May 26, 2001 – Birth or naturalization in the U.S. possessions provides special estate and gift tax benefits.
Persons who obtain U.S. citizenship by reasons of their birth or naturalization in any of the U.S. possession are treated for U.S. estate and gift tax purposes as non-citizens not resident in the United States when they are resident in one of the possessions at the time a gift is made or are resident in one of the possessions at the time of death.
Specifically, for federal estate tax purposes, Section 2209 of the Internal Revenue Code of 1986, as amended, (the "Code") provides that a person who acquires U.S. citizenship solely by reason of (1) being a citizen of a U.S. possession or (2) birth or residence within such possession is treated as a non-resident not a citizen of the United States if residing in a possession at the time of death. Under Code Section 2501(c), a person meeting these requirements is treated as a non-resident for federal gift tax purposes if residing in a possession at the time of making the gift.
This document sets out the rules applicable to U.S. possessions, with the U.S. Virgin Islands used for illustrative purposes where appropriate.
A "non-resident, not a citizen" is taxable only on certain U.S. situs assets.
The gross estate of a decedent who at the time of death was a non-resident, not a citizen of the United States is determined in the same manner as the gross estate of a U.S. citizen or resident, no matter where the property is located. However, only the part of the gross estate that is located in the United States is subject to the tax under Section 2103 of the Code. For purposes of determining the location of assets for federal estate and gift tax purposes, the "United States" includes the 50 states and the District of Columbia, but not the possessions.
Federal estate tax rates for a "non-resident, not a citizen" are the same as for a citizen, but a special credit applies.
For the estates of decedents dying after Nov. 10, 1988, the estate tax rates applicable to U.S. citizens are also applicable to the estates of non-resident aliens. The estate tax must first be computed, but only in respect of U.S. situs assets, and then reduced by certain credits. For a non-resident, not a citizen who resides in a U.S. possession and was a U.S. citizen because of birth or naturalization in the possession, section 2102(c)(1) of the Code provides that the taxpayer's estate qualifies for a credit of $13,000.
For gifts made by non-resident, non-citizens, the federal gift tax applies to a transfer only if the property is situated in the United States, pursuant to section 2511(a) of the Code. For such gifts, the $10,000 annual exclusion provisions (for the year 2000) apply to such taxpayers.
Here's how to take advantage of the special possession rules.
Individuals who can meet both the possessions residency and the birth or naturalization requirements may be able to reduce their federal estate and gift tax liabilities. Although it is always too late to advise clients where they should be born, the clients can have some control over their naturalization. Accordingly, a person who seeks U.S. citizenship and who has assets located outside the United States should consider being naturalized through the Immigration and Naturalization Service Office in the U.S. Virgin Islands or another possession instead of through an INS office in one of the 50 states or the District of Columbia.
Treasury Regulation Section 20.2209-1 sets out several examples of situations that constitute being a citizen of a U.S. possession or acquiring citizenship solely by birth or residence within a U.S. possession, including the following:
– A person who is born in the U.S. Virgin Islands or another U.S. possession is considered to have acquired U.S. citizenship solely by reason of birth in the possession pursuant to Section 306 of the Immigration and Nationality Act, even though the person's parents were U.S. citizens by reason of their birth in Boston.
– A former French citizen who acquired U.S. citizenship through naturalization proceedings in a U.S. Virgin Islands court after having qualified for citizenship by residing in the U.S. Virgin Islands for five years was considered to have received U.S. citizenship solely by reason of residence within the U.S. Virgin Islands.
– A person who acquired U.S. citizenship under Section 5 of the Act of March 2, 1917, by reason of being a citizen of Puerto Rico is considered to have acquired U.S. citizenship solely by reason of being a citizen of Puerto Rico.
Revenue Ruling 74-25 held that a person born in one possession who dies while a resident of another possession is treated as a non-resident, not a citizen.
