Puerto Rico Act 60: How You Can Lower Your Federal and State Tax Rates