Is Puerto Rico a Tax Haven Worth Considering?
Puerto Rico has been attracting a lot of attention as a potential tax haven for wealthy Americans. The territory offers some significant tax incentives that can dramatically reduce the amount of taxes people pay.
But is Puerto Rico really the right choice? And does it actually qualify as a true tax haven? Let’s take a closer look.
From Spanish Colony to American Tax Refuge
Puerto Rico became a US possession in 1898 after the Spanish-American War. Since then, Congress has tried various approaches to revive Puerto Rico’s economy, including direct aid, business incentives, and tax breaks. But the results have been mixed at best.
The first tax incentives for Puerto Rico were introduced in 1921. In 1976, Congress allowed US companies to operate there tax-free, leading many businesses, especially in pharmaceuticals, to move to the island. But by the mid-1990s, these incentives were costing the US Treasury billions, so Congress repealed them.
The incentives enacted in 2012 consisted of personal and business incentives. The personal tax incentives were contained in Act 22. The business tax incentives were contained in Act 20.
In 2019, the Puerto Rico Legislative Assembly enacted Act 60 to replace both Act 20 and 22. Act 60 was amended in 2021 and again in 2022.
Puerto Rico guarantees these provisions will remain in place until the end of 2035.
Puerto Rico’s Tax Haven Status: How It Works
Puerto Rico is able to offer such generous tax incentives thanks to a special provision in the US tax code. Section 933 of the Internal Revenue Code specifically excludes “income derived from sources within Puerto Rico” from certain types of federal income tax for individuals who are “bona fide residents of Puerto Rico.”
In other words, the US government has given Puerto Rico the power to tax its own residents as little or as much as it wants. And since 2012, Puerto Rico has decided to offer a very low tax regime in an effort to attract wealthy Americans from the mainland to move themselves and their businesses there.
This has turned Puerto Rico into what’s essentially a tax haven within the United States. By becoming a bona fide resident of Puerto Rico, Americans can significantly reduce their federal tax burden on investment income, capital gains, and other passive sources of revenue.
But there are some important caveats. Residents must actually live in Puerto Rico for at least 6 months of the year to qualify for the tax breaks. And the US government could always choose to change or eliminate these special tax provisions if it decides they are eroding the federal tax base too much.
Overall, Puerto Rico’s tax haven status is a complex and sometimes controversial topic. While the incentives can be very appealing for some, there are also risks and potential downsides that anyone considering a move there should carefully evaluate. It’s important to understand both the benefits and the limitations of Puerto Rico’s unique tax regime.
Puerto Rico’s Personal Tax Incentives
Puerto Rico offers some very attractive tax benefits for individuals who become bona fide residents of the territory. These include:
Key Benefits
- 100% tax exemption from Puerto Rico income taxes on all Puerto Rican-source dividends and interest payments.
- 100% tax exemption from Puerto Rico income taxes on all short-term and long-term capital gains accrued since becoming a resident.
- Capital gains accrued before becoming a resident are eligible for a 5% tax rate after 10 years of residency.
- These tax incentives are valid until December 31, 2035.
Requirements
To take advantage of these personal tax benefits, you must:
- Spend at least 183 days per year physically present in Puerto Rico and make it the “center of your vital interests”.
- Buy a residential property within 2 years of arriving in Puerto Rico.
- Donate $10,000 or more to a local charity each year.
- Pay a $5,000 annual renewal fee to maintain the tax incentives.
- Generate no more than $3,000 in earned income from U.S. sources (such as wages, salaries, or professional fees).
Puerto Rico offers very generous personal income tax exemptions, but there are also specific requirements residents must meet in order to qualify. Anyone considering a move to Puerto Rico should carefully review these rules and restrictions.
Puerto Rico’s Business Tax Incentives
Puerto Rico offers some attractive tax incentives for businesses that provide “export services” from the territory. These incentives are available through a special tax decree that is valid for 15 years, with a possible 15-year extension.
Key Benefits
- 4% tax rate on corporate profits for qualifying export services businesses.
- Tax-free dividends remitted to owners of a qualifying export services business, if they are bona fide residents of Puerto Rico.
Requirements
- To take advantage of these business tax incentives, there are a few key requirements:U.S. owners of the business must move to Puerto Rico and follow the same physical presence rules as individual investors – spending at least 183 days per year in the territory.
- You must pay yourself a “reasonable salary” based on the value of the services you provide for the company. On that salary, you’ll pay:
- Local Puerto Rico income tax up to 33%.
- Federal Social Security tax of 12.4% on the first $147,000 (for 2022).
- Federal Medicare tax of 2.9% with no cap.
- Maintain detailed records to demonstrate your continuing eligibility for the export services tax incentives.
- File a Puerto Rico income tax return, a declaration and reconciliation statement of income tax withholding, and a municipal tax return.
Puerto Rico offers a very low 4% corporate tax rate for qualifying export services businesses. But there are specific residency, salary, and reporting requirements that must be met in order to take advantage of these incentives. Careful planning and documentation is essential.
Beware: Strict Audits Await Those Seeking Puerto Rico Tax Breaks
It’s important to understand that the tax authorities in Washington are not thrilled about the prospect of losing tax revenue to Puerto Rico’s generous incentives. As a result, they have become quite strict in ensuring that anyone taking advantage of these programs is fully complying with the rules.
You can expect to face audits at both the local and federal level.
Local Audits in Puerto Rico
Anyone who moves to Puerto Rico to take advantage of the Act 60 tax incentives can expect to be audited regularly by the local authorities. For businesses utilizing the export services tax breaks, you can expect an annual audit to verify your continued eligibility.
IRS Audits on the Mainland
In addition, the IRS is actively auditing every US citizen who has applied for the personal tax incentive packages offered in Puerto Rico. They are closely scrutinizing whether these individuals are truly meeting the residency requirements.
The bottom line is that documentation is key. If you make even a minor mistake in complying with the rules, you could face a significant tax bill from both Puerto Rico and the IRS.
So before relocating to Puerto Rico or setting up a business there, be sure you fully understand the compliance requirements and are prepared to meticulously document your eligibility. The tax authorities are watching closely, and they won’t hesitate to claw back any perceived tax benefits.
Is Puerto Rico Right for You?
Ultimately, whether Puerto Rico is the right choice as a tax haven comes down to your specific situation and goals. The tax benefits can be significant, but you have to weigh that against factors like the residency requirements, cost of living, and potential risks.
Puerto Rico Tax Incentives: How Much Can You Really Save?
Much has been made of the Puerto Rico Tax Incentives brought in in 2012. But how much tax could you really save? And do you qualify? Find out here: Puerto Rico tax incentives.
Need Help?
Over the past 40+ years, we’ve helped thousands of clients build better wealth protection plans. Part of that is to look for legal ways to minimize your tax burden.
Since 2012, Puerto Rico has offered a very attractive program to Americans looking to reduce their tax bill. But, it’s not something you should try to do on your own.
Done well, it can indeed lower your taxes. But if not done in full compliance with the regulations, it could attract unwelcome attention.
If you’re wondering if it’s right for you, please get in touch to see if our services can help you on your way. It starts with a free, no-obligation consultation with one of our Associates. You can do that here.