The IRS has generally adopted an expansive approach when determining whether a person is considered a non-resident, not a citizen for federal estate and gift tax purposes. The IRS 21 years ago issued Revenue Ruling 74-25, which held that a decedent who acquired U.S. citizenship solely by virtue of birth in Puerto Rico and who was a resident of the U.S. Virgin Islands at the time of death was considered to be a non-resident, not a citizen of the United States under Section 2209 of the Code.
The ruling noted that, despite the literal language of the statute, there was no indication in the legislative history underlying Code Section 2209 that Congress intended to distinguish between possession citizens who at the time of their death were residents of the possession through which they derived citizenship and those who were residents of a possession other than the one through which they derived citizenship. The IRS has subsequently issued a series of Private Letter Rulings (PLR's) on this issue set out below.
PLR 9119049 (Feb. 12, 1991): The IRS determined that a U.S. citizen residing in Puerto Rico was exempt from U.S. gift tax on transfer of mutual fund units.
The IRS held that a U.S. citizen who was born in Puerto Rico and resides in Puerto Rico can transfer units in a mutual fund administered in the United States and established under the laws of New York to his child without being subject to gift tax on the transfer. Federal gift tax is not imposed on gifts of intangibles transferred by non-resident aliens, and the IRS held shares in a mutual fund to be an intangible.
PLR 9302026 (Oct. 20, 1992): The IRS determined that since a couple’s citizenship was based on their permanent resident status gained in Puerto Rico, they were considered non-residents, not citizens of the United States for U.S. gift and estate tax purposes.
The IRS held that a couple were considered to be non-residents, not citizens of the United States for gift and estate tax purposes where their qualification for U.S. citizenship was based on their permanent resident status gained in Puerto Rico.
The facts underlying the IRS determination are as follows. In 1961, the taxpayers left their country of citizenship and resided in Miami, Fla., until September 1962, when they moved to Puerto Rico. The taxpayers went to Martinique in 1965 and applied to become permanent residents of Puerto Rico. They also filed a declaration of intent to become U.S. citizens. The taxpayers became U.S. citizens in 1970, based on their five years as permanent residents of Puerto Rico (1965-70).
In explaining its determination, the ruling stated that, generally, "when a citizen of the United States, born in the United States or naturalized by permanent residence in the United States, not a possession, for five years, moves to a possession of the United States, the move does not change the citizen’s status for gift and estate tax purposes." The ruling continued that "if the same person was born in a possession of the United States or naturalized by permanent residence in a possession of the United States, the gift and estate tax provisions are generally applied to that person as if they were a non-resident, not a citizen of the United States.&
quot;
The ruling did not deal with a situation when a person was naturalized in a U.S. possession after a period of permanent residence that combines time spent in the United States, not a U.S. possession, and in a U.S. possession.
PLR 9403009 (Oct. 20, 1993): The IRS determined that a Cuban-born U.S. citizen born to a U.S. citizen is a non-resident, not a U.S. citizen, for estate tax purposes.
The IRS held that a person born in Cuba to an alien mother and to a father born in Puerto Rico is considered to be a non-resident, not a citizen of the United States for federal estate and gift purposes if residing in the U.S. Virgin Islands.
The facts underlying the IRS determination are as follows. The taxpayer's father was born in Puerto Rico in 1896, where he resided until 1916, when he moved to Cuba. The taxpayer was born in Cuba in 1922. The taxpayer moved to Maryland in 1962. Two years later, she applied for a certificate of citizenship issued under Section 241 of the Immigration and Nationality Act.
The report and recommendation section of the application, which was completed by the immigration officer, concluded that the taxpayer did acquire U.S. citizenship at birth through her father, who became a citizen of the United States through collective naturalization of citizens of Puerto Rico under the Act of March 2, 1917. The certificate of citizenship as issued states that the taxpayer established to the satisfaction of the Immigration and Naturalization Service that she was a U.S. citizen from the date of her birth. In 1967, the taxpayer moved to the U.S. Virgin Islands, where she continues to reside. The taxpayer represents that she will continue to reside in the U.S. Virgin Islands until the time of her death.
