Since the United States taxes based on citizenship, if you’re an American citizen or permanent resident, the IRS will follow you all over the world, demanding you pay taxes on everything you earn, even if no US resources were involved in generating your income. Even moving to a country with no income taxes won’t reduce what you have to pay to Uncle Sam on the income you generate. If you decide you’ve had enough of this and want to expatriate, however, the procedure is complicated and you’ll have to pay a substantial exit tax.
- Renunciation of U.S. Citizenship (Do you really want to do this?)
- IRS: The Expatriation Tax (Yikes!)
There has to be a better solution.
[NOTE: This article is a chapter in our
Comprehensive Guide to Tax Havens.]
The good news is that, for the next few years, there is a way for overtaxed Americans to pay less tax without dumping their citizenship: establish primary residence in Puerto Rico. If you move to Puerto Rico under the provisions of recent legislation, you can retain your American citizenship and still pay no taxes to the IRS. You will have to pay territorial taxes in Puerto Rico, but these are much more modest.
Let’s dive deeper into this scenario.
Table of Contents
Contents
A Legislature in Search of Financial Incentives
How did Puerto Rico become a haven for over-taxed Americans?
It all started when the U.S. territory went bankrupt in 2017. Puerto Rico issued too much municipal bond debt and began relying on the funds borrowed from its bond issuance to meet its budget and pay its debts. The crisis leading to bankruptcy began in 2014 when the government couldn’t pay its debts and Puerto Rican government-issued bonds were downgraded by three credit agencies to “junk” status. The downgrade prevented the government from issuing any more bonds, so to pay its debts before it ran out of savings, it began to raise taxes and cut services, which provoked social unrest and distrust. Finally, Puerto Rico filed for bankruptcy in 2017, having over $70 billion in bond debt and $49 billion in unfunded pension liabilities.
Anticipating such problems, Puerto Rico introduced legislation in 2012 designed to attract high net worth individuals and businesses to the island. Act 22 of the Puerto Rican legislature specifies zero percent tax from capital gains on assets acquired after moving to the island. This includes stocks and fund investments and dividends as well as local real estate. It does not include capital gains on real estate still owned on the mainland. Furthermore, Act 20 specifies a 4% corporate tax rate on net business income earned on the island. This includes internet businesses or other businesses providing services to people living outside of Puerto Rico.
In 2019, Acts 20 and 22 were combined under Act 60 with some additions and changes.
The goal of the legislation is two-fold: (1) extend the benefits of Act 20 to make Puerto Rico an international financial center by encouraging businesses that offer services to clients outside of Puerto Rico to establish the island as their operational base; and (2) extend the benefits of Act 22 to incentivize individuals with passive income to relocate to Puerto Rico.
Although U.S. citizens are usually taxed on their worldwide income no matter where they live, the U.S. tax code (IRC §933) makes an exception for all income derived from all non-U.S. government sources for bona fide residents of Puerto Rico.
Establishing bona fide Puerto Rican residency requires being physically present in Puerto Rico at least 183 days during the tax year, not having a tax home outside Puerto Rico during the taxable year, and not having a closer connection to the United States or any other foreign country than to Puerto Rico.
Business Incentives under Act 60
To benefit from the incentives under Act 60, eligible businesses have to request and receive a tax exemption decree signed by the Secretary of the Department of Economic Development and Commerce of Puerto Rico. This exemption has a term of 15 years and is renewable for another 15 years if certain conditions are satisfied, and the contract it represents is not subject to alteration by any subsequent legislation. Beyond this, the only requirement is that the business have at least one employee if its annual volume exceeds $3 million U.S.
Eligible businesses must have a real office located in Puerto Rico, perform services for non-resident or foreign entities with no connection to Puerto Rico, and not in any way be related to trade, business, or other activity within Puerto Rico. Any service that the Secretary of Economic Development and Commerce determines, in consultation with the Secretary of the Treasury, to be in the best social and economic interest of Puerto Rico, will be treated as an eligible service. But export service industries that are currently recognized as eligible are as follows:
- Financial services, including investment banking and brokerage services
- Economic, environmental, technological, scientific, managerial, marketing, human resources, computer, and auditing consulting services
- Legal, tax, accounting, and other professional services
- Centralized management services for accounting, finance, tax, auditing, marketing, engineering, quality control, human resources, communications, electronic data processing, and any other centralizable services
- Advertising and public relations services
- Electronic data processing centers
- Computer program development
- Call centers
- Voice and data telecommunications services among persons located outside Puerto Rico.
