Time Running Out for Disclosure Options
Key Takeaways:
- The IRS is devoting greater resources to investigating and auditing wealthy Americans who have taken advantage of Puerto Rico’s lucrative tax benefits.
- The IRS continues to face external pressure from Congress to curb abuses of Puerto Rico’s tax benefits – results are to be expected in the form of increased IRS examinations and, in certain circumstances, criminal charges being brought for violations.
- Time is running out to take advantage of an IRS disclosure program for anyone who has a potential issue and is seeking to avoid potential prosecution or a civil penalty.
Prompted by congressional scrutiny of the Internal Revenue Service’s (IRS) efforts to root out those abusing lucrative Puerto Rico tax benefits, the agency has committed to devoting more resources to audits of those taking advantage of the tax benefits.[1] Increased enforcement of individuals who are utilizing the benefits without meeting all the requirements has been expected for quite some time, with the IRS reporting last year that it had identified about 100 high-net-worth individuals who have claimed these benefits and that it expected many of those cases to proceed to criminal investigation.[2] Individuals and companies that are benefiting should expect that the IRS will be ramping up their investigations and that Congress will continue to pressure the IRS for results. It is important to note that once selected for audit, an individual is no longer available for one of the IRS voluntary disclosure programs that enable a taxpayer to avoid penalties and prosecution.
The Commonwealth of Puerto Rico passed Acts 20 and 22 (collectively, Act 60) to encourage U.S.-based individuals and companies to relocate to Puerto Rico in an effort to stimulate the Puerto Rican economy. This regime “results in tax benefits that Americans could not obtain anywhere else in the world,”[3] including, among others, paying a zero percent tax rate on Puerto Rico-sourced capital gains, and it has encouraged thousands of Americans to move to Puerto Rico. In order to qualify for these benefits, however, an individual must become a bona fide resident of Puerto Rico and their income must be Puerto Rican-sourced income.
But not all wealthy Americans taking advantage of these perks have met the residency or income sourcing requirements, and despite efforts by the IRS and Puerto Rico authorities to combat these abuses, it remains to be seen whether IRS examinations of U.S. persons claiming these benefits will increase. Because of this, the Senate Finance Committee began over the past year to monitor these investigations and put pressure on the IRS to do more. As noted by Senate Finance Chair Ron Wyden, the individuals taking advantage of these programs have “gambled that they could stay ahead of any big enforcement effort, and that approach has paid off for them.”[4] A whistleblower letter underscored the size of the potential problem – referring to “tax evasion of epic proportions.”[5]
Last year, the Senate Finance Committee signed a letter to the IRS criticizing the efforts to investigate abuses of the Puerto Rico tax breaks. Congress has continued to pressure the IRS to do more in this area, including by making public statements that have resulted in media coverage. “They are behind the ball on this, and it is a failure that must be turned around as soon as possible,” stated Rep. Alexandria Ocasio-Cortez. Bolstering this pressure, the IRS additionally received an anonymous letter from a field agent critiquing the agency for failing to stop the brazen and widespread tax evasion, referring to the IRS’ response as a “clown show.”
Despite these critiques, the IRS has made clear that investigating those misusing the Puerto Rican tax breaks is and has been important to the agency. The IRS issued a report in November 2020, which included a commitment from the IRS to expand information sharing with the Hacienda (the Puerto Rico revenue service).[6] In October 2020, a press release stated that the IRS intended to “vigorously pursue any individuals and professionals that fraudulently enrich themselves by abusing government tax incentive programs,” specifically mentioning Act 20.[7] And in January 2021, the IRS added Puerto Rico Act 22, Individual Investors Act, to its audit campaign and U.S. individuals claiming Act 60 tax breaks to its Large Business and International Compliance Campaign.[8] In spite of these efforts, the cases haven’t been filed, and Congress continues to call out and publicly demand more effective policing by the IRS.
Now, in response to these critiques, the IRS will be deploying a team of additional agents and will open additional audits of individuals claiming tax benefits under Act 60. They will also devote greater resources to continuing the investigations of cases already opened. Vigorously pursuing cases already opened on the island may be a way for the IRS to show results more quickly, but the announcement that they will be opening new cases also means that more individuals and companies are likely to end up in the IRS’ crosshairs. Individuals and companies that think they may not be – or have not been – in compliance should act now to consult with counsel and consider voluntary disclosure to the IRS. The time to consider disclosing is running out.
[1] The first thing the IRS typically does in effectuating these audits is obtain a summons for the taxpayer’s financial records to see where the taxpayer is making charges on their credit card, as well as pulling the taxpayer’s commercial flight records from the Department of Homeland Security to see how often the person flew to and from Puerto Rico. From there, the IRS is generally able to figure out the number of days that a given person has spent in Puerto Rico to know if they are truly meeting the requirements of bona fide residency.
[2] BakerHostetler, IRS Enforcement Efforts in Puerto Rico Gaining Steam – Wave of Cases Expected, July 27, 2023, https://www.bakerlaw.com/insights/irs-enforcement-efforts-in-puerto-rico-gaining-steam-wave-of-cases-expected/.
[3] Letter from Members of Congress to the Honorable Gene Dodaro, Comptroller General, U.S. Government Accountability Office, July 20, 2023, https://democrats-naturalresources.house.gov/imo/media/doc/gao_request_letter_for_act_60_puerto_rico_tax_review.pdf.
[4] Naomi Jagoda, Hill Tax Brief: IRS Escalates Audits on Puerto Rico Tax Break, June 10, 2024, https://www.bloomberglaw.com/bloomberglawnews/daily-tax-report/X75RHT4K000000?bna_news_filter=daily-tax-report#jcite.
[5] Id.
[6] See IRS, Report to Congress Pursuant to Pub. L. 116-93 Regarding Interaction of Certain Puerto Rico and U.S. Tax Laws (Nov. 2020) (Tax Notes 2020-43051).
[7] Press Release, Puerto Rico CPA Indicted and Arrested on Wire Fraud Charges in Relation to Act 20 and Act 22 Scheme, Dept. of Just., Oct. 21, 2020, https://www.justice.gov/usao-pr/pr/puerto-rico-cpa-indicted-and-arrested-wire-fraud-charges-relation-act-20-and-act-22.
[8] IRS, Large Business and International Active Campaign (Jan. 29, 2021); Coral Murphy Marcos and Patricia Mazzei, The Rush for a Slice of Paradise in Puerto Rico, N.Y. Times, Jan. 31, 2022, https://www.nytimes.com/2022/01/31/us/puerto-rico-gentrification.html.
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