Overview
The New York metropolitan area has always been the largest Puerto Rican community outside of Puerto Rico. Puerto Ricans have been coming to “Nueva York” since Puerto Rico was a Spanish colony. The heaviest migration of Puerto Ricans to New York was in the decade of the 1950’s principally. This is when Maria from West Side Story presumably came to New York. The Puerto Ricans largely settled in East Harlem (aka Spanish Harlem) and the South Bronx among other areas. Esmeralda Santiago’s award winning book “When We Were Puerto Rican” personally captures the migration and personal life and assimilation of her own family in New York. The author despite a very background of poverty in a family of eleven children in Spanish Harlem eventually graduated from Harvard with high honors.
The term “Nuyorican” was originally a pejorative term until Jesus Colon and other writers, and artists transformed the meaning of the term to validate the experience of Puerto Ricans in New York and the United States. The advent of this “Nuyorican” cultural influence in the 1960’s started with Tito Puente’s “Oye Como Va” which later became one of Carlos Santana’s (Mexican American) greatest hits. As the rock and roll and Motown influences of the 1960’s evolved, the children of Puerto Ricans in New York grafted those musical influences into the traditional Afro-Cuban sound of their parents to create the Latin Boogaloo (think of songs like “Bang Bang” or “I Like it Like That”). Great Music!!!
One of my favorite movies is “El Catante” on the life of the great salsa singer Hector Lavoe. His band leader and one of the great musical influences of that era, Willy Colon, didn’t even speak Spanish that time. As a matter of full disclosure, Willy Colon is one of my favorite Salsa performers. The advent of the Fania Record label(started by an American who loved Latin Music.) and its incredible popularity during the 1970’s represented a further transition from the traditional roots of Afro-Cuban music into a uniquely “nuyorican” sound.
Puerto Ricans have served very proudly in our Armed Forces and have achieved success in every realm of American society (think Sonia Sotomayor). She may be the best dancer among the Supreme Court justices! Even in recent times, the economic difficulties have resulted in a new wave of migration to New York, New Jersey and Florida. In my personal experience, the language and culture of the parents or grandparents is lost by the third generation raised as a “gringo” to be a “gringo” in the United States.
How ironic it is to offer the suggestion that “Nuyoricans” aka Puerto Ricans from the New York City area, to give serious consideration to moving back to “La Isla del Encanto”. For successful Puerto Rican business owners and professionals living and working in the New York City area, they live with in the midst of the most lethal combination of municipal, state and federal taxes in the country. Whether it is New Jersey or New York, Puerto Ricans in the highest tax bracket are facing a total marginal bracket in excess of fifty percent. I have written extensively on the tax incentives under Act 22 and Act 20 of 2012 designed by the Puerto Rican government to stimulate the Puerto Rican economy.
This article summarizes the tax benefits available under Act 20 and Act 22 with a focus on the special consideration of pointing these benefits out to Nuyoricans. We would not expect Americans of Italian or Sicilian descent to consider moving back to Italy or Sicily but let me point out the obvious – there is no tax benefit to moving back to Palermo.
Overview of Puerto Rican Tax Considerations and Residency
A. Puerto Rican Tax Basics
Two important pieces of legislation were passed by the Puerto Rican legislature in 2012. Both the Export Services Act (Act 20) and the Individual Investors Act (Act 22) were signed into law by the Governor of Puerto Rico on January 17, 2012.
The definition of a U.S. person under §7701(a) (30), however, does not include Puerto Rican entities. As a result, a Puerto Rican entity is not subject to U.S. income taxation unless the entity is engaged in a trade or business within the United States and its income is considered effectively connected income, or investment income that would be subject to a withholding tax under §871 (unless an exemption for portfolio interest under §881(a) applies).
Under §933, bona fide residents of Puerto Rico who have Puerto Rico-sourced income are exempt from U.S. taxation. Section 937 defines a bona fide resident for tax purposes. A person is a Puerto Rican resident for tax purposes if the person is present in Puerto Rico for at least 183 days during the taxable year and he or she does not have a tax home outside Puerto Rico and does not have a closer connection to the U.S. or a foreign country than to Puerto Rico.
Section 2209 provides that Puerto Rican residents are not subject to U.S. estate taxation at death provided that the Puerto Rican resident acquired his or her U.S. citizenship by virtue of birth in Puerto Rico or naturalization as a U.S. citizen in Puerto Rico. Puerto Rico administers its own estate and gift tax system that largely parallels the U.S. system. Note that a U.S. person who does not expatriate, but merely takes up Puerto Rican residency, will not avoid U.S. federal transfer taxes on worldwide assets, unless born in Puerto Rico. The Puerto Rico estate tax for non-Puerto Rican property is 10 percent.
For federal income tax purposes you will be considered a bona fide resident of Puerto Rico if you meet the following: (i) the physical presence test (generally spending 183 days in PR, or less than 90 days in the US); (ii) the tax home test; and (iii) the closer connection test for the entire taxable year which means that you can’t have stronger personal connections to another jurisdiction that is not Puerto Rico, as prescribed in the regulations promulgated under Section 937 of the Internal Revenue Code.
