Overview

I was recently in San Juan in late November 2014. I am not very nostalgic by nature, but on this trip was struck by a strong sense of how much Puerto Rico reminded me of the Panama Canal Zone – tropical climate, American infrastructure and American legal system, and strong U.S. federal government and military presence. No offense to my fellow Floridians, but I lived in South Florida for a long time, and Puerto Rico is prettier.

As I have written a number of times, I grew up in the Panama Canal Zone. In college I was a Spanish and Portuguese major. I also previously lived in Miami, the capital of Latin America for almost a decade. Furthermore, I was recently diagnosed by a professional colleague as being culturally schizophrenic. We all have something!

I am a Christian but a great admirer of all things Jewish – people, culture, religion, history and wisdom. A common expression of Jews living in the Diaspora in the celebration of Passover is the expression, “Next Year in Jerusalem”.  The expression embodies a sense of longing and remembrance of the Promised Land. 

From a tax perspective, American taxpayers and entrepreneurs do not have to wait any longer to think about the perfect place to live for tax purposes – Puerto Rico.  Since the introduction of Acts 20 and 22, the American entrepreneur has the perfect outlet of where to live and operate a business without the oppressive impact of federal and state income taxation. Since 2012, more than 200 business owners have relocated their businesses to Puerto Rico with another 200 business owners moving through the process. Many of the business owners have moved from places that were already pretty desirable. Based on an informal inquiry of my clients and others that have made the move to Puerto Rico, everyone is happy in Puerto Rico without exception.

As you plan your business and tax year and begin to consider to implement decisions, you need to make an adjustment and add Puerto Rico to the top of your list of business planning considerations. First, you are not moving to Central America. Puerto Rico is a U.S. commonwealth. Second, transportation access to San Juan is more available and less expensive than travel to most American cities. 

Third, for the New York or LA commuter, the pace of life in San Juan is very comfortable. Add another five years to your life! Fourth, English is probably more widely spoken in San Juan than it is in Miami. Fifth, it is not a prison sentence to spend at least six months of the year on a beautiful tropical island. Sixth, receiving a decree under Act 22 and 20, is not the equivalent of an eternity in a tropical Purgatory. If you saved $100,000 in income taxes over a ten year period, and invested those funds at eight percent, you would have an additional $1.5 million in accumulated wealth from the tax savings at the end of the ten years.  

This article is intended to shock the procrastinator into considering Puerto Rican residency as a viable planning option. This year in San Juan!  

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.

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

What does it take to become a Puerto Rican resident in order to take advantage of Act 22? How about $50 for the application fee which is less than the cost of dinner in a good restaurant, and meeting three tax tests? For federal income tax purposes the taxpayer will be considered a bona fide resident of Puerto Rico if you meet the following: (i) Substantial Presence Test -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) Closer Connection Test - 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.

(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. 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.

In many cases, a business may have multiple owners and is often the case, the business owner cannot convince the spouses of his fellow shareholders to move to Puerto Rico. Surprise! It is possible to structure a new Puerto Rican corporation with the business owner that becomes a Puerto Rican resident. The new corporation can be structured so that the new Puerto Rican corporation is not treated as a controlled foreign corporation for tax purposes allowing the Puerto Rican corporation to be taxed at four percent instead of 39.6 percent or 35 percent.

Summary

As the great former Redskins coach George Allen was known to say, “The future is now”. The reality is that the personal and business transition to Puerto Rico is far less complicated than previously imagined. The trailblazers under Acts 22 and Act 20 are enjoying their Puerto Rican experiences and residency. Equally as importantly, these business owners are reaping substantial financial benefits as a result of the move. 

Take the first step. Commission an evaluation of your particular situation with respect to Acts 22 and 20. Next, purchase a ticket and visit “La Isla del Encanto”. Get your accountant to provide a pro forma of your business in order to financially quantify the benefits of the move.