Tax Court Denies Government Summary Judgement in Foreign Income Case

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Tax Court Denies Government a Quick Win in Foreign Income Case

In Zuhovitzky v. CIR, T.C. Memo 2015-158, the government filed a motion for partial summary judgment on the issue wither the petitioner is subject to U.S. tax on worldwide income in the absence of a section 6013(g) election.

What is a 6013 election?

A 6013(g) election allows a nonresident who is married to a U.S. citizen or resident at the end of the year to be treated as a resident for income tax purposes. A couple who makes the election must file a joint return in the election year but a joint or separate return may be filed for subsequent years.

A 6013(h) election allows a dual status resident (i.e., who is a resident at the end of the year but not the beginning) that is married to an individual who is either a U.S. citizen or resident at the end of the year to be treated as a full year resident for income tax purposes.

Such an election must be made by attaching a signed statement to the joint return for the first year in which it applies.

Facts

During the years at issue, petitioner Jonathan Zuhovitzky was a citizen of both Israel and the United States; petitioner Esther Zuhovitzky was a citizen of both Israel and Austria. Esther has never resided in the United States. [The Zuhovizkys] filed joint tax returns for 1992 through 2008 but never filed an election under section 6013(g) to treat Esther as a resident of the United States during these years.

[The IRS] issued a notice of deficiency for the years at issue, in which [the IRS] determined the following:

Fraud penalty
Year Deficiency sec. 6663
2000 $276,596.00 $207,447.00
2001 265,143.00 198,857.25
2002 244,427.00 183,320.25
2003 337,244.00 252,933.00
2004 299,062.00 224,296.50
2005 174,870.00 131,152.50
2006 308,746.00 231,559.50
2007 124,137.00 93,102.75
2008 137,467.00 103,100.25

These deficiencies and penalties stem from determined unreported interest and dividend income from a UBS account in Esther’s name.

Issue

A nonresident alien has no requirement to report foreign income and assets, unless they’ve made an election to be treated as a resident, such as in this case, under IRC 6013(g).

Treas. Reg. § 1.6013-6(a)(4) provides that a 6013(g) election must be made on a signed statement attached with the tax return for the first year in which the election is made.

The issue in this case is whether a non-resident taxpayer that has filed jointly (and therefore as a U.S. tax resident) but has not made a 6013(g) election can be subject to U.S. tax on worldwide income.

Law

As discussed above, the 6013(g) election allows a non-resident spouse married to a U.S. citizen or resident to elect to be treated as a resident for tax purposes and file jointly.

The IRS argues that while the taxpayer did not make a 6013(g) election, the fact that they filed jointly should be construed as having made a valid election. The government seeks to apply two common law doctrines: substantial compliance and the duty of consistency.

Substantial compliance

The substantial compliance doctrine is a narrow equitable doctrine that we may apply to avoid hardship where one party establishes that the other party intended to comply with a provision, did everything reasonably possible to comply with the provision, but did not comply with the provision because of a failure to meet the provision’s specific requirements.

Under the substantial compliance doctrine, [taxpayers] must have both intended to make the section 6013(g) election and substantially complied with the requirements for the election. [The IRS] contends that by filing joint returns, [taxpayers] expressed their intent to make a section 6013(g) election. [Taxpayers], on the other hand, argue that they had no intent to make a section 6013(g) election. [Taxpayers’] intent is a matter of material fact in dispute, and thus, the issue of substantial compliance is inappropriate for summary judgment and requires trial.

Duty of consistency

We may also apply the equitable doctrine of “quasi-estoppel” or “the duty of consistency.” The “duty of consistency” is based on the theory that the taxpayer owes the Commissioner the duty to be consistent with his tax treatment of items and will not be permitted to benefit from his own prior error or omission.  The duty of consistency doctrine prevents a taxpayer from taking one position one year and a contrary position in a later year after the limitations period has run on the first year.

[The IRS] contends that the Court should treat [taxpayers] as if they had made a section 6013(g) election under the duty of consistency. [The IRS] argues that [taxpayers] represented that they were eligible to file joint returns by filing joint returns from 1992 through 2008. [The IRS]  further argues that because Esther was a nonresident alien, [taxpayers] were entitled to file joint returns only if: (1) they made a section 6013(g) election or (2) Esther satisfied the substantial presence test under section 7701(b)(3)…[The IRS] contends that he relied upon this representation by accepting [taxpayers’] joint returns and that [taxpayers] are now trying to change their representation about their joint-filing eligibility after the expiration of the period of limitations for 1992 through 1999.

Conclusion

The court finds that the application of the substantial compliance and duty of consistency doctrines require factual determinations which cannot be made in summary judgment, and that the case must proceed to trial.

Final word about IRC 6013 elections

It’s important that individuals immigrating to the U.S. with significant foreign income and assets have proper tax planning. Nonresident spouses should be cautious in making a 6013 election or filing jointly, which may unintentionally subject them to U.S. tax on foreign income and FBAR/FATCA reporting requirements.

A 6013(h) election is often advisable, especially since the taxpayer is a resident anyway for at least part of the year. It allows taxpayers to use lower married filing jointly tax rates, itemize deductions, and claim personal exemptions.

A 6013(g) election, on the other hand, will treat a nonresident alien spouse as a resident when they would have otherwise not been subject to U.S. tax. In addition, it would apply in subsequent years unless terminated in writing. A non-resident spouse would have to file as a U.S. resident filing jointly or separately. The 6013(g) should almost never be made, except where the nonresident spouse has insignificant foreign income and assets. Generally, where one spouse is a nonresident, the resident spouse should file separately. The nonresident spouse then has no U.S. tax return filing obligation, unless they have U.S. source income.