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TREASURY GOES AFTER VIRGIN ISLAND TAX SCHEMES

June 24, 2004

The Treasury today warned taxpayers against tax schemes involving the Virgin Islands and other U.S. Possessions:

   The notice describes a form of arrangement
   that has been promoted and that involves 
   running a taxpayer's salary or business 
   income through a U.S. Virgin Islands entity 
   such as a limited partnership.  The notice
   warns, however, that these questionable 
   positions may also be promoted through 
   other forms of arrangements and with 
   respect to U.S. possessions other than the 
   U.S. Virgin Islands.

Notice 2004-45, which was issued separately today by the IRS, describes a typical version - a version very similar to one that we have seen marketed.

Under these deals, a taxpayer pretends to quit his job to move to the U.S. Virgin Islands. The taxpayer then invests in a Virgin Islands partnership, which contracts with the employer that the taxpayer pretended to leave to do the employee's work. The taxpayer then works for the "former" employer through the partenrship.

The partnership then claims a U.S.V.I. economic development credit that eliminates 90% of the tax, and the partner pays tax on only 10% of his income.

The fatal flaw of these deals is that they require the IRS to be almost willfully stupid, and to believe that, say, an investment banker who offices in Chicago is really is a Virgin Islands resident. What one might call "anectotal evidence" indicates a lot of folks have given this a whirl, so it will be interesting to watch it play out.

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