How US Territories and Possessions are Taxed by IRS, A Primer

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How US Territories and Possession are Taxed by IRS

How US Territories and Possession are Taxed by IRS

How are US Territories and Possessions Taxed

The United States is one of the only countries on the planet that follows a citizenship-based taxation model. But, the phrase can be confusing because it is not limited to you are citizens; it also includes Lawful Permanent Residents and for nationals to meet the Substantial Presence Test. From a baseline perspective, US persons are taxed on their worldwide income. Therefore, whether or not the taxpayer resides in the United States or abroad, and/or earns all of their income from US or foreign sources, does not necessarily matter — they are still required to report this information on the US tax return and pay taxes on it (although the Foreign Earned Income Exclusion, foreign housing exclusion, and foreign tax credits may help to reduce or eliminate US tax liability). What about US territories and possessions, are they taxed? Let’s take a brief look.

US Tax for Income from US Territories and Possessions

Oftentimes, residence and sources of income will help dictate the tax filing requirements for taxpayers with income from US territories and possessions. First off, if a US person resides within the United States and earns income from a territory or possession, chances are they are going to have to pay US tax on that income (aka worldwide income). But, if the taxpayer does not actually reside in the United States or in the possession/territory may impact the overall tax liability. For example, if a person is considered a Bona Fide Resident of Puerto Rico and they do not have any income beyond income source in Puerto Rico, then they usually will only have to file a tax return in Puerto Rico and not a US form 1040. This is important, because it may eliminate certain international information reporting requirements –– although not all of them because U.S. Citizens typically still have to file the FBAR and Form 3520.

Multiple Tax Returns May be Required

For some taxpayers who are residents in a U.S. possession or territory and earn income both within that possession or territory and outside of it, they may have to file multiple tax returns. That is because if a person resides in U.S. possession or territory they may not necessarily meet the bona fide residence test of that and/or they may have income outside of the area that requires additional tax return filing.

IRS Information for Territories and Possessions

As provided by the IRS:

      • An individual who has income from American Samoa, the Commonwealth of the Northern Mariana Islands (CNMI), Guam, Puerto Rico or the U.S. Virgin Islands will usually have to file a tax return with the tax department of one of these territories. In some situations, you may have to determine if you are a resident or a nonresident of the territory. For forms and advice on filing a territory tax return, contact that territory’s tax department. The addresses and telephone numbers for the tax departments of the U.S. territories may be found in Publication 570, Tax Guide for Individuals With Income From U.S. Possessions. Additional information about the U.S. territories can be found at State and Local Government on the Net.

      • If you have income from one of these U.S. territories, you may have to file a U.S. tax return only, a territory tax return only, or both returns. This generally depends on whether you are considered a bona fide resident of one of the U.S. territories. In some cases, you may have to file a U.S. return, but be able to exclude income earned in a territory from U.S. tax. Filing requirements for specific U.S. territories are explained in Publication 570, Tax Guide for Individuals With Income From U.S. Possessions.

Possession Exclusion for Bona Fide Residents  of American Samoa

      • Currently, the possession exclusion – under Internal Revenue Code (IRC) section 931 – applies only to U.S. citizens or resident aliens who are bona fide residents of American Samoa. If you qualify for this exclusion, you may have to attach Form 4563, Exclusion of Income for Bona Fide Residents of American Samoa, to their U.S. federal individual income tax returns.

      • Individuals in the following U.S. territories are NOT eligible for the possession exclusion: Baker Island, the CNMI, Guam, Howland Islands, Jarvis Island, Johnston Island, Kingman Reef, Midway Islands, Palmyra, Puerto Rico, the U.S. Virgin Islands, and Wake Island.

      • Please refer to Publication 570, Tax Guide for Individuals With Income From U.S. Possessions, for the exclusions, credits, and deductions which apply to residents of the CNMI, Guam, Puerto Rico, and the U.S. Virgin Islands.

Determining Residency Status in U.S. Territories

      • IRC 937 establishes the criteria for determining the residency of an individual in American Samoa, the CNMI, Guam, Puerto Rico, and the U.S. Virgin Islands, and for determining whether income is sourced in a U.S. territory. An individual is generally considered a bona fide resident of a U.S. territory if he or she (1) is physically present in the territory for 183 days during the taxable year, (2) does not have a tax home outside the territory during the tax year, and (3) does not have a closer connection to the U.S. or a foreign country. However, U.S. citizens and resident aliens are permitted certain exceptions to the 183-day rule. For a detailed explanation of the U.S. territory residency rules and income sourcing rules, please refer to Publication 570, Tax Guide for Individuals With Income From U.S. Possessions.

      • IRC 937 also establishes the filing requirement for Form 8898, Statement for Individuals Who Begin or End Bona Fide Residence in a U.S. Possession for individuals who became or ceased to be a bona fide resident of a U.S. Territory. If you are required to file Form 8898 for any tax year and fail to file it, you may be subject to a penalty of $1,000.

      • Individuals who are required to file Form 8898 generally must do so by the due date (including extensions) for filing Form 1040 or Form 1040-NR. Form 8898 must be filed by itself; do not file it with Form 1040 or Form 1040-NR. Refer to Residents of U.S. Possessions-Form 8898 Bona Fide Residence for more information.

Self-Employment Tax

      • A U.S. citizen who is self-employed in a U.S. territory must pay self-employment tax on net self-employment earnings of $400 or more. This rule applies whether or not the earnings are excludable from gross income (or whether or not a U.S. income tax return must otherwise be filed).

      • Your payments of self-employment tax contribute to your coverage under the social security system. Social security coverage provides you with old age, survivor, and disability benefits and hospital insurance.

      • If you are a resident of American Samoa, the CNMI, Guam, Puerto Rico, or the U.S. Virgin Islands who has net self-employment income and you do not have to file Form 1040 with the United States, use Form 1040-SS, U.S. Self-Employment Tax Return, to figure your self-employment tax.

      • Note: If you are a resident of Puerto Rico, you can file Form 1040 (PR) instead of Form 1040-SS. Form 1040 (PR) is the Spanish-language equivalent of Form 1040-SS. These forms must be filed with the U.S. Internal Revenue Service at the address shown in the instructions for Form 1040 (PR) and Form 1040-SS.

      • Note: This page contains one or more references to the Internal Revenue Code (IRC), Treasury Regulations, court cases, or other official tax guidance. References to these legal authorities are included for the convenience of those who would like to read the technical reference material. To access the applicable IRC sections, Treasury Regulations, or other official tax guidance, visit the Tax Code, Regulations, and Official Guidance page. To access any Tax Court case opinions issued after September 24, 1995, visit the Opinions Search page of the United States Tax Court.

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