 States nor
the District of Columbia. They are generally treated as a for-
eign country for Federal income tax purposes. See sec.
7701(a)(9).
In 1921 Congress made a predecessor of the Code part of
the internal law of the Virgin Islands. Act of July 12, 1921,
ch. 44, sec. 1, 42 Stat. 123 (codified as amended at 48 U.S.C.
sec. 1397 (2006)).
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(222) HUFF v. COMMISSIONER 225
This 1921 statute set up the ‘‘mirror tax’’ system that remains in use:
‘‘Virgin Islands’’ is in effect substituted for ‘‘United States’’ (and vice versa)
in the Internal Revenue Code so that, to satisfy Virgin Islands tax obliga-
tions, an individual or corporation in the Virgin Islands pays taxes to the
BIR equivalent to the taxes an individual or corporation under the same
circumstances in the United States would pay to the Internal Revenue
Service. * * * [Danbury, Inc. v. Olive, 820 F.2d 618, 620 (3d Cir. 1987).]
As the law developed under the mirror tax system, the provi-
sions of the Code have been made applicable to the Virgin
Islands so long as the specific section to be applied is ‘‘ ‘not
manifestly inapplicable or incompatible’ with a separate
territorial income tax’’. Chi. Bridge & Iron Co. v. Wheatley,
430 F.2d 973, 976 (3d Cir. 1970) (quoting Sayre & Co. v.
Riddell, 395 F.2d 407, 410 (9th Cir. 1968)).
The Internal Revenue Service (IRS) implemented the
mirror tax system in 1935. Under the mirror tax system as
implemented, some taxpayers, both business entities and
individuals, were required to file two returns.
For example, a corporation considered ‘‘domestic’’ in the United States but
doing business in the Virgin Islands was required to submit a return to
the BIR, paying tax on income from sources in the Virgin Islands, and to
submit a return to the Internal Revenue Service, paying tax on worldwide
income, with a foreign tax credit allowed for the tax paid to the Virgin
Islands. The mirror system, with its two separate taxing jurisdictions,
operated similarly for citizens of the United States who resided in the
Virgin Islands. * * * [Danbury, Inc. v. Olive, supra at 621.]
The 1954 Revised Organic Act of the Virgin Islands (ROA),
ch. 558, sec. 28, 68 Stat. 508 (1954), modified the administra-
tion of the mirror tax system. ROA sec. 28(a) provided that
the ‘‘proceeds of any taxes levied by the Congress on the
inhabitants of the Virgin Islands * * * shall be covered into
the treasury of the Virgin Islands, and shall be available for
expenditure as the Legislature of the Virgin Islands may pro-
vide’’. The section also provided:
That the term ‘‘inhabitants of the Virgin Islands’’ as used in this section
shall include all persons whose permanent residence is in the Virgin
Islands, and such persons shall satisfy their income tax obligations under
applicable taxing statutes of the United States by paying their tax on
income derived from all sources both within and outside the Virgin Islands
into the treasury of the Virgin Islands * * *. [Id.]
In 1986 the mirror tax system was again modified. Section
932(c)(4), enacted as part of the Tax Reform Act of 1986 (TRA
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226 135 UNITED STATES TAX COURT REPORTS (222)
1986), Pub. L. 99–514, sec. 1274(a) 100 Stat. 2596, and
amended in 1988, provides the current rules with respect to
the taxation and filing requirements of individuals:
SEC. 932. COORDINATION OF UNITED STATES AND VIRGIN
ISLANDS INCOME TAXES.
(c) TREATMENT OF VIRGIN ISLANDS RESIDENTS.—(1) Application of sub-
section.—This subsection shall apply to an individual for the taxable year
if—
(A) such individual is a bona fide resident of the Virgin Islands at
the close of the taxable year, or
(B) such individual files a joint return for the taxable year with an
individual described in subparagraph (A).
(2) FILING REQUIREMENT.—Each individual to whom this subsection
applies for the taxable year shall file an income tax return for the tax-
able year with the Virgin Islands.
* * * * * * *
(4) RESIDENTS OF THE VIRGIN ISLANDS.—In the case of an individual—
(A) who is a bona fide resident of the Virgin Islands at the close of
the taxable year,
(B) who, on his return of income tax to the Virgin Islands, reports
income from all sources and identifies the source of each item shown
on such return, and
(C) who fully pays his tax liability referred to in section 934(a) to
the Virgin Islands with respect to such income,
for purposes of calculating income tax liability to the United States,
gross income shall not include any amount included in gross income on
such return, and allocable deductions and credits shall not be taken into
account.
Thus, an individual who is a bona fide resident of the
Virgin Islands and incurs income tax obligations to both the
United States and the Virgin Islands may satisfy his
reporting and payment requirements by filing only with, and
paying tax only to, the Virgin Islands if he satisfies each of
the three requirements of section 932(c)(4). If the individual
fails to meet any of these requirements, he must file a Fed-
eral income tax return with the IRS. See S. Rept. 100–445,
at 315 (1988). Consequently, an individual failing to satisfy
all three requirements of section 932(c)(4) may be required to
file an income tax return and be liable for taxes in both the
United States and the Virgin Islands.
