Huff v. Commissioner

GEORGE C. HUFF, PETITIONER v. COMMISSIONER OF

INTERNAL REVENUE, RESPONDENT

Docket No. 12942–09. Filed March 19, 2012.

Claiming to be a bona fide resident of the U.S. Virgin

Islands (Virgin Islands) 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, and

paid income tax to, the Virgin Islands Bureau of Internal Rev-

enue (BIR) for 2002, 2003, and 2004 (years involved). P did

not file Federal income tax returns with, or pay Federal

income tax to, the Internal Revenue Service (IRS) for those

years. P asserts he was a member of NASCO Corporate

Finance Consultants, LLC (NASCO), a Virgin Islands limited

liability company. NASCO filed Virgin Islands partnership

returns with the BIR for the years involved. NASCO did not

258

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(258) HUFF v. COMMISSIONER 259

file partnership returns with the IRS. Because P did not file

tax returns with the IRS for the years at issue, R conducted

a nonfiler examination. R determined that for the years

involved P did not qualify for the I.R.C. sec. 932(c)(4) income

tax exclusion and therefore was not excused from his Federal

tax filing and tax payment obligations. R mailed P a notice of

deficiency. P maintains that this case involves a partnership

item and therefore R should have issued a notice of final part-

nership administrative adjustment to the tax matters partner

of NASCO pursuant to the procedural rules of the Tax Equity

and Fiscal Responsibility Act of 1982 (TEFRA), as opposed to

issuing P a notice of deficiency. P posits R’s notice of defi-

ciency is invalid, and thus he requests the Court to dismiss

this case for lack of jurisdiction. Held: The procedural rules of

TEFRA do not herein apply in that (1) NASCO did not file a

partnership return with the IRS, and (2) NASCO is not classi-

fied as a partnership for purposes of TEFRA. Held, further,

P’s motion to dismiss for lack of jurisdiction will be denied.

William M. Sharp, Lawrence R. Kemm, Joseph A. DiRuzzo

III, and Marjorie Rawls Roberts, for petitioner.

Daniel N. Price, Ladd Christman Brown, Jr., and Justin L.

Campolieta, for respondent.

OPINION

JACOBS, Judge: This matter is before the Court on peti-

tioner’s motion to dismiss for lack of jurisdiction (petitioner’s

motion), the resolution of which turns on whether respondent

should have issued a notice of final partnership administra-

tive adjustment (FPAA) to the tax matters partner (TMP) of

NASCO Corporate Finance Consultants, LLC (NASCO), pursu-

ant to the procedural rules of the Tax Equity and Fiscal

Responsibility Act of 1982 (TEFRA), Pub. L. No. 97–248, sec.

402(a), 96 Stat. at 648, rather than issue, as respondent did,

a notice of deficiency to petitioner.

Background 1

I. Petitioner

Petitioner is a U.S. citizen who claims he was a bona fide

resident of the U.S. Virgin Islands (Virgin Islands) during

1 For additional background information, see Appleton v. Commissioner, 135 T.C. 461 (2010),

rev’d, 430 Fed. Appx. 135 (3d Cir. 2011), Huff v. Commissioner, 135 T.C. 222 (2010), and Huff

v. Commissioner, 135 T.C. 605 (2010).

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260 138 UNITED STATES TAX COURT REPORTS (258)

2002, 2003, and 2004 (years involved). Respondent disputes

petitioner’s claim.

Petitioner filed territorial income tax returns with, and

paid income tax to, the Virgin Islands Bureau of Internal

Revenue (BIR) for each of the years involved. Petitioner

asserts that during the years involved he was a member of

NASCO, which was established under the laws of the Virgin

Islands as a limited liability company (LLC). 2

Petitioner maintains he qualified for the section 932(c)(4) 3

gross income exclusion for each of the years involved; con-

sequently, he did not file Federal income tax returns or pay

Federal income tax for those years. Because he did not file

returns with the Internal Revenue Service (IRS), respondent

conducted a nonfiler examination for the years involved and

determined that petitioner did not qualify for the income

exclusion under section 932(c)(4).