- Creative goods and services industries for a non-Puerto Rican customer base in the following sectors: architectural and environmental design; arts (music, visual arts, performing arts, and publishing); fashion, graphic, industrial, interior, and video game design; and online media, digital, and multimedia content development
- Construction, drafting, engineering, architectural, and project management services for projects outside Puerto Rico
- Storage and distribution centers for companies engaged in the business of transportation of items and products that belong to third parties, otherwise known as “hubs”
- Medical and laboratory services for non-Puerto Rican sourced testing
- Research and development for projects outside Puerto Rico
As regards the incentives, any American citizen who becomes a bona fide resident of Puerto Rico and moves his or her business there will enjoy the following business benefits:
- Eligible businesses will have a 4% flat corporate income tax rate on net income related to their services
- Dividends are 100% tax exempt
- There is a 50% exemption on municipal taxes
- There is a 75% exemption on property taxes
- Distribution from earnings and profits derived from an eligible business are 100% exempt from Puerto Rican income tax
Individual Incentives under Act 60
Act 60, as an extension of Act 22, also incentivizes high-net-worth individuals (HNWI) to relocate to Puerto Rico. To be eligible for individual tax exemptions, an individual investor must have established physical residency in Puerto Rico for at least 183 days of the tax year and not have been a resident of Puerto Rico during the ten-year period preceding the effective date of the legislation (2009 to 2019).
Further eligibility requirements for individual investors are as follows: (1) before the tax exemption decree under Act 60 can be signed, a one-time fee of $5,000 U.S. must be paid to the “Special Fund under the Act to Promote the Transfer of Individual Investors to Puerto Rico”; (2) every individual investor holding tax exemption under Act 60 must make a $10,000 U.S. contribution to an appropriately registered non-profit organization located in Puerto Rico (that is not controlled by that investor); and (3) within two years of obtaining the decree, the individual investor must purchase a residential property in Puerto Rico (no minimum cost is specified) that is classified and used as a permanent residence.
Once individual investors have jumped through these qualifying hoops, the tax benefits they will enjoy are as follows:
- Capital gains from securities and digital assets are 100% tax exempt
- Any and all capital gains from eligible investments accrued after becoming a new resident of Puerto Rico are 100% tax exempt
- Dividends and interest on investments are 100% tax exempt
The following restrictions apply:
- Any capital gains generated prior to becoming a new resident but realized after moving to Puerto Rico may be subject to Puerto Rican tax at the standard rate
- In order for gains to be exempted from taxation under Act 60, they must be realized and recognized prior to January 1, 2036.
Traders, investors, and other financial professionals who are thinking long-term and expecting to realize large capital gains are ideal candidates for relocating to Puerto Rico under Act 60, since securities trading and cryptocurrencies are free from capital gains tax. Unfortunately, as noted, this 0% rate only applies to the holding period after Puerto Rican residency is established. For publicly traded securities, including stocks as well as options and commodities futures contracts, the price must be recorded the day its owner moves to the island. All profits accumulated prior to that date are considered to have been generated before the move and are taxable by both Puerto Rico and the United States. In light of this, some investors choose to liquidate their portfolio prior to moving, then reinvest after their residency is established.
Is Puerto Rico a Cryptocurrency Tax Haven?
Investing in cryptocurrencies and conducting business using them has been an effective way of avoiding taxation, but these glorious days are coming to an end. The IRS has been greedily eyeing the world of cryptocurrencies for a while now, and the U.S. government has increased its efforts to collect taxes on cryptocurrency transactions and investment gains as one of the many bits of hidden legislation in the current infrastructure bill.
