To print this article, all you need to do is register or log in to Mondaq.com.
The U.S. Internal Revenue Court’s June 23, 2022 ruling in Morgan v. Commissioner, which addressed whether a taxpayer was a tax resident of Saudi Arabia, did not directly address whether an individual was a genuine resident of Puerto Rico, but they met fairly close to where they live . An individual who is a legal resident of Puerto Rico is not subject to United States federal income tax on Puerto Rico income.2 An individual can attain this exalted status only by passing three tests: (i) the attendance test, (ii ) the tax home test and (iii) the closer connection test. In Morgan, supra, the court shed light on when a person satisfies the residency and affiliation tax checks. Accordingly, the case is instructive for individuals seeking to be treated as genuine Puerto Rican residents.
At Morgan, the taxpayer was both an immigrant to the United States and a US Army veteran. He retired from the army in 2008 and bought a house in Georgia.3 He lived in the house with his daughter until 2013, when he moved. His daughter stayed at home. The taxpayer’s other family members also resided in the North Georgia/Chattanooga, Tennessee area.
In 2013, the taxpayer took a job at Vinnell Arabia (“Vinnell”) in Saudi Arabia, where he trained Saudis to fly helicopters. Our taxpayer was industrious, working nine hours a day, five days a week. Vinnell said the taxpayer’s performance was excellent. He joined a charitable Saudi social club and has been active in Saudi charity programs. He stayed in Vinnell-provided accommodation in Saudi Arabia and spent his time using facilities (gym, grocery store, etc.) in the condominium. At the time of the trial, the taxpayer was still living in Saudi Arabia and was engaged to a woman who had lived and worked in Saudi Arabia for over 20 years. The taxpayer had Saudi Arabian health insurance and a Saudi resident alien card (Iqama) and driver’s license. Apart from VAT, the taxpayer has not paid any Saudi Arabian tax.
The taxpayer didn’t turn in his US driver’s license. He used his vacation time to visit his daughter (at his home in Georgia) and his mother in the United States. The taxpayer also kept his veteran’s US health insurance.
The taxpayer contended that his Vinnell income was exempt from “foreign-earned income” for the purposes of Code § 911(a)(1) and was therefore not subject to US federal income tax. The exclusion of foreign earned income is only available if the taxpayer has a “tax home abroad”. The Tax Home for bona fide residents of Puerto Rico directly includes the Tax Home Test under Code §911.4. Accordingly, agencies interpreting the tax home test for purposes of excluding foreign earned income are directly relevant to the application of the tax home test to bona fide residents of Puerto Rico.
The exclusion of foreign earned income defines an individual’s tax residence by cross-referencing the rules for determining deductible business expenses.5 As a general rule, an individual’s tax residence is the individual’s place of establishment, place of work or place of business . even if the person’s family residence is elsewhere.6 For purposes of the exclusion of foreign income, a person is not a resident of the United States if he or she is a resident of the United States (unless the person is located in the armed forces in a combat zone).7
The requirement that an individual not be a resident of the United States in order to have satisfied the tax residency test does not apply in determining whether an individual is a tax resident of Puerto Rico, but Puerto Rico residents do consider whether the taxpayer resides in the United States to determine whether that test is met.9 In Morgan, supra, the court applied the same factors that bona fide residents of Puerto Rico use to determine compliance with the closer association test to determine whether the taxpayer is a resident of the United States.
Specifically, in Morgan, above, the court “compared and contrasted” the taxpayer’s domestic ties with its ties to Saudi Arabia. The following facts supported the conclusion that the taxpayer’s ties to Saudi Arabia were stronger than his ties to the US:
- His involvement in the Saudi community and leisure activities were “relatively significant” compared to the same activities in the United States;
- He received a residency card for Saudi Arabia;
- He had Saudi Arabian health insurance;
- He had a Saudi Arabian driver’s license;
- He did not seek work outside of Saudi Arabia;
- He had limited visits to his family in the United States;
- He did not visit doctors in the United States;
- The home he owned in the US was occupied full-time by his daughter; and
- He was not financially responsible for any US relatives.