On February 27, 2009, respondent mailed petitioner a

notice of deficiency. Respondent’s primary position in the

notice of deficiency was that NASCO was not a legitimate

business entity and that petitioner was not a partner in

NASCO. Rather, respondent alleges petitioner used NASCO in

connection with ‘‘a tax avoidance scheme which involved

* * * [petitioner’s] improperly claiming to be a resident of

the USVI and superficially recasting US-source income as

USVI-source income in order to inappropriately and invalidly

claim a tax credit of 90% under the USVI Economic Develop-

ment Program.’’ 4

In contrast, petitioner asserts that (1) NASCO was a valid

LLC organized under the laws of the Virgin Islands, was rec-

ognized as such by the BIR, and should be respected for Fed-

eral tax purposes, and (2) this case involves a partnership

item and hence respondent should have issued an FPAA to

the TMP of NASCO pursuant to the procedural rules of TEFRA,

as opposed to issuing petitioner a notice of deficiency.

2 For purposes of petitioner’s motion, respondent treats NASCO as a legitimate Virgin Islands

business entity. However, respondent’s litigating position is that NASCO is not a legitimate

business entity. We make no determination with respect to the actual status of NASCO.

3 Unless otherwise indicated, all section references are to the Internal Revenue Code (Code)

in effect for the years involved.

4 Respondent asserts alternate positions in the notice of deficiency. As each of these alternate

positions is a variation of respondent’s primary position, we need not discuss them in the con-

text of petitioner’s motion.

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(258) HUFF v. COMMISSIONER 261

II. NASCO

As noted supra p. 260, NASCO was organized as a Virgin

Islands LLC. In this regard, the Virgin Islands government

issued a certificate of existence to NASCO on June 20, 2001.

Article 8 of NASCO’s articles of organization provides: ‘‘No

member of the Company shall be liable for the debts and

obligations of the Company under Section 1303, Subsection

(c) of the Uniform Limited Liability Act.’’

During each of the years involved NASCO had more than 10

members and at least 1 of its members was neither an indi-

vidual, a C corporation, nor an estate of a deceased person.

For each of the years involved NASCO filed a Virgin Islands

partnership tax return with the BIR.

III. The Virgin Islands

The Virgin Islands is an insular area of the United States;

it is not part of one of the 50 States or the District of

Columbia. The Virgin Islands is generally treated as a for-

eign country, see sec. 7701(a)(9); Huff v. Commissioner, 135

T.C. 222, 224 (2010), and has a ‘‘mirror tax’’ system; i.e., the

Virgin Islands uses as its tax law the tax laws of the United

States. In this regard, 48 U.S.C. sec. 1397 (2006) provides

that the Code is to be used by the Virgin Islands, with the

words ‘‘Virgin Islands’’ being substituted for the words

‘‘United States’’ and vice versa. The revised version of the

Code is known as the ‘‘mirror code’’.

Virgin Islands residents are required to file territorial

returns with, and pay territorial taxes to, the BIR. Mirror

code secs. 1, 6212(a)(1)(A). Virgin Islands partnerships are

required to file territorial partnership returns with the BIR

pursuant to mirror code section 6031(a).

The BIR does not have its own territorial tax forms; rather,

it uses IRS tax forms for reporting purposes. Thus, resident

Virgin Islands individuals file Form 1040, U.S. Individual

Income Tax Return, with the BIR; Virgin Islands partner-

ships file Form 1065, U.S. Return of Partnership Income,

with the BIR; and Virgin Islands corporations file Form 1120,

U.S. Corporation Income Tax Return, with the BIR.

Section 932(c) coordinates U.S. and Virgin Islands income

tax liability and filing requirements for individuals who are

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262 138 UNITED STATES TAX COURT REPORTS (258)

subject to U.S. taxation (e.g., U.S. citizens and residents). 5

An individual subject to U.S. taxation who is a bona fide resi-

dent of the Virgin Islands may satisfy his Federal income tax

reporting and payment requirements by filing solely with,

and paying tax to, the BIR, provided the individual satisfies

all of the requirements of section 932(c)(4). If the individual

fails to satisfy all of the section 932(c)(4) requirements, he/

she may be required to file tax returns with, and pay tax to,

both the IRS and the BIR. See S. Rept. No. 100–445, at 315

(1988), 1988 U.S.C.C.A.N. 4515, 4826.

In order to ensure the ‘‘fair implementation’’ of section 932,

the United States and the Virgin Islands entered into an

agreement ‘‘for the exchange of information and mutual

assistance with respect to taxes in order to prevent the eva-

sion or avoidance of United States or Virgin Islands taxes’’.