The earliest form of the cryptocurrency amendment in the bill was rejected, but it’s clear that the U.S. government intends to regulate and tax cryptocurrencies. Taxation and regulation are governmental inevitabilities. The invention of mediums of exchange lying outside government regulation and interference are of immense benefit to individuals, but inimical to the interests of government, so when they appear, they will never last long. While it hasn’t firmed up its policy yet, the IRS is already asking about cryptocurrency holdings and will be increasing its crypto tax reporting and enforcement efforts.
If you have substantial cryptocurrency holdings and are distressed about the latest government maneuvers, moving your primary residence to Puerto Rico can provide relief. The IRS has classified crypto as a capital asset, so any transaction involving its liquidation—which could be as simple as exchanging one cryptocurrency for another—is a taxable event. Individuals able to take advantage of Act 60, however, will not be taxed on cryptocurrency gains at all.
Since Puerto Rico’s 0% tax on capital gains applies only to those gains realized after moving there, your best option may be to sell your crypto and then rebuy it after you have relocated. Another possibility is to retain your current crypto holdings and buy more after moving to Puerto Rico. Gains on crypto purchased after the move will not be taxed, and if you have the patience, once you’ve been a resident of Puerto Rico for ten years, you can receive a 50% reduction in tax on capital gains on assets possessed prior to your move.
Must I Really Establish Physical Residency in Puerto Rico?
Normally, a tax haven does not require foreign individuals or businesses to establish a substantial as opposed to a legal local presence. Tax benefits are achievable by setting up the requisite accounts and instruments in the legislative structure of the tax haven without actually being there. In practice, this can lead to thousands of foreign businesses sharing the same local address.
In reality, however, acquiring actual residency is a very useful component in a tax avoidance strategy. For this reason, many tax havens offer “citizenship through investment” to high net worth individuals as well as various less expensive ways of establishing a long-term residency that can lead to citizenship. By investing in a tax haven in these specified ways, citizenship and a local passport can be acquired, leaving individuals free to consider establishing businesses under their new nationality, and even more drastically, as noted earlier, renouncing citizenship in their home country and living abroad under their new citizenship to avoid tax liabilities that might otherwise follow them around the world.
- Why You Need a Second Tax Residency in a Tax Haven
- The Best Citizenship by Investment Programs: Getting a Second Passport
The fact remains that very few Americans give up their citizenship for tax reasons, however. Even so, before you decide that Puerto Rico is your best tax-reduction strategy while retaining your citizenship, you should evaluate other tax haven options—Panama, for instance. Offshore Panamanian companies are allowed to conduct business tax-free both within and outside the jurisdiction of Panama. Neither the offshore companies nor their owners are subject to income taxes, corporate taxes, or local taxes, and there are no nationality restrictions on who may establish a corporation in Panama.
If you want a Panamanian passport, you will need to proceed by establishing residency in Panama. Residency can be obtained either through a friendly nations visa, a retirement visa, or a residency-by-investment visa. For wealthy investors, permanent residency in Panama can be expedited in a month or less. If you maintain Panamanian residency for five years, you are eligible to apply for citizenship through naturalization and get a Panamanian passport. Having Panamanian citizenship is advantageous because it provides for visa-free travel, or visa-upon-arrival, in 121 different countries around the world, including most of Europe, Asia, and Latin America. Once you have acquired Panamanian citizenship, your spouse, children, grandchildren, and descendants also will all be entitled to Panamanian citizenship.
If you retain your American citizenship, U.S. persons living and working in Panama are entitled to the Foreign Earned Income Exclusion, but if your net profits from business exceed $250,000, you may actually be better off seeking tax residency in Puerto Rico. If you’re making $100,000 or less from your business, however, it’s a better strategy to move its location outside of any U.S. jurisdiction and pay zero tax using the Foreign Earned Income Exclusion. Panama is one of the best tax havens for this purpose
- The Top 10 Caribbean Tax Havens
- The Foreign Earned Income Exclusion Tax Advantage
- IRS: The Foreign Earned Income Exclusion
If you decide that Puerto Rico is your best option, you need to come to terms with the fact that you will have to move there. Some offshore investment advisors may suggest to you that Act 60 benefits can be available to you while you remain in the U.S. For example, they say that you can establish a Puerto Rican corporation, hire employees in Puerto Rico if you need to do so, and conduct business from your home in the United States. The idea would be that you would only pay tax to the IRS on the salary you draw from the company, while the income of the company itself would be taxed at Puerto Rico’s 4% rate. Not so. While this describes the Puerto Rican tax consequences adequately, it grossly misunderstands the U.S. tax code.
