Move to Puerto Rico for tax benefits?
Updated: Mar 20, 2020
In this interesting article, Andrew Henderson of Nomad Capitalist takes on the sometimes trendy idea to reduce your tax burden by moving to Puerto Rico. Henderson gives a great deal of explanation for how you might do this along with the pitfalls you should avoid. Here, please enjoy a book report-style synopsis.
Moving to Puerto Rico has recently become a popular haven for tax-sensitive Americans, thanks to some attractive tax incentives that encourage foreign investment. Puerto Rico started the tax-advantaged programs six years ago to help address its own credit issues and
have grown more in popularity among US-based corporations and investors seeking tax relief.
That said, these programs do come with some strings attached, and you do have other options which may provide greater freedom. However, if you really want to reduce or eliminate your US income tax obligation, you may consider living overseas or renouncing your US citizenship. For some, that may be a pretty extreme alternative and may not be appropriate or desirable for all. In particular, Henderson specializes in helping six- to seven-figure income earners relocate their businesses and wealth overseas for tax planning purposes.
Puerto Rico Tax Incentives
There are two main Puerto Rican tax incentives for US citizens: Act 20 - Export Service Act and Act 22 - Individual Investors Act. Here's a brief rundown of how each one works:
Act 20 - Export Service Act
Under the Export Service Act, you can relocate to Puerto Rico with a qualifying business, then enjoy a 4% corporate income tax rate. By qualifying business, this means a service-based company undeniably operating in Puerto Rico and serving outside markets. You need 1+ Puerto Rican employee(s) who are actually doing work for your company. You must earn a reasonable salary and pay personal income taxes, Social Security, and Medicare. You must also apply for tax concession. You can then enjoy 100% exemption from personal and real property taxes for five years, which thereafter is reduced to a 90% exemption. What's truly important is that you have to set up a bona fide residence in Puerto Rico to avoid CFC rules that tax an additional 6.5% on US-Owned Controlled Foreign Companies. More on bona fide residence shortly.
Act 22 - Individual Investors Act
Come one, come all. Enjoy 0% tax on capital gains, interest, and dividends as a bona fide resident of Puerto Rico. Well… also there are some rules here too. First, 0% tax applies to investments while you are living in Puerto Rico. So if you're sitting on a ton of gains in the US and move to Puerto Rico, your tax rate is prorated based on the holding period in the US vs. Puerto Rico. So, this is a long term strategy; one where you are living your life in Puerto Rico for the long haul. This may be a good strategy if you have large capital gains, because the foreign earned income exclusion does not protect you from taxes on passive income. This might be perfect for you if you own a business with large capital gains that you are looking to sell in several years, so you can take advantage of the prorated taxes.
You have to be a bona fide resident of Puerto Rico. You need to live there at least half the year in order to qualify, and it will take you one full year to establish your residence. Moreover, you have to prove that Puerto Rico is your center of life. You have no tax home outside of Puerto Rico. You off
ice, vote, and bank in Puerto Rico. You have no closer connection to any other place: permanent home, family, and pets are all in Puerto Rico. Seriously, do not think you can outsmart the IRS on this one. And to add a couple other maybes to the mix, you should remember that these tax savings programs have been in place only for six years. They may be eliminated at some point. Or Puerto Rico could some day become a state. All this to say that there is still a degree of uncertainty to the high commitment required to move your financial life to Puerto Rico.
Not Ready to Commit?
There are some other options. You could focus moving on a smaller scale, downsizing from a high tax state like California to a low tax state like Texas. You could consider moving offshore and using the Foreign Earned Income Exclusion to reduce your US income taxes. The benefit here is the freedom to move to various countries, rather than maintaining your bona fide residence in Puerto Rico. You also avoid the real estate investment and potential HR issues required for the tax incentives. Or you can go full throttle, you can eliminate your US income taxes by renouncing your citizenship, but I must admit that the process falls beyond the scope of ye olde book report.
To sum up, it has become somewhat trendy to consider moving to Puerto Rico in order to benefit from tax incentives. You can benefit from lower corporate tax for Puerto Rico-based businesses. You can lower your taxes on capital gains, interest, and dividends on a prorated basis while living in Puerto Rico. But you have to commit to being a bona fide resident of Puerto Rico to enjoy these benefits. There are additional opportunities for expatriates to reduce their US income taxes, allowing you to globe trot more freely without tying you to Puerto Rico as a bona fide residence.
For more information on tax planning strategies, please contact your advisors.