New federal tax law redefines tax residency

The Commonwealth may lose some revenues as a result of the implementation of a new federal tax law that grants the U.S. Internal Revenue Service, rather than the local government, the authority to determine a jurisdiction’s tax residents, according to a Saipan-based tax attorney.

Commenting on the impact of the American Jobs Creation Act of 2004 to U.S. possessions, including the CNMI and Guam, attorney Alexis Fallon said the new law would diminish the local governments’ ability to determine which residents should file their income tax return with the local government and which should pay taxes to the federal government.

This, Fallon wrote in the journal Tax Notes International, could have adverse effects on the local governments’ treasuries.

“For example, if the IRS determines that an individual does not qualify as a bona fide resident, the local treasuries will most likely have to refund the taxes paid by that individual,” Fallon wrote. “That will severely hamper the collection authority of the local government because residents who are fearful of the IRS may simply choose to pay the United States rather than risk a determination by the IRS that they are not bona fide residents.”

Under the new law, individuals must meet three requirements for them to be considered CNMI tax residents.

First, an individual must be present at least 183 days during the tax year in the CNMI.

Second, he or she must not have a tax home outside of the CNMI. One’s tax home is the jurisdiction where he or she votes, where his or her family resides, etc.

Directly related with this is the third criterion, which is that an individual must not have a closer connection to the United States or a foreign country other than the CNMI.

“If you meet all three of those tests, then you can file with the CNMI. But if you can’t meet those tests, you will have difficulty in establishing residency here to file your income tax return,” said Fallon, the guest speaker at yesterday’s Saipan Chamber of Commerce meeting.

She added, however, that a taxpayer does not have to meet the 183-day requirement if he or she spends less than 90 days in the mainland U.S. But the tax home and closer connection tests still apply.

Furthermore, Fallon maintained that she did not expect the new law to have a significant impact on the CNMI’s collection.

She noted that generally, the new law applies only to U.S. citizens and green card holders residing or doing business in the Commonwealth. The law does not cover nonresident workers.

“I wouldn’t say the government will lose huge amounts of income because if you look at our base population, I don’t think we have that many mainland U.S. people here. To hazard a guess, they would probably be less than 5 percent of our population. So there will definitely be an impact, but I don’t think it would be huge,” Fallon said.

“But then again, we won’t know until it goes into effect. We wouldn’t know until they start applying it next year,” she was quick to add.