A corporation based in Puerto Rico is classified as a non-U.S. corporation by the IRS and is subject to the rules that govern such corporations. When such a corporation has employees on the ground in the U.S. operating its business, it is regarded as an “ETBUS,” that is, a company that is “engaged in trade or business in the United States.” A non-U.S. corporation is subject to tax on any income that is effectively connected with its conduct of business inside the United States.
In short, because you would be running the company from your home in the U.S., there would have to be an allocation assessment determining how much of the company’s income was attributable to your role compared to what was attributable to any employees in Puerto Rico. The portion of the income attributable to your work in the U.S. would then be subject to U.S. tax at rates up to 35%. If that income were then removed from the U.S. in order to run the operation in Puerto Rico, it would be subject to an additional branch profits tax of 30%, yielding an effective maximum tax rate of 54.5% (35% on the U.S. allocation plus 30% on the remaining 65%). The bottom line is that, if you’re looking to reduce your taxes, you don’t want to be running an ETBUS based in Puerto Rico out of your home in the United States.
Avoiding these consequences means that you’re going to have to move to Puerto Rico to run your business so that you’ll no longer have employees on the ground in the United States. That is the only way you will avoid having to pay taxes to the IRS, since American citizens living outside U.S. jurisdiction are subject to Foreign Account Tax Compliace Act (FATCA) legislation.
As mentioned, moving to Puerto Rico is really best suited to those netting more than $250,000 because you are required to pay yourself a salary from your business—which is taxed at the ordinary progressive territorial rates that aren’t negligible—before you can then pay 4% on net corporate profits after you’ve paid yourself. Those making $100,000 or less from their business are better living outside U.S. jurisdiction entirely and taking advantage of the Foreign Earned Income Exclusion.
Is Puerto Rican Real Estate a Good Investment?
The Puerto Rican real estate market is coming back with a vengeance after being in a downward slide that has lasted over a decade. The debt crisis, which had been building since the turn of the millennium, combined with a shrinking GDP and unemployment that reached as high as 16.4% in 2010, led to a loss in net worth among Puerto Ricans of $30 billion, much of it associated with the collapse of real estate prices.
When the bottom dropped out of the real estate market, the mortgages of many Puerto Rican families went underwater and, in difficult financial times, they were unable to secure approval for refinancing at lower rates and were in danger of foreclosure. Then hurricane Maria struck in 2017, killing almost 3,000 people, severely damaging the island’s infrastructure, destroying thousands of small businesses, and destroying or damaging over 350,000 homes, leaving in its wake $90 billion of devastation.
At this point, the only place to go was up. After hurricane Maria, response measures and the legislative initiatives of Acts 20 and 22 (later consolidated under Act 60), began to have an effect. The U.S Department of Housing and Urban Development (HUD) approved $1.5 billion for disaster relief and community development in July 2018, followed by another $8.2 billion in funds to the program in March 2019—both installments of which provided substantial assistance to vulnerable households and the elderly—and rejuvenated the housing market. Changes to Puerto Rican law that expedited business licensing, certification, and land-use authorizations, paved the way for economic recovery and property sales, and the growing recognition of Puerto Rico as a tax haven for wealthy Americans and American businesses has created a steadily growing demand, especially in the luxury market (homes over $500,000) and in the sale of pleasure boats.
With the exception of a minor slowdown for a couple months in the first quarter of 2020 due to the pandemic, Puerto Rican real estate is now booming. Prices are rising steadily, and in some cases steeply, but they have a long way they can go, and now is still a great time to get into the action, especially as part of a tax-motivated move to Puerto Rico.