The taxpayer’s relevant U.S. relationships included:
- He owned a home in the United States;
- He retained his US driver’s license;
- He maintained a US bank account (but the account was required by Vinnell);
- He retained his US citizenship; and
- He retained US health insurance.
The US Internal Revenue Service (“IRS”) addressed the fact that the taxpayer continued to own the Georgia home and expected to return there after his employment in Saudi Arabia ended. The Court ruled that the determination of whether the taxpayer was a US tax resident (closer association) with the United States was made through an examination of the taxpayer’s situation in the relevant year. Accordingly, the court ruled that although he would likely return there at some point in the future, the continued ownership of the Georgia home did not compel the taxpayer to have residency in the United States. It is worth noting that under the closer association test, a taxpayer’s home does not indicate that the taxpayer has a closer association with the United States if the taxpayer can enter the home “only for short-term stays”10
The Morgan case underscores the challenges that continued US contacts, including home ownership and financial ties, pose for individuals seeking to be treated as genuine Puerto Rican residents. It appears that the Morgan taxpayer would have had an easier time with the IRS if he had gifted his daughter’s home after moving abroad and giving up his US driver’s license. The closer connection test is more stringent than the “residence” node of the home tax test, which applies to the exclusion of foreign earnings; However, it’s likely that the IRS will focus on similar factors to scrutinize taxpayers who claim to have a closer connection to Puerto Rico than to the United States. Accordingly, individuals who wish to be treated as true residents of Puerto Rico should carefully consider what U.S. contacts they should maintain after relocating to Puerto Rico.
Mark Leeds (mleeds@mayerbrown.com; (212) 506-2499) and Juan Lopez Valek (jlopezvalek@mayerbrown.com; (212) 506-2471) are tax attorneys in Mayer Brown’s New York office. Mark and Juan regularly advise corporations and individuals on US tax considerations applicable to relocations and relocations to Puerto Rico.
footnotes
1 TC Memo 2022-10 (June 23, 2022).
2 Section 933(1) of the Internal Revenue Code of 1986, as amended (the “Code”).
3 Our title borrows a text by Otis Redding and Steve Cropper (Sitting on) The Dock of the Bay (Stax Volt 1967).
4 treasures. Registration number. § 1.937-1(d). The Tax Home Test for bona fide residents of Puerto Rico eliminates the rule preventing the taxpayer from passing the Tax Home Test if he is a resident of the United States. ID.
5 Code § 911(d)(3) Cross references Code § 162(a)(2).
6 The court quoted Mitchell v. Comm’r, 74 TC 578, 591 (1980) for this proposal. There are countless instances where the same test is used. See eg Barnhill v. Comm’r, (1945, CA4) 148 F2d 913; Putnam v. US, (1994, CA5) 32 F3d 911 rev’g (1993, DC LA) 826 F Supp 988; Walter Priddy, (1940) 43 BTA 18, Acq 1941-1 CB 7; Arnold P Bank, (1946) 6 TC 851.
7 Code § 911(d)(3).
8 treasures. Registration number. § 1.937-1(d).
9 treasures. Registration number. § 1.937-1(e)(1)(i), inclusion of rules in Treas. Registration number. § 301.7701(b)-2(d).
10 treasures. Registration number. § 301.7701(b)-2(d)(2).
Visit us at mayerbrown.com
Mayer Brown is a global legal services provider comprised of law firms that are separate entities (the “Mayer Brown Firms”). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe – Brussels LLP, both limited liability partnerships located in Illinois, USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorised and regulated by the Solicitors Regulation Authority and registered in England and Wales under number OC 303359); Mayer Brown, a SELAS based in France; Mayer Brown JSM, a Hong Kong partnership and its affiliates in Asia; and Tauil & Checker Advogados, a Brazilian law partnership with which Mayer Brown is affiliated. “Mayer Brown” and the Mayer Brown logo are trademarks of Mayer Brown Practices in their respective jurisdictions.
© Copyright 2020. The Mayer Brown Practices. All rights reserved.
This article by Mayer Brown provides information and commentary on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should obtain legal advice before taking any action with respect to any matter discussed herein.
