Puerto Rico & US Tax: Keep US Citizenship & Avoid Taxes, Maybe: Many high-net worth Taxpayers are (understandably) upset about the massive U.S. taxes levied on their employment, investment, and corporate income. Sometimes, effective tax planning can help avoid these taxes. The goal of tax planning is to legally limit, minimize, and if possible, avoid US tax — while also avoiding a tax fraud audit (eggshell or reverse eggshell) or special agent investigation. When US taxpayers begin researching how to relinquish their US status, oftentimes they will come across Puerto Rico. Puerto Rico is a great investment opportunity, because it does not require a passport for US citizens — and it does not require the US citizen to expatriate in order to gain the tax benefits under Acts 20 and 22 (combined into Act 60) — but, is it really that easy?
Of course not.
Let’s explore the tax implications, pitfall, and tripwires for US individuals to be aware of before relocating to Puerto Rico.
Purpose of Act 60
The purpose of Act 60 is to promote investment in Puerto Rico by providing investment residents with tax breaks.
As provided by Act 60:
- This Code is approved with the conviction that it shall improve Puerto Rico’s economic competitiveness. The Code shall create a simple, streamlined, and efficient process that focuses on the client, and shall earn the trust of the people and the private sector by having a transparent process for the granting of incentives.
- Likewise, the incentives offered shall be continuously reviewed in order to identify those that are not cost-effective and to strengthen those that have proven to have an impact and which generate a return on investment for the Treasury. Thus, with the tools provided by this Code, this Administration shall keep boosting the economy and attracting private capital to the Island.
What does this mean?
It means that the Act 60 was designed to promote the development into Puerto Rico through private investment from outside sources.
US Citizens Moving to Puerto Rico
For many US taxpayers who pay significant amounts of US federal and state income tax (ie NY, CA, NJ, etc.) — they want to find a way to legally avoid the overbearing US tax rules, while not necessarily expatriating and renouncing their US citizenship. Contrary to popular belief, just getting a Golden Visa without further action does not reduce an American’s tax liability.
When a US person obtains a Golden Visa, they have a second passport (CBI) or travel privileges (RBI). But if they have not actually renounced their own US citizenship — they are still subject to US tax on their worldwide income no matter where they reside.*
*This is primarily an issue for US Citizens who do not have citizenship elsewhere. Long-Term Permanent Residents (LTR) tend to not have this issue, since LTRs already have citizenship in another country. For US citizens who are not dual-citizens and have been US citizens from birth, the idea of giving up their citizenship can be overwhelming.
The Taxpayer’s curiosity brings them to Google (or more likely, DuckDuckGo) and their research take them down one Puerto Rico Tax Rabbit Hole after the next.
Let’s get some clarity on how the tax situation plays out:
Puerto Rico Presence Test
To begin with, becoming a resident of Puerto Rico is not as simple as purchasing a property and visiting the PR Coast a few times a year. Rather, the US person has to become a Bona-Fide Resident of Puerto Rico. Noting, the Puerto Rico BFR rules are not the same as the Substantial Presence Test BFR rules — but the concept is the same.
Bona Fide Resident
For purposes of this subpart, section 865(g)(3), section 876, section 881(b), paragraphs (2) and (3) of section 901(b), section 957(c), section 3401(a)(8)(C), and section 7654(a), except as provided in regulations, the term “bona fide resident” means a person—
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Who is present for at least 183 days during the taxable year in Guam, American Samoa, the Northern Mariana Islands, Puerto Rico, or the Virgin Islands, as the case may be, and
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who does not have a tax home (determined under the principles of section 911(d)(3) without regard to the second sentence thereof) outside such specified possession during the taxable year and does not have a closer connection (determined under the principles of section 7701(b)(3)(B)(ii)) to the United States or a foreign country than to such specified possession.
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For purposes of paragraph (1), the determination as to whether a person is present for any day shall be made under the principles of section 7701(b).
Presence Test vs Substantial Presence Test
What is important to note is that Foreign Nationals do not use the standard “Substantial Presence Test” to determine whether or not they qualify for residence in Puerto Rico. SPT which is used by Foreign Nationals to determine whether they qualify as a US person for income tax purposes. Rather, it is a specific test to determine whether or not the person qualifies as being present for the sufficient number of days in Puerto Rico.
Of important consequence is the fact that the person cannot have a closer connection to the United States or a second tax home.
Act 60 Tax Rules in Puerto Rico (Basics)
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While Puerto Rico is considered part of the United States, it is not a state per se and therefore, the US tax treatment rules are different.
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Puerto Rico operates with some independent from the US government. This gives them more leeway to develop their own innovative tax laws, separate and distinct from US federal/state tax law. In order to promote investment into Puerto Rico, they developed Act 60 to attract high net-worth individuals and businesses.
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With proper tax planning and sourcing allocations, a person can feasibly reduce their tax liability to nearly zero on income and assets generated and acquired once becoming a Puerto Rican resident — but it’s not quite that simple.
Let’s traverse some of the key points of act 22 for Individuals (Act 20 is for Businesses) (now combined into act 60) as it relates to individuals and investments to US residents who relocate to Puerto Rico and become a bona fide resident (citations refer directly to the act).