The IRS pointed out that the taxpayer's father had acquired his citizenship solely by reason of being a citizen of a possession of the United States. Under Section 7 of the Foraker Act, all Spanish subjects who resided in Puerto Rico on April 11, 1899, and continued to reside there through April 12, 1900, and their children born subsequent thereto who did not file a declaration of Spanish allegiance prior to April 11, 1900, were deemed to be citizens of Puerto Rico. The taxpayer's father met these requirements. Section 5 of the Jones Act subsequently conferred U.S. citizenship upon all persons who became citizens of Puerto Rico under the Foraker Act, effective March 2, 1917.
In addition, the IRS pointed to Section 1401(g) of Title 8 of the U.S. Code, which provides that a person is a U.S. citizen when that person is born outside the United States and its outlying possessions and when one of the person's parents is an alien and the other is a citizen of the United States who, prior to the birth of such person, was physically present in the United States or its outlying possessions for periods totaling not less than five years, at least two of which were after attaining the age of 14 years. Since the taxpayer's father lived in Puerto Rico from the time of his birth until he was 20, she also met this requirement for citizenship.
In holding that the taxpayer was a non-resident, not a citizen for federal estate and gift tax purposes, the IRS stressed that the taxpayer's U.S. citizenship was derived solely from her father, who was a U.S. citizen solely by reason of his Puerto Rican citizenship, which in turn was obtained by his birth and residency in Puerto Rico. Thus, the IRS found that the taxpayer's citizenship was derived solely from a U.S. possession for purposes of applying Sections 2209 and 2501(c) of the Code, and that she would continue to be considered a non-resident, not a citizen as long as she remains a resident of the U.S. Virgin Islands (or, presumably, another possession).
PLR 9522033 (March 3, 1995): The IRS held that a Cuban-born person whose parent was naturalized while the person was a minor is a non-resident, not a citizen, for U.S. estate tax purposes.
The IRS ruling held that a person born in Cuba in 1926 to then-Cuban parents is considered to be a non-resident, not a citizen of the United States for federal estate and gift purposes in a case where the taxpayer's mother became a naturalized citizen of the United States in Puerto Rico in 1936 when the taxpayer was 10 years old and the taxpayer's father never became a U.S. citizen.
The taxpayer moved to Maryland to attend school and in 1944, at the age of 18, obtained a certificate of U.S. citizenship. According to this certificate, her citizenship is "derivative" and had been acquired as of 1936, when her mother became a U.S. citizen. The taxpayer returned to Puerto Rico after finishing her studies and continues to reside there. She requested the ruling in connection with a proposed gift in excess of $10,000 to her children.
In determining that the taxpayer was a non-resident, not a citizen for gift and estate tax purposes, the IRS pointed to Example 5 of Treasury Regulation Section 20.2209-1, which held that a French citizen who acquired U.S. citizenship through naturalization proceedings in the U.S. Virgin Islands after residing in the Virgin Islands for five years was considered to have acquired his U.S. citizenship solely by reason or his birth or residence in the Virgin Islands. The IRS then pointed to Section 1433(a) of Title 8 (Aliens and Nationality) of the U.S.Code, which provides in pertinent part that:
– A child born outside of the United States, one or both of whose parents is at the time of applying for the naturalization of the child, a citizen of the United States either by birth or naturalization, may be naturalized if under the age of 19 years and not otherwise disqualified from becoming a citizen … and if residing permanently in the United States, with a citizen parent pursuant to a lawful admission for permanent residence on the application of such citizen parent, upon compliance with all of the provisions of this title, except that no particular period of residence or physical presence in the United States shall be required.
Section 1101(a)(38) of the Immigration and Nationality Act of 1952 defines the term "United States" to mean the continental United States, Alaska, Hawaii, Puerto Rico, Guam and the U.S. Virgin Islands.