The term ‘‘bona fide resident of the Virgin Islands’’ is not
defined by the Code. Nor is it given any definition by the
legislative history. Instead, Congress authorized the Sec-
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(222) HUFF v. COMMISSIONER 227
retary to promulgate regulations for determining Virgin
Islands residency. See TRA 1986 sec. 1274(c), 100 Stat. 2598. 1
A Virgin Islands taxpayer may petition the District Court
to redetermine a Virgin Islands tax deficiency determined by
the BIR in the same manner as a U.S. taxpayer may petition
this Court. Secs. 6212, 6213 (mirror code); V.I. Code Ann. tit.
33, sec. 943 (1994); see WIT Equip. Co. v. Dir., V.I. Bureau
of Internal Revenue, 185 F. Supp. 2d 500, 510 (D.V.I. 2001).
The District Court has ‘‘exclusive jurisdiction over * * * the
income tax laws applicable to the Virgin Islands * * * except
the ancillary laws relating to the income tax enacted by the
legislature of the Virgin Islands.’’ 48 U.S.C. sec. 1612(a)
(2006).
II. The Virgin Islands Economic Development Program
In order to encourage economic development in the Virgin
Islands, Congress has explicitly permitted the Virgin Islands
government to reduce certain taxes. Section 934(b)(1) pro-
vides that the Virgin Islands may reduce taxes on ‘‘income
derived from sources within the Virgin Islands or income
effectively connected with the conduct of a trade or business
within the Virgin Islands.’’
Pursuant to this grant of authority, the Virgin Islands
government enacted several investment incentives, including
the Virgin Islands Industrial Development Program (referred
to by the parties as the economic development program or
EDP), currently codified at V.I. Code Ann. tit. 29, secs. 701–
726 (1998 & Supp. 2010). Intended to promote growth and
the development and diversification of the Virgin Islands’
economy, the EDP granted certain industrial development
benefits to companies that do business in the Virgin Islands.
See V.I. Code Ann. tit. 29, sec. 701 (1998). Participating
companies receive substantial benefits including: A 90-per-
cent exemption on local income taxes, a 90-percent exemption
on the taxation of dividends, and a 100-percent exemption on
gross receipts taxes.
1 For the years at issue, regulations have not been promulgated defining a ‘‘bona fide resident
of the Virgin Islands’’. However, in Notice 2004–45, 2004–2 C.B. 33, 34, the Commissioner states
that the determination turns on the facts and circumstances and the individual’s intentions with
respect to the length and nature of his or her stay in the Virgin Islands, citing sec. 1.934–1(c)(2),
Income Tax Regs., which in turn cites the principles of secs. 1.871–2 through 1.871–5, Income
Tax Regs.
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228 135 UNITED STATES TAX COURT REPORTS (222)
III. Notice 2004–45
In 2004 the IRS determined that certain tax advisers were
encouraging taxpayers ‘‘to take highly questionable, and in
most cases meritless, positions’’ to claim many of the benefits
of the EDP. To that end, the IRS issued Notice 2004–45, 2004–
2 C.B. 33 (the notice). According to the notice, the following
is a typical scenario used by the promoters of those plans:
Promoters typically approach a taxpayer (Taxpayer) living and working
in the United States and advise Taxpayer to (i) purport to become a USVI
resident by establishing certain contacts with the USVI, (ii) purport to
terminate his or her existing employment relationship with his or her
employer (Employer) and (iii) purport to become a partner of a Virgin
Islands limited liability partnership (V.I.LLP) that is treated as a partner-
ship for U.S. tax purposes. V.I.LLP then purports to enter into a contract
with Employer to provide Employer with substantially the same services
that were provided by Taxpayer prior to the creation of this arrangement.
Typically, after entering into the arrangement, Taxpayer continues to pro-
vide substantially the same services for Employer that he or she provided
before entering into the arrangement, but Taxpayer is nominally a partner
of V.I.LLP instead of an employee of Employer.
Under this arrangement, Employer makes payments to V.I.LLP for Tax-
payer’s services and no longer treats the payments as wages paid to Tax-
payer subject to the withholding and payment of employment taxes and
reporting on Taxpayer’s Form W–2. V.I.LLP, in turn, makes payments to
Taxpayer for his or her services to Employer. V.I.LLP typically treats these
payments for tax accounting purposes either as guaranteed payments for
services or as distributions of Taxpayer’s allocable share of partnership
income. Under this arrangement, the promoter may be a general partner
in V.I.LLP and may retain a percentage of the fees received from
Employer.
V.I.LLP either has or secures a reduction, up to 90 percent, in USVI
income tax liability under the Economic Development Program (EDP) of
the USVI. Taxpayer takes the position that the EDP benefits granted to
V.I.LLP provide a corresponding reduction in the income tax liability that
Taxpayer reports on his or her USVI income tax return with respect to
guaranteed payments from the partnership or distributive shares of the
partnership’s net income, or both. Taxpayer pays tax to the USVI in an
amount approximately equal to 10% of the U.S. income tax liability that
otherwise would be imposed on Taxpayer’s income from performing the
services. Taxpayer claims that, for purposes of computing his or her U.S.
income tax liability, gross income does not include guaranteed payments
received from V.I.LLP or Taxpayer’s distributive share, if any, of the part-
nership’s net income, or both.