Tax Implementation Agreement Between the United States

of America and the Virgin Islands (TIA), Feb. 24, 1987, 1989–

1 C.B. 347, 347–348. The TIA applies to (1) all taxes imposed

by the Code, (2) all taxes imposed by the mirror code, and

(3) all local income taxes imposed by the Virgin Islands as

authorized by the Tax Reform Act of 1986. See id. art. 2,

1989–1 C.B. at 348. TIA article 4 governs the exchange of

information between the two governments. Clause 1 thereof

provides that the competent authorities of the United States

and the Virgin Islands shall exchange information to admin-

ister and enforce their respective tax laws. See id. art. 4(1),

1989–1 C.B. at 348.

TIA article 4(2)(b) provides that the Virgin Islands shall

routinely supply to the United States information with

respect to audit changes that disclose information of interest

to the U.S. Government, including, among other matters, (1)

information about the ownership interests of all corporations

subject to Virgin Islands tax having non-Virgin Islands-

source income and which receive a rebate, subsidy, or deduc-

tion of Virgin Islands taxes, as well as (2) information about

any individual subject to Virgin Islands tax who has non-

Virgin Islands-source income and who claims for the first

5 In general, the United States taxes U.S. citizens and alien individuals residing in the United

States on all of their income regardless of the income’s origin (i.e., on their worldwide 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). Individuals subject

to U.S. tax are generally required to file a tax return if their income exceeds a threshold

amount. Sec. 6012(a)(1)(A). Sec. 932 preempts these general rules.

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(258) HUFF v. COMMISSIONER 263

time to be a Virgin Islands resident. In addition, TIA article

4(2)(b) provides that the Virgin Islands shall supply to the

United States ‘‘copies of reports of individual, partnership,

corporate, and employment audit changes that disclose

information relevant to the United States.’’ Id. art. 4(2)(b),

1989–1 C.B. at 348–349. To this end, the TIA provides that

the BIR will permit the IRS to examine Virgin Islands tax

returns. Id. app. A, sec. 3.1, 1989–1 C.B. at 352.

Discussion

This Court is a court of limited jurisdiction; we may exer-

cise our jurisdiction only to the extent provided by Congress.

See sec. 7442; see also GAF Corp. & Subs. v. Commissioner,

114 T.C. 519, 521 (2000). We have jurisdiction to redetermine

a deficiency only if a valid notice of deficiency is issued by

the Commissioner and a petition contesting the Commis-

sioner’s deficiency determination is timely filed by the tax-

payer. GAF Corp. & Subs. v. Commissioner, 114 T.C. 519.

Petitioner’s motion is premised on petitioner’s assertion that

respondent’s notice of deficiency is invalid.

I. TEFRA Partnership Proceedings

Partnerships, in general, do not pay Federal income taxes.

Rather, they file annual information returns reporting the

partners’ distributive shares of the partnership’s income,

deductions, and other tax items. Secs. 701, 6031. Each

partner reports his/her respective distributive share of part-

nership income, deductions and credits on his/her income tax

return. Secs. 701–704; sec. 1.702–1(a), Income Tax Regs.

Before the enactment of TEFRA, adjustments of partnership

items were determined at the individual partner level,

resulting in duplication of administrative and judicial

resources and inconsistent results between partners. To

resolve this problem Congress enacted TEFRA, which created

a single unified procedure for determining the tax treatment

of all partnership items. Pursuant to the procedures of

TEFRA, assessments for nonpartnership item adjustments are

subject to deficiency proceedings, secs. 6212(a), 6230(a)(2),

whereas the tax treatment of a partnership item is deter-

mined at the partnership level, sec. 6221.

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264 138 UNITED STATES TAX COURT REPORTS (258)

Section 761(a) provides that a ‘‘ ‘partnership’ includes a

syndicate, group, pool, joint venture or other unincorporated

organization through or by means of which any business,

financial operation, or venture is carried on’’ and is not a cor-

poration, or a trust or estate. Section 6231(a)(1)(A) provides

that except as provided in section 6031(a)(1)(B) (regarding

‘‘small partnerships’’) ‘‘the term ‘partnership’ means any

partnership required to file a return under section 6031(a).’’ 6

Thus, an entity falls under the provisions of TEFRA if the

entity is required to file a partnership return. See Wolf v.

Commissioner, T.C. Memo. 1991–212, aff ’d, 4 F.3d 709 (9th

Cir. 1993).