In this case, the taxpayer obtained her certificate of U.S. citizenship in 1944 while residing in Maryland. The certificate indicated that her citizenship was "derivative" and was acquired as of 1936, when her mother became a naturalized citizen of the United States and a citizen of Puerto Rico after having lived in Puerto Rico for more than five years.
Thus, the IRS held that for purposes of Section 2501(c) of the Code the taxpayer acquired her U.S. citizenship solely by reason of her residence within a possession of the United States (that is, her residence in Puerto Rico during the five years preceding 1936). Accordingly the taxpayer satisfied the requirements of Code section 2501(c) and for federal gift tax purposes is treated as a non-resident, not a citizen of the United States. If at the time of her death the taxpayer is a resident of Puerto Rico, she will similarly be treated as a non-resident, not a citizen of the United States for federal estate tax purposes.
PLR 9522033 goes beyond the prior rulings in two respects.
First, it holds that a taxpayer born in a foreign country (here, Cuba) who obtained her citizenship by virtue of a parent's naturalization in Puerto Rico and subsequent application for the naturalization of the minor was treated as a nonresident, not a citizen by reason of her residence within such possession of the United States. In the prior rulings the taxpayers were born in Puerto Rico (Revenue Ruling 74-25) and born to a person who was born in Puerto Rico and acquired citizenship through collective naturalization prior to the taxpayer's birth (PLR 9403009), so that each taxpayer was a U.S. citizen from birth.
Second, it looks to the place where the parent obtained citizenship (here, Puerto Rico) and not to the place where the taxpayer obtained her certif
icate of U.S. citizenship (here, Maryland) in determining that the taxpayer acquired her citizenship "solely by reason of her residence within a possession of the United States."
PLR 9720027: The IRS held that a donor born to Puerto Rican parents outside of that U.S. possession but who has resided in Puerto Rico since 1935 will not be subject to U.S. estate and gift taxes.
The donor's parents were born in Puerto Rico in 1895 and 1896, respectively, and both acquired U.S. citizenship under the Foraker Act. They never filed a declaration of allegiance to Spain. The parents lived their entire lives in Puerto Rico, except for 1924-35, when they lived in two foreign countries. The donor was born in one of those countries. Since 1935, the donor has resided in Puerto Rico. The donor, proposing to transfer property to his children in excess of $10,000, sought a ruling as to whether he is subject to U.S. estate and gift taxes.
In reaching its conclusion, the IRS examined the Foraker Act, which held under Section 7 that "all Spanish subjects who resided in Puerto Rico on April 11, 1899, and continued to reside therein through April 12, 1900, and their children born subsequent thereto who did not file a declaration of Spanish allegiance prior to April 11, 1900" shall be deemed to be citizens of Puerto Rico. Section 5 of the Jones Act conferred U.S. citizenship, effective March 2, 1917, upon all persons who became citizens of Puerto Rico under the Foraker Act.
The IRS also looked to Section 1401(c) of Title 8 of the U.S. Code, which provides that a person shall be a citizen of the United States where that person is born outside of the United States and its outlying possessions to parents both of whom are citizens of the United States and one of whom has had a residence in the United States or one of its outlying possessions prior to the birth of such citizen.
The IRS determined that the donor derived his Puerto Rican citizenship under the Foraker Act and his U.S. citizenship either under the Jones Act, by virtue of his Puerto Rican citizenship, or under 8 USC 1401(c) and its predecessor statutes. Under these circumstances, the IRS found that his citizenship was derived solely from his citizenship of a U.S. possession for purposes of applying Section 2209 and 2501(c). Thus the IRS concluded that the donor was a "non-resident, not a citizen of the United States" and would continue to be so considered for such time as he remains a resident of Puerto Rico or another outlying U.S. possession.
PLR 9725025: The IRS held that an individual's U.S. citizenship was derived solely from her residence within a U.S. possession where she moved to the United States at age 11, received permanent residence status two years later, and became a naturalized U.S. citizen in 1973 after marriage.
