Publication 570: Tax Rules for U.S. Possessions

IRS Publication 570, “Tax Guide for Individuals With Income From U.S. Possessions,” is for U.S. citizens and resident aliens with financial ties to American Samoa, Guam, the Commonwealth of the Northern Mariana Islands (CNMI), Puerto Rico, or the U.S. Virgin Islands (USVI). The publication clarifies the tax responsibilities that arise from earning income in these locations and addresses the primary question of whether an individual is considered a resident of a possession for tax purposes.

The rules outlined in the publication help taxpayers navigate their filing obligations, which can differ significantly based on their residency status. For some, it may mean filing a tax return only with the possession’s tax agency, while for others, it could involve filing returns with both the IRS and the possession.

Determining Bona Fide Residence

Establishing bona fide residence in a U.S. possession for a tax year is a process governed by three specific tests, all of which must be met. The first of these is the Presence Test, which requires an individual to be physically present in the relevant possession for a certain number of days. To meet this test, a person must satisfy one of the following conditions:

• Be present in the possession for at least 183 days during the tax year.
• Be present in the possession for at least 549 days over a three-year period that includes the current tax year and the two prior years, with at least 60 days of presence in each of those years.
• Be present in the United States for no more than 90 days during the tax year.
• Have no significant connection to the United States.
• Have minimal U.S. source income while spending more days in the possession than in the United States.

A taxpayer must also satisfy the Tax Home Test. A tax home is the general area of an individual’s main place of business, employment, or post of duty, regardless of where they maintain their family home. If a person does not have a regular or main place of business due to the nature of their work, then their tax home may be the place where they regularly live. For the purpose of this test, an individual’s tax home must be in the relevant U.S. possession on the last day of the tax year.

The final requirement is the Closer Connection Test, which examines whether an individual has maintained more significant ties to the possession than to the United States or any foreign country. The IRS evaluates several factors, and no single factor is decisive. The assessment is based on the totality of the circumstances to determine where a person’s connections are strongest. Factors include:

• The location of the individual’s permanent home, family, and personal belongings.
• Where the person is registered to vote.
• The location of their banking activities.
• The jurisdiction that issued their driver’s license.
• Social, cultural, religious, and political affiliations, such as memberships in clubs or religious institutions.

Tax Filing for Bona Fide Residents

An individual who meets the criteria to be a bona fide resident of a U.S. possession is generally able to exclude income derived from sources within that possession from their U.S. income tax. The source of income is determined by where the services that generate the income are performed. For instance, salary earned by an individual for work performed in the possession is considered possession-sourced income.

Income from the sale of personal property is generally sourced based on the seller’s tax home. For business income, the source is typically where the business activities occur. Dividend income is usually sourced to the jurisdiction where the paying corporation is organized.

Bona fide residents of a possession who are self-employed are subject to self-employment tax. These individuals must pay self-employment taxes to the United States on their self-employment income, reported on Form 1040-SS, U.S. Self-Employment Tax Return. This applies even if the individual does not have a U.S. income tax filing requirement because all of their income is possession-sourced and excludable.

The obligation to pay self-employment tax covers contributions for both Social Security and Medicare, and the tax is calculated on net earnings from self-employment above a certain threshold. This ensures their participation in the U.S. Social Security and Medicare systems.

Tax Filing for Non-Bona Fide Residents

U.S. citizens and resident aliens who earn income from a U.S. possession but do not meet the requirements to be a bona fide resident face different tax obligations. These individuals are taxed by the United States on their worldwide income, which includes any income earned within the possession. Because the possession may also tax the income earned within its borders, these taxpayers are at risk of double taxation.

To alleviate this, the U.S. tax system allows for a foreign tax credit. Taxpayers can claim a credit against their U.S. income tax liability for the income taxes they have paid or accrued to the U.S. possession. The foreign tax credit is claimed by filing Form 1116, Foreign Tax Credit, with the U.S. tax return.

The credit is generally limited to the amount of U.S. tax liability on the foreign source income. This approach ensures that non-bona fide residents are treated similarly to U.S. taxpayers earning income in foreign countries, as they report all income but receive a credit for taxes paid to another jurisdiction on that same income.

Required Forms and Statements

Navigating the tax rules for U.S. possessions often involves specific forms, with Form 8898, Statement for Individuals Who Begin or End Bona Fide Residence in a U.S. Possession, being a primary example. This form must be filed by any individual who changes their residency status, either by becoming a bona fide resident of a possession or by ceasing to be one during the tax year. To complete Form 8898, the taxpayer must provide detailed information for the year of the move, including the date the taxpayer began or ended their bona fide residence. It is filed as an attachment to the individual’s U.S. income tax return for the year of the change in residency.

Another key document is Form 8689, Allocation of Individual Income Tax to the U.S. Virgin Islands. This form is specifically for bona fide residents of the USVI and is used to figure the amount of income tax that should be paid to the Virgin Islands Bureau of Internal Revenue. It is not filed with the IRS but rather with the USVI tax authorities. The form requires the taxpayer to calculate their total tax liability as if they were filing with the U.S. and then allocate a portion of that tax to the USVI based on the income sourced there. This calculation determines the proper division of tax payments between the U.S. and the USVI for certain individuals.