Business entities that are classified as foreign partnerships

for Federal tax purposes are generally exempt from filing

partnership returns and are not subject to the provisions of

TEFRA. Sec. 6031(e)(1). However, foreign partnerships that

earn gross income derived from sources within the United

States or earn gross income that is effectively connected with

the conduct of a trade or business within the United States

are required to file partnership returns and therefore are

within the purview of TEFRA. Sec. 6031(e)(2).

II. Contentions of the Parties

Petitioner asserts that this case should be dismissed for

lack of jurisdiction because respondent failed to follow the

procedural rules of TEFRA. Petitioner maintains that because

NASCO filed territorial partnership returns with the BIR, it in

essence filed Federal partnership returns with the IRS for the

years at issue pursuant to section 6233(a). Consequently,

petitioner reasons the procedural rules of TEFRA apply. Alter-

natively, petitioner posits that NASCO should be classified as

a foreign partnership and was required to file a Federal part-

nership return for each of the years involved because for

such years it had U.S.-source income or income effectively

connected with a U.S. trade or business. Continuing, peti-

tioner maintains that the issues raised in respondent’s notice

of deficiency are, in reality, partnership items and hence,

pursuant to the procedural rules of TEFRA, are determined at

the partnership level. Thus, petitioner concludes respondent

6 Sec. 6031(a) provides that partnerships shall make a return for each taxable year stating

each item of gross income and deduction allowable by subtit. A.

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(258) HUFF v. COMMISSIONER 265

properly should have issued an FPAA to the TMP of NASCO,

rather than, as respondent did, a notice of deficiency to peti-

tioner. See sec. 6223(a); sec. 301.6223(a)–1, Proced. & Admin.

Regs.

Solely for purposes of disposing of petitioner’s motion,

respondent accepts petitioner’s assertion that NASCO is a

legitimate foreign business entity. Respondent disputes the

remainder of petitioner’s assertions, maintaining: (1) NASCO

never filed Federal partnership returns; and (2) if NASCO is

to be treated as a business entity, it should be classified as

a foreign corporation. Consequently, respondent posits TEFRA

procedures do not apply and the notice of deficiency issued

to petitioner is valid.

III. Whether Filing a Partnership Return With the BIR Con-

stitutes the Filing of a Partnership Return With the IRS

NASCO timely filed 2002, 2003, and 2004 partnership

returns with the BIR using Form 1065; it did not file partner-

ship returns with the IRS. On May 4, 2006, the IRS obtained

copies of the returns filed by NASCO with the BIR pursuant

to the information sharing provisions of the TIA between the

United States and the Virgin Islands.

Petitioner claims that NASCO’s filing of Form 1065 with the

BIR constitutes its filing of a Federal partnership return with

the IRS. In this regard, petitioner asserts that the Virgin

Islands is not an independent sovereign, like a State or a for-

eign country, but rather is an unincorporated territory of the

United States and as such is ‘‘an extension of the federal

government.’’

Petitioner’s claim that for tax return filing purposes the

Virgin Islands ‘‘is an extension of the federal government’’ is

incorrect. Since 1958 courts have noted that the United

States and the Virgin Islands are distinct taxing jurisdic-

tions, although the Virgin Islands income tax laws arise from

an identical statute applicable to each. Dudley v. Commis-

sioner, 258 F.2d 182, 185 (3d Cir. 1958), aff ’g 28 T.C. 992

(1957); see Chase Manhattan Bank v. Gov’t of the V.I., 300

F.3d 320 (3d Cir. 2002); Abramson Enters., Inc. v. Gov’t of the

V.I., 994 F.2d 140, 142 (3d Cir. 1993); Danbury, Inc. v. Olive,

820 F.2d 618 (3d Cir. 1987); Miller v. Quinn, 792 F.2d 392

(3d Cir. 1986); Chi. Bridge & Iron Co. v. Wheatley, 430 F.2d

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266 138 UNITED STATES TAX COURT REPORTS (258)

973, 976 (3d Cir. 1970). Consistent with this principle, courts

have held that a notice of deficiency issued by the BIR cannot

be petitioned to the Tax Court, Dudley v. Commissioner, 258

F.2d 182, and a notice of deficiency issued by the Commis-

sioner of Internal Revenue cannot be petitioned to the U.S.

District Court, District of the Virgin Islands, McHenry v.

Commissioner, No. 1:10–cv–00021 (D.V.I. July 18, 2011)

(order granting motion to dismiss for lack of jurisdiction).