[Id., 2004–2 C.B. at 33.]
The IRS stated that the promoters of these plans claim that
(1) individuals who participate in the plan can continue to
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(222) HUFF v. COMMISSIONER 229
work in the United States and still be a bona fide resident
of the Virgin Islands; (2) Virgin Islands source income
includes income from services performed in the United
States; (3) for purposes of determining the source of income,
the Virgin Islands includes the United States; and (4) non-
Virgin Islands income can be treated as effectively connected
with the conduct of a trade or business within the Virgin
Islands even if under equivalent circumstances that type of
income would not be considered effectively connected with
the conduct of a U.S. trade or business. Respondent deter-
mined that the transactions in which petitioner participated
were the type of transactions discussed in the notice.
IV. Jurisdiction
This Court may exercise jurisdiction only to the extent
authorized by Congress. Naftel v. Commissioner, 85 T.C. 527,
529 (1985). However, the Court has the authority to deter-
mine whether it has jurisdiction over a particular case.
Kluger v. Commissioner, 83 T.C. 309, 314–315 (1984).
We have jurisdiction to redetermine deficiencies in income,
estate, gift, and certain excise taxes when the Commissioner
makes a determination that a deficiency is due, a valid notice
of deficiency is issued with respect to that determination,
and a petition is timely filed in response to the notice of defi-
ciency. See secs. 6211–6215; Kluger v. Commissioner, supra
at 314; Hannan v. Commissioner, 52 T.C. 787, 791 (1969).
Petitioner maintains that the deficiencies relate to a Virgin
Islands tax matter over which this Court lacks jurisdiction.
Petitioner posits that sections 932 and 934, which coordinate
United States and Virgin Islands income taxes, constitute
the tax law of the Virgin Islands and therefore jurisdiction
over the underlying matters properly belongs to the District
Court pursuant to the provisions of 48 U.S.C. sec. 1612 (a).
Continuing, petitioner maintains that inasmuch as 48 U.S.C.
sec. 1612(a) grants ‘‘exclusive’’ jurisdiction to the District
Court with regard to Virgin Islands income tax laws, this
Court lacks jurisdiction because ‘‘Congress was removing all
other courts of any district, jurisdiction, or level from hearing
cases ‘with respect to the income tax laws applicable to the
[USVI].’ 48 U.S.C. §1612.’’ Petitioner maintains that even
though an individual may have both Federal and Virgin
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230 135 UNITED STATES TAX COURT REPORTS (222)
Islands tax obligations under section 932, this does not affect
the District Court’s jurisdiction. We do not subscribe to peti-
tioner’s position.
U.S. citizens are subject to Federal taxation on their world-
wide income. See Cook v. Tait, 265 U.S. 47, 56 (1924). Gross
income for the purpose of calculating taxable income is
defined as ‘‘all income from whatever source derived.’’ Sec.
61(a). Every individual whose gross income for the taxable
year equals or exceeds a threshold amount is (with enumer-
ated exceptions not applicable here) required to file a Federal
income tax return. Sec. 6012(a)(1)(A).
As a U.S. citizen, petitioner is required to file a Federal
income tax return and use his worldwide gross income to cal-
culate his Federal income tax. Section 932(c) affects the
determination of gross income of an individual subject to
U.S. taxation. If the individual (in this case, petitioner) satis-
fies all three requirements of section 932(c)(4), then the
amount of gross income reported on the individual’s Virgin
Islands tax return (filed under section 932(c)(2)) is not
includable in determining his gross income for purposes of
the Federal income tax. Thus, if the amount of petitioner’s
gross income was that which was reported on his Virgin
Islands tax return, then petitioner’s gross income for pur-
poses of calculating his income tax liability to the United
States would be zero. In such a case, because petitioner
would have no gross income for Federal income tax purposes,
he would not need to file a Federal income tax return. But
if petitioner does not satisfy all three requirements, as
respondent alleges, then for each of the years at issue he will
be required to file a Federal income tax return even if he
filed a Virgin Islands tax return. See sec. 932(a)(2).
Although this case involves putative Virgin Islands trans-
actions, the notice of deficiency determines deficiencies in
petitioner’s Federal income tax. Petitioner filed a timely peti-
tion for redetermination with this Court pursuant to section
6213(a). Whether petitioner satisfies all the requirements
under section 932(c)(4), and thus need not file a Federal tax
return or pay Federal income tax for 2002, 2003, and 2004,
is in dispute and is a matter which this Court has jurisdic-
tion to decide. Because the subject matter herein is within
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(222) HUFF v. COMMISSIONER 231
the Court’s jurisdiction, we shall deny petitioner’s motion to
dismiss for lack of jurisdiction.
An appropriate order will be issued.
f
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