The Unique Tax Status of US Territories
One of the American tax system’s many oddities is the way the country deals with US territories like Guam, the Northern Mariana Islands, the US Virgin Islands, and Puerto Rico. As territories and not states, they aren’t fully part of the federal tax system, and Congress has granted them considerable freedom to create their own tax incentives.
Puerto Rico’s Tax Benefits for US Citizens
Shortly after the US took control of Puerto Rico in 1898, Congress began enacting tax incentives and aid packages to spur economic growth in the territory. The main federal tax incentive today is Section 933 of the Tax Code, which excludes “income derived from sources within Puerto Rico” from personal income tax for bona fide Puerto Rican residents.
This opened the door for Puerto Rico to enact its own set of tax incentives, including Act 20 and Act 22 in 2012. This law offered a 100% tax exemption on Puerto Rican-source dividends, interest, and capital gains for new residents.
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.
The Rise of Puerto Rico as a Tax Haven
The combination of the federal tax exemption and Puerto Rico’s own incentives made the territory an attractive tax haven, particularly for wealthy Americans.
Over 2,300 individuals and 1,900 businesses relocated to Puerto Rico by the end of 2019 to take advantage of these benefits.
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.
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.
Crackdown by Congress and the IRS
But we were skeptical of the long-term viability of these tax incentives. We believed that either Congress or Puerto Rico itself would eventually shut them down. While that hasn’t happened yet, the IRS has now launched a crackdown, focusing on ensuring taxpayers properly meet the residency requirements to qualify for the benefits.
The Uncertain Future of Puerto Rico’s Tax Benefits for US Citizens
The IRS campaign, combined with potential political opposition and Puerto Rico’s history of broken financial promises, suggests the territory’s generous tax breaks may not last much longer. Congress could amend the federal tax code, Puerto Rico’s government could rescind the incentives, or the courts could rule them unconstitutional.
Ultimately, the future of Puerto Rico’s tax haven status remains highly uncertain. Those who have relocated there to take advantage of the incentives would be wise to ensure they are fully compliant with the rules to avoid potential issues down the line.
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