The taxpayer was born in 1951 in a foreign country of which her parents were both citizens. In 1962, when the taxpayer was 11, the family moved to a United States possession. In 1964, the taxpayer applied for and received permanent resident status. In 1969, she moved to another location in the United States to attend college. In 1971, the taxpayer married a man believed to have been a U.S. citizen. In 1972 or 1973, the taxpayer's father became a U.S. citizen based on his residency in the United States. In 1973, while attending college and residing in the United States, the taxpayer applied for and became a U.S. citizen through a naturalization proceeding. In 1975, the taxpayer divorced, finished college, and moved back to a U.S. possession, where she has lived since then.
In reaching its decision, the IRS pointed out that marriage to a U.S. citizen alone is not sufficient to qualify a resident alien for U.S. citizenship. Generally one needs status as a permanent resident alien for at least five years before one can apply for U.S. citizenship, although marriage to a U.S. citizen reduces the number of years to three. In the case at hand, the IRS noted that the taxpayer had permanent residence status since 1964 and resided in the U.S. possession for seven years before attending college outside the territory.
At the time the taxpayer moved to the mainland United States to attend college, she had fulfilled the five year residency requirement and could have applied for U.S. citizenship immediately. Thus, when she married she was already eligible for U.S. citizenship based on residency. The IRS concluded that the taxpayer's U.S. citizenship is derived solely from the taxpayer's residency within a U.S. possession for purposes of applying Code Sections 2209 and 2501(c).
Here's how individual residency in the U.S. Virgin Islands is determined under Section 932(c) of the Code for tax purposes.
Section 932(c) of the Internal Revenue Code of 1986 provides that a person is taxed as a U.S. Virgin Islands resident if a bona fide resident of the U.S. Virgin Islands as of the last day of his or her tax year, generally Dec. 31. Thus an individual could move to the U.S. Virgin Islands in December of a given year and be taxed for income tax purposes as a U.S. Virgin Islands resident for that year.
Under Section 932(c), individuals who are bona fide residents of the U.S. Virgin Islands at the close of their taxable year are required to file an income tax return for the taxable year with the U.S. Virgin Islands, reporting their worldwide income on the return and paying tax on the income to the U.S. Virgin Islands. If a taxpayer does so, the taxpayer has no filing obligation with the United States.
The IRS has prepared draft Treasury Regulations to use in determining who is a U.S. Virgin Islands resident. However, these regulations have not yet been released for public comment.
A person seeking a green card leading to U.S. citizenship can invest in the U.S. Virgin Islands as an immigrant investor
The Immigration Act of 1990 created a new investor/employment-creation category of immigrant visa. Section 121(a) provides a yearly maximum of 10,000 visas for applicants with U.S. $1 million to invest in a new commercial enterprise employing at least 10 full-time U.S. workers. To qualify under this category, the new enterprise must be:
– One established by the alien.
– One in which the alien has invested, or is in the process of investing, at least $1 million (for St. Thomas/St. John) or $500,000 (for jurisdictions meeting certain unemployment requirements).
– One which will benefit the U.S. economy and create full-time employment for not fewer than 10 U.S. workers, exclusive of the immigrant and the immigrant's spouse and children, and in which the alien takes at least a policymaking role.
Investor/employment-creation visas are issued conditionally for two years. After that, the applicant must petition the INS to "remove conditions," at which time the INS must determine whether the applicant has established a commercial enterprise complying with investor/employment-creation category guidelines before removing the conditional status.
A single new commercial enterprise may be used for investor/employment-creation classification by more than one investor, provided that each petitioning investor has invested, or is actively in the process of investing, the required amount, that and each investment results in the creation of at least 10 full-time positions for qualifying employees.
A new commercial enterprise may count for investor/employment-creation classification even though there are several owners, including persons not seeking classification, if the sources of all capital invested are identified and all invested capital has been derived by lawful means. The investor immigrant must be involved in day-to-day managerial control of the enterprise or manage through policy formulation.