(1) The Individual Investor's Act
Under the Individual Investors Act, neither capital gains (long-term or short-term), interest, nor dividends are subject to Puerto Rican taxation. Dividend income is subject to U.S. federal income taxation for U.S.-sourced dividend income, as is interest income unless the interest income is exempt under the portfolio interest exemption. Long-term capital gains derived by the resident individual investor that (1) were deemed to have accrued before the individual became a Puerto Rican resident and (2) are recognized within the first 10 years after the date the individual becomes a resident, will be taxed at a 10 percent rate.
If the gains are recognized after the 10-year period but before January 1, 2036, the gains will be taxed at a 5 percent rate. Gains considered to have accrued after the investor becomes a Puerto Rican resident will receive a 100 percent exemption. Dividend and portfolio interest income are exempt from Puerto Rican taxation under the new law.
(2) The Export Services Act
A business that relocates to Puerto Rico can significantly reduce its tax liability provided that the Puerto Rican entity is not engaged in a U.S. trade or business. The top U.S. corporate tax rate is 35 percent to 40 percent for most corporations, assuming a federal rate of 35 percent and a state rate of five percent. Under Puerto Rico’s Export Services Act, the corporate tax rate is flat four percent. Additionally, shareholders who relocate to Puerto Rico will have a 100 percent exemption on corporate distributions received from the Puerto Rican company.
Under the Export Services Act, services that are directed to foreign markets may generate income that will qualify for the special tax rate. Services for foreign markets include services performed for nonresident individuals and businesses. To qualify as “promoter services” under the Export Services Act, the net income must be earned and service performed within the 12-month period ending on the day preceding the day the business commenced operations within Puerto Rico. The term “eligible services” includes a wide range of service-oriented businesses from research and development to investment management.
A business (service provider) must request and obtain a tax exemption decree on or before December 31, 2020. The decree has a 20-year term and may be renewed for an additional 10 years providing certain conditions are met. During the period of the exemption, the business will enjoy a four percent tax rate on its export services income and a 100 percent exemption on the distributions of earning and profits from the services income. The business will also be eligible for a 100 percent property tax exemption during the first five years of operation and a 90 percent exemption after the fifth year.
Existing businesses that become eligible for benefits under the Export Services Act receive the special tax rate (four percent) only on the portion of net income that exceeds the average net income for the three years preceding the request for a tax-exemption decree. This aspect of the law is designed to prevent existing businesses from becoming tax-exempt without a corresponding increase in economic activity in Puerto Rico.
(3) Puerto Rican Tax Incentives for Research and Development
The Government of Puerto Rico and the Puerto Rico Science, Technology and Research Trust (the “Trust”), in collaboration with industry and the academic community, have taken a number of measures to help create an environment conducive to stimulating competitive research.
At the individual level, the Puerto Rico Internal Revenue Code provides that eligible researchers/scientists residing in Puerto Rico will be 100 percent tax exempt on income generated for services rendered to the University of Puerto Rico or other institutions of higher education in relation to certain eligible scientific investigations. The exemption is limited to an amount equal to the maximum salary amount established by the National Health Institute for researchers receiving grants under their programs are excluded from taxation. The amount in the initial year of the program - 2008 - was $195,000. The amount is indexed each year.
The Puerto Rican Tax Code provides that up to $250,000 of the compensation may be exempt from taxation received by eligible researchers/scientists residing in Puerto Rico and conducting an research within the Puerto Rico Science District created by Act No. 208 of 2011 will be exempt from Puerto Rico income taxes.
On the corporate level, companies under Act No. 73 of 2008 can receive a 50 percent tax credit for eligible investments in research and development, clinical trials, toxicology tests, etc.
Similar to the Export Services Act, technology companies are taxed at a flat rate of 4 percent fixed income tax rate available for eligible laboratories engaged in scientific or industrial research and development activities and other businesses engaged in eligible activities under Act 73.
Firms can also qualify for a one percent fixed income tax rate for innovative firms introducing "pioneer" activities or operations in Puerto Rico. This corporate tax rate can be reduced to 0.5 percent in the fixed income tax rate, when the business is located in an industrial area of low or intermediate development (as determined by the Office of Industrial Tax Exemption).
Summary
The advertising slogan “I Love New York” has been an excellent marketing campaign for New York City and State. Nevertheless, it is easy to lose some of that love quickly when the government is holding on to fifty percent or more of your income. The PR Alternative under Acts 22 and 20 offers a lot of financial promise for business owners and professionals suffering under the heavy burden of taxation.
The bolero “En Mi Viejo San Juan written by Noel Estrada for his brother who was stationed in Panama during WW II, is a song of nostalgia. It has become the anthem for Puerto Rican emigration to New York. The song is a reminder of the past with the hope of a return that never comes. Nuyoricans may need to learn and practice singing it in Spanish. Nevertheless, the compelling tax benefits of Acts 20 and 22 may inspire the children of Puerto Ricans that emigrated to New York in the 1940’s and 1950’s to actively embrace the land of “Los Padres.”