Act 60 Updates from Act 22 (Individuals)
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The individual cannot have been a resident of Puerto Rico for at least 10 years prior — this is increased from previously in which it was six years.
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The non-profit charitable contribution requirement which was previously at $5,000 has been increased to $10,000.
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Puerto Rico now requires the individual to purchase residential property within the first two years of becoming a resident. This is important, because under the previous version of the rule, there was no need to actually purchase property. As a side note, this will help solidify US residents in making Puerto Rico their main home because owning property or real estate in a location and claiming it as primary residence goes a long way in showing Puerto Rico is actually the tax home.
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From a technical standpoint, the new version of the act provides a detailed definition of the term securities and what will be covered under the long-term capital gain exemption rules.
Tax Exemption to Income Derived from Interest and Dividends
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The income derived from all sources by a Resident Individual Investor after becoming a resident of Puerto Rico but before January 1, 2036, consisting of interest and dividends including but not limited to interest and dividends from a registered investment company described in Section 1112.01 of the Puerto Rico Internal Revenue Code, shall be fully exempt from income taxes in Puerto Rico, including the alternate basic tax provided in the Puerto Rico Internal Revenue Code.
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In addition, the income derived by a Resident Individual Investor after becoming a resident of Puerto Rico, but before January 1, 2036, consisting of interest, financing charges, dividends or partnership interest received from International Banking Entities authorized under the “Banking Center Act,” shall be fully exempt from income taxes in Puerto Rico, including the alternate basic tax provided in the Puerto Rico Internal Revenue Code.
What does this mean?
It means that once the person becomes a resident individual investor of Puerto Rico and until 1/1/2036, any dividend or interest income is exempt from tax in Puerto Rico.
Planning Tip: Puerto Rico income is not taxable in the US — but the US still taxes the individual on their worldwide income (other than Puerto Rico Income under IRC 933). Therefore, it is important to note that the Taxpayer must plan to try to keep their income sourced in Puerto Rico to avoid any unnecessary pitfalls.
Special Tax for Resident Individual Investors on Net Capital Gain
(a) Appreciation Before Becoming a Resident Individual of Puerto Rico.
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The portion of the net long-term capital gain generated by a Resident Individual Investor attributable to any appreciation of the Securities or other Assets owned by such Resident Individual Investor before becoming a Resident Individual of Puerto Rico, which appreciation is recognized ten (10) years after becoming a Resident Individual of Puerto Rico and before January 1, 2036, shall be subject to a five percent (5%) – tax, in lieu of any other tax imposed under the Puerto Rico Internal Revenue Code and shall not be subject to the alternate basic tax provided in Subsection A of the Puerto Rico Internal Revenue Code.
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If such appreciation is recognized at any other time, the net capital gain with respect to said Securities or other Assets shall be subject to income taxes in accordance with the tax treatment provided by the Puerto Rico Internal Revenue Code. The amount of the net long- term capital gain shall be limited to the portion of the gain related to the appreciation of the Securities or other Assets while the Resident Individual Investor resided outside of Puerto Rico.
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For taxable years after December 31, 2016, said capital gain shall be considered income from sources outside of Puerto Rico for purposes of the income tax provided in the Puerto Rico Internal Revenue Code. (b) Appreciation after becoming a Resident Individual of Puerto Rico.
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The total net capital gain generated by a Resident Individual Investor related to any appreciation of Securities or other Assets after said Resident Individual Investor becomes a Resident Individual of Puerto Rico, that is recognized before January 1, 2036, shall be fully exempt from income taxes in Puerto Rico, including the alternate basic tax provided in the Puerto Rico Internal Revenue Code.
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If such appreciation is recognized after December 31, 2035, the net capital gain with respect to said Securities or other Assets shall be subject to income taxes in accordance with the tax treatment provided by the Puerto Rico Internal Revenue Code. The amount of said net capital gain means the portion of the gain related to the appreciation of the Securities or other Assets owned by the Resident Individual Investor at the time of becoming a Resident Individual of Puerto Rico and those acquired by him after becoming a Resident Individual of Puerto Rico.
What does this mean?
It means that if an individual is granted Puerto Rico tax exemption under the act, long term gains as a result of investments made after becoming a resident will be exempt from tax in Puerto Rico. And, if it the income is sourced in Puerto Rico, it would escape tax in the U.S. as well. If a US person relocates to Puerto Rico and has realized but unrecognized capital gain and waits to recognize the gain until being a resident for 10 years will only be subject to a 5% Puerto Rico tax rate. If the unrecognized gain is US-sourced, it will still generally be taxable in the US.
Tax Planning is Important
It is important to understand what is excluded for tax purposes and what is not excluded under Act 60. It is important to understand that in order to exclude the income from capital gains and dividends, it should be accrued after arriving in Puerto Rico and acquiring dividends and capital gains as a Resident of Puerto Rico.
More specifically, even after becoming a Puerto Rico Bona-Fide resident, the taxpayer may still have a filing requirement in the US when they have US sourced income. Thus, in the most ideal of situations, the taxpayer will move to Puerto Rico and become a Bona-Fide resident without having realized but unrecognized gain already. Then, once becoming a bona fide resident of Puerto Rico, the taxpayer will then begin to acquire income sourced from Puerto Rico so that it is not taxable in the United States. There are always exceptions, exclusions, and limitations to be aware of.