An enterprise can qualify as a single new commercial enterprise in one of four ways. An investor can (1) create an original business; (2) purchase and restructure an existing business; (3) expand an existing business, thereby substantially changing the net worth or number
of employees therein; or (4) invest in a troubled business so that there is a 40 percent change in net worth or number of employees.
Any for-profit entity formed for the ongoing conduct of lawful business may serve as a new commercial enterprise. This includes sole proprietorships, general and limited partnerships, holding companies, joint ventures, corporations, business trusts or other publicly or privately owned entities. A holding company and its wholly owned subsidiaries can also constitute a new commercial enterprise if each such subsidiary is engaged in a for-profit activity formed for the ongoing conduct of a lawful business.
The enterprise can also receive tax benefits from the U.S. Virgin Islands Economic Development Commission or comparable programs in other jurisdictions.
Naturalization in an INS district requires short-term residency.
Even if a person has acquired permanent resident ("green card") status through a means other than as an immigrant investor in the U.S. Virgin Islands or another possession, the person can apply for naturalization in the INS District where the possession is located. The IRS has not specifically ruled on how long a person must reside in a possession in order to acquire citizenship "solely by residence within a U.S. possession."
To be eligible to be naturalized in the U.S. Virgin Islands, a person who has already attained permanent resident alien status must meet all of the usual requirements for naturalization in the United States and must have actual residence in the U.S. Virgin Islands or Puerto Rico (which are in the same INS district) for at least the three months immediately preceding the filing of the application for naturalization. The usual requirements for naturalization are that the permanent resident alien must:
– Have continuous residence in the United States for at least the five years preceding the application.
– Be physically present in the United States for at least one-half of the time of continuous residence.
– Reside continuously within the United States from the date the application is filed until the date of admission to citizenship.
– Be a person of good moral character.
A person who meets the above requirements may file a naturalization petition with one of the INS offices in the U.S. Virgin Islands or Puerto Rico and become naturalized there once the application is approved.
"Residence" for the purposes of these naturalization rules means a person's principal actual dwelling place. The duration of residence in a particular location begins from the moment it is established at that location. "Continuous residence" as used above does not necessarily mean continuous physical presence. In fact, absences from the United States of up to six months (and in some cases, longer) are allowed so long as "residence" is maintained.
At the time of submitting the application, or later, the applicant may be required to submit evidence of residence in the U.S. Virgin Islands or Puerto Rico for the three-month period preceding the application. Actual physical presence during the entire three months is not required, however.
U.S. Virgin Islands law exempts U.S. Virgin Islands residents from inheritance and gift taxes.
A resident of the U.S. Virgin Islands is exempt from U.S. Virgin Islands inheritance tax pursuant to Section 5, Chapter 1, Title 33, V.I. Code. Section 5 provides in pertinent part that an inheritance "is exempt from the payment of inheritance taxes if the decedent, when living, would have been considered a 'non-resident, not a citizen of the United States' under 26 USC Section 2501(c), or if the decedent was a resident of the Virgin Islands … at the time of his death." Although the U.S. Virgin Islands inheritance tax is still codified in U.S. Virgin Islands law, as a practical matter no U.S. Virgin Islands inheritance tax is imposed on inheritances.
Similarly, a U.S. Virgin Islands resident is exempt from U.S. Virgin Islands gift tax under Section 31, Chapter 2, Title 33, V.I. Code. Section 31 provides that a "person is exempt from the payment of gift taxes … if that person is considered a 'non-resident, not a citizen of the United States' under 26 USC Section 2501(c), or if the person was a resident of the Virgin Islands at the time the gift was made." Again, although the U.S. Virgin Islands gift tax is still on the books, essentially all gifts are exempt.
Editor's note: St. Thomas tax and offshore investment attorney Marjorie Roberts presented the above information under the title "One Country, Two Systems: Creative Planning through U.S. Possessions" at a recent conference in San Juan, P.R., sponsored primarily by Offshore Investment Conferences, affiliated with Offshore Investment Magazine. The approximately 60 attendees came from the U.S. mainland, Ireland, and many Caribbean islands.