Petitioner next asserts that even if the filing of a return

with the BIR does not constitute a filing of a return with the

IRS, pursuant to the TIA the BIR should be treated as an

agent of the IRS. And continuing, petitioner posits that

because the BIR should be deemed an agent of the IRS, and

because the BIR forwarded copies of NASCO’s partnership

returns to the IRS, the filing of NASCO’s Virgin Islands part-

nership return with the BIR constitutes the filing of a Federal

partnership return with the IRS. We do not agree with peti-

tioner’s assertion.

An agency relationship is defined as: ‘‘the fiduciary rela-

tionship that arises when one person (a ‘‘principal’’) mani-

fests assent to another person (an ‘‘agent’’) that the agent

shall act on the principal’s behalf and subject to the prin-

cipal’s control, and the agent manifests assent or otherwise

consents so to act.’’ 1 Restatement, Agency 3d, sec. 1.01

(2006). An agency relationship is created when by mutual

consent, either implied or expressed, one party (i.e., the

agent) agrees to act on behalf of the other (i.e., the principal)

and be subject to the principal’s control. This consent is gen-

erally manifested by (1) statements or actions by the prin-

cipal that the agent will act on behalf of the principal, (2) the

agent’s acceptance of such undertaking, and (3) an under-

standing by both parties that the principal is to be in control

of such undertaking. See 2A C.J.S., Agency, sec. 32 (2003).

The TIA does not establish an agency relationship, or sup-

port the existence of such a relationship, between the United

States and the Virgin Islands or their respective tax depart-

ments (i.e., the IRS and the BIR). To the contrary, the TIA is

an agreement between equal parties ‘‘for the exchange of

information and mutual assistance with respect to taxes in

order to prevent the evasion or avoidance of United States or

Virgin Islands taxes’’. TIA, 1989–1 C.B. at 347–348. The BIR

is not under the control of the IRS or vice versa.

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(258) HUFF v. COMMISSIONER 267

Finally, relying on Beard v. Commissioner, 82 T.C. 766,

777 (1984), aff ’d, 793 F.2d 139 (6th Cir. 1986), petitioner

asserts that the copies of the partnership returns NASCO filed

with the BIR for the years at issue should be treated as

NASCO’s partnership returns for Federal tax purposes. We do

not agree with petitioner’s assertion.

In Beard, we held that within the context of determining

the commencement of the period of limitations with respect

to the filing of one’s Federal income tax return, the document

submitted to the IRS will be considered a valid tax return if:

1. the document contains sufficient data to calculate the

tax liability;

2. the document purports to be a tax return;

3. there is an honest and reasonable attempt by the filer

of the document to satisfy the requirements of the tax law;

and

4. the filer executes the return under penalties of perjury. 7

Id. at 777. Petitioner claims that the returns NASCO filed

with the BIR satisfy all four of the aforementioned criteria

and thus should be treated as Federal partnership returns

filed with the IRS because:

First, the information [on the return filed by NASCO] is sufficient to cal-

culate the tax liability as NASCO used the very form drafted and issued

by the Service. Second, the Form 1065 is by definition a return and claims

to be nothing other than a return. Third, a form drafted and issued by the

Service that taxpayers in turn used must be considered to be an honest

and reasonable attempt to satisfy the requirements of the tax law. Fourth,

the return was signed under penalties of perjury as the jurat provision was

executed.

Petitioner cites Germantown Trust Co. v. Commissioner,

309 U.S. 304 (1940), as the ‘‘seminal case’’ to support his

position. In Germantown Trust Co., the taxpayer filed the

wrong form with the IRS as its tax return. The Supreme

Court held that the filing constituted a tax return because

the taxpayer filed in good faith a return from which its tax

could be computed. Thus, the underlying issue therein was

whether the return filed with the IRS constituted a valid

return. Such is not the case here. The issue here is whether

7 The Commissioner has adopted these four criteria in determining whether the purported tax

return should be respected as such. See Internal Revenue Manual pt. 25.6.1.9.4.1 (Oct. 1, 2007).

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268 138 UNITED STATES TAX COURT REPORTS (258)

the filing of a return with the BIR constitutes the filing of a

return with the IRS.