Part of the issue, especially with the luxury market, is that the demand greatly exceeds the supply. Luxury properties in some areas of Puerto Rico are seeing prices of more than $1,000 per square foot, which puts Puerto Rico in the same real estate league as New York, San Francisco, or Miami. Earlier this year, the sale of the most expensive house in the history of Puerto Rico was reported. It is located in the municipality of Dorado, about 20 minutes outside of the capital, San Juan, near the Ritz-Carlton Reserve Resort. It sold for a price of $30 million.
Hundreds of wealthy Americans have been moving to Puerto Rico, first under the provisions of Acts 22 and Act 20, and now under the updated provisions of Act 60, and in the process saving themselves millions in tax dollars that would otherwise have been paid to the IRS. They are also acquiring real estate that is appreciating in value, much like what is happening in other Caribbean tax havens. For example, on Saint Barthélemy, a country with no income taxes, a house recently sold for $90 million.
Such exorbitant properties, of course, are way out of the league even of many relatively wealthy individuals, but there is a fundamental economic principle at work here: a rising tide lifts all boats. In the two years after hurricane Maria in 2017, the Puerto Rican housing market experienced a 78% rise in new home sales and a 17% rise in the sale of existing properties. The island real estate market is rising across the demographic board, with home prices increasing 14.59% in 2020. Now is a great time to get involved.
A Final Reality Check
Now that you’re all excited about moving to Puerto Rico, let’s take stock what such a move would entail. This isn’t so much about curbing your enthusiasm as making sure you’re aware of the ramifications and taking them into account.
If you really want no longer to be beholden to the IRS and have all the benefits of Puerto Rican tax incentives, you have to be a bona fide resident of Puerto Rico. This means more than just spending at least 183 days each year on the island. It means that you cannot have a “tax home” outside of Puerto Rico, nor can you have “closer connections” to any place other than Puerto Rico. In particular, passing the test of closer connections means that you’re going to have to move your whole life to the island to prove that it’s really your home. This means that Puerto Rico will be:
- The location of your primary and permanent home
- The place where your family lives
- The primary location of your automobiles, furniture, clothing and other personal goods
- The location of your bank accounts and financial activities
- The location of your business activities (though these will be export businesses to take advantage of the business tax incentives)
- The location of your primary social, religious, cultural, professional, political and other relationship associations
- The primary location for the charitable organizations to which you contribute
- The jurisdiction in which you hold your driver’s license
- The jurisdiction in which you vote
- The country of residence that you list on all of your official documents
This is no small deal. Some other things you need to remember are that you cannot easily avoid paying U.S. tax on the appreciation of your assets before you move to Puerto Rico. If you move with appreciated stock, crypto, or other investments, when you cash it in you will have to pay U.S. tax on it unless you wait a full ten years after you move. Waiting ten years may not be an easy thing to do and it certainly isn’t a quick fix. Your best option is probably going to be to liquidate all your investments, pay the taxes that are owed, then repurchase them once you’ve established bona fide residence on the island.
If you own real estate on the mainland and sell it to purchase a home in Puerto Rico, as long as you don’t make more than $250,000 capital gains filing individually, or $500,000 filing jointly with your spouse, you will not owe any capital gains tax. If your home on the mainland is worth considerably more than this, however, if you’re able to do so, it may be worthwhile to purchase a separate home as your primary residence in Puerto Rico, and maintain your home on the mainland as an investment property. The sad fact, however, is that the sale of U.S. real estate will always be U.S.-sourced income that will be fully taxed when you sell it, even if you wait ten years.
One final caveat emptor: any time a new tax strategy emerges, the sharks smell fresh blood and start to circle with all manner of schemes and scams that are harmful to unwary participants and that compromise the long-term viability of the tax incentives themselves. It is the responsibility of every investor and entrepreneur seeking to take every legal advantage of the wonderful opportunity these tax incentives represent to exercise due diligence. Do your research and get the professional advice you need!
This much said, if you’re an internet entrepreneur or have plans to start a business in one of the Act 60-eligible export service industries, or if you make a living trading securities or managing a hedge fund for clients who pay you fees for your services, Puerto Rico is offering you a pretty sweet deal. You should look into it.
Bienvenido a Puerto Rico!
[NOTE: This article is a chapter in our
Comprehensive Guide to Tax Havens.]