The returns NASCO filed with the BIR do not purport to be

Federal returns (as required by criterion 2 of Beard), nor are

those returns an attempt to satisfy the requirements of Fed-

eral tax law (as required by criterion 3 of Beard). NASCO filed

its partnership returns with the BIR in order to comply with

its Virgin Islands filing obligations as opposed to any obliga-

tion under the tax laws of the United States.

IV. Whether NASCO Is Classified as a Partnership

Even though NASCO, an LLC, did not file Federal partner-

ship returns, NASCO may come under the purview of TEFRA

if it can be classified for Federal tax purposes as a partner-

ship that is required to file a Federal partnership return.

Petitioner takes the position that NASCO had a Federal part-

nership return filing obligation and thus should be classified

as a partnership for Federal tax purposes. On the other

hand, respondent contends that NASCO is a corporation for

Federal tax purposes and therefore the procedural rules of

TEFRA do not apply.

Business entities are generally classified for Federal tax

purposes by section 7701 and the ‘‘check-the-box’’ regulations

of sections 301.7701–1 through 301.7701–5, Proced. &

Admin. Regs. 8 The Virgin Islands, and the businesses estab-

lished therein, are generally considered foreign for purposes

of the Code because the Virgin Islands is not one of the 50

States or the District of Columbia. See sec. 7701(a)(4), (5),

(9). 9

Petitioner concedes that NASCO is a foreign entity. Peti-

tioner further concedes that (1) generally, the check-the-box

regulations of section 301.7701–3(b)(2)(i)(B), Proced. &

Admin. Regs., would classify NASCO as a foreign association

taxable as a corporation because it is a foreign ‘‘eligible

entity’’ in which all of its owning members have limited

liability, 10 and (2) generally, in such a situation the provi-

8 The

Virgin Islands classifies business entities with the mirror versions of these sections.

9 Sec.

7701(a)(4) provides that ‘‘domestic’’ when applied to a corporation or partnership gen-

erally means one created or organized in the United States under the law of the United States

or one of the States. Sec. 7701(a)(5) provides that a foreign corporation or partnership is one

that is not domestic. Sec. 7701(a)(9) provides that ‘‘The term ‘United States’ when used in a geo-

graphical sense includes only the States and the District of Columbia.’’

10 A business entity that is not a corporation as defined in sec. 301.7701–2(b), Proced. &

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(258) HUFF v. COMMISSIONER 269

sions of TEFRA do not apply. However, petitioner argues that

the check-the-box regulations are superseded by section

1.932–1(h)(4), Income Tax Regs., which provides:

Solely for the purpose of determining classification of an eligible entity

under § 301.7701–3(b) of this chapter [the check-the-box regulations] and

under that section as mirrored in the Virgin Islands, an eligible entity sub-

ject to this paragraph (h) will be classified for both Federal and Virgin

Islands tax purposes using the rule that applies to domestic eligible enti-

ties.

Thus, petitioner posits that although NASCO is generally

treated as a foreign entity for purposes of the Code, for pur-

poses of determining whether NASCO is a corporation or a

partnership the Court should treat NASCO as a domestic

eligible entity and use the check-the-box regulations that

apply to such entities. Petitioner reasons that pursuant to

section 301.7701–3(b)(1)(i), Proced. & Admin. Regs., the

domestic eligible entity check-the-box regulations would clas-

sify NASCO as a partnership since it is an entity with two or

more members. We are of the opinion that section 1.932–

1(h)(4), Income Tax Regs., does not apply to NASCO.

Section 1.932–1(h)(2)(i), Income Tax Regs., provides that

section 1.932–1(h), Income Tax Regs., applies to domestic

(i.e., U.S.) business entities that are owned in whole or in

part by bona fide residents of the Virgin Islands or by Virgin

Islands business entities. Section 1.932–1(h)(2)(ii), Income

Tax Regs., applies section 1.932–1(h), Income Tax Regs., to

Virgin Islands business entities that are owned in whole or

in part by U.S. persons, other than bona fide residents of the

Virgin Islands. In this case, NASCO is a Virgin Islands LLC,

and according to petitioner all of the members of NASCO are

bona fide residents of the Virgin Islands. Therefore, the regu-

lations petitioner relies upon do not apply to his situation.

Moreover, section 1.932–1(h)(5)(iv), Income Tax Regs., pro-

vides that ‘‘In the case of an entity created or organized prior

Admin. Regs., is an eligible entity and may elect its classification for Federal tax purposes. Sec.

301.7701–3(a), Proced. & Admin. Regs. If an eligible entity does not make an election for Fed-

eral tax purposes, then the regulations provide for default classifications depending on the at-

tributes of the eligible entity. A foreign eligible entity in which all of its owning members have

limited liability, as apparently is the case with respect to all of the owning members of NASCO,

is classified by the default rules as an association. See sec. 301.7701–3(b)(2)(ii), Proced. &

Admin. Regs., for the definition of ‘‘limited liability’’.

Sec. 301.7701–2(b)(8), Proced. & Admin. Regs., provides a list of foreign business entities that

are corporations and may not elect their classification. In the Virgin Islands, entities that are

established as ‘‘corporations’’ are not eligible entities and may not elect their status.

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270 138 UNITED STATES TAX COURT REPORTS (258)

to April 11, 2005, paragraph (h)(4) of this section will take

effect for Federal income tax purposes (or Virgin Islands

income tax purposes, as the case may be) as of the first day

of the first taxable year of the entity beginning after April

11, 2005.’’ NASCO operates on a calendar year basis. Hence,

the first year that the classification rules of section 1.932–

1(h)(4), Income Tax Regs., would apply is 2006. But the years

involved are 2002, 2003, and 2004.

Petitioner argues that the regulations should be applied

retroactively regardless of the specific effective date. Peti-

tioner points to the preamble to the temporary regulation,

which states:

To the extent they provide rules under the operative provisions of the Code

relating to the possession, as amended by the 1986 Act and the 2004 Act,

these regulations generally apply to taxable years ending after October 22,

2004. The underlying statutory rules, however, generally apply to taxable

years beginning after December 31, 1986. Accordingly, taxpayers may rely

upon the guidance provided in these regulations with respect to prior years

for which the underlying statutory rules are in effect, provided they do so

consistently. [T.D. 9194, 2005–1 C.B. 1016, 1020. 11]

We apply a regulation according to its plain or ordinary

meaning, unless that interpretation would lead to absurd

results or another construction is supported by unequivocal

evidence of administrative intent. Philips Petroleum Co. v.

Commissioner, 101 T.C. 78, 107 (1993), aff ’d without pub-

lished opinion, 70 F.3d 1282 (10th Cir. 1995). Section 1.932–

1(h)(5)(iv), Income Tax Regs., specifically provides that the

classification rules of section 1.932–1(h)(4), Income Tax

Regs., apply only to tax years beginning after April 11, 2005.

Petitioner does not suggest that the application of the plain

meaning of section 1.932–1(h)(5)(iv), Income Tax Regs., will

lead to an absurd result. Nor does the preamble amount to

unequivocal evidence of administrative intent to retroactively

apply the default classification rule of the regulation.

The preamble discusses how affirmative elections by tax-

payers regarding the classification of entities will be treated

under the regulation. It does not mention taxpayers who

allowed their business entities to be classified under the

11 We are mindful that the language of sec. 1.932–1T(h)(4), Temporary Income Tax Regs., 70

Fed. Reg. 18920, 18933–18934 (Apr. 11, 2005), is identical to the language in the final regula-

tion and that sec. 1.932–1T(h)(5)(iv), Temporary Income Tax Regs., supra, has the same effective

date of April 11, 2005, as the final regulation.

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(258) HUFF v. COMMISSIONER 271

default rules through their own inaction. Moreover, the pre-

amble to the temporary regulation discusses retroactivity

regarding the temporary regulation’s general effective date of

October 22, 2004. Section 1.932–1(h)(4), Income Tax Regs.,

has its own specific effective date; i.e., effective for tax years

beginning after April 11, 2005. As the temporary regulation’s

preamble does not mention that effective date, it cannot be

said that there is unequivocal evidence of administrative

intent to retroactively apply the default classification rule.

Consequently, section 1.932–1(h)(4), Income Tax Regs., does

not apply. 12

To conclude, because NASCO did not file a Federal partner-

ship return and because NASCO is classified as a foreign cor-

poration for Federal tax purposes, the TEFRA procedural rules

do not apply. Consequently, we hold that (1) respondent was

not required to issue an FPAA, and (2) respondent issued a

valid notice of deficiency. Consistent with the foregoing, peti-

tioner’s motion will be denied.

An appropriate order will be issued.

f

12 Because we conclude that NASCO is not classified as a partnership for Federal tax pur-

poses, we need not address the issue of whether NASCO has U.S.-source income or income effec-

tively connected to a U.S. trade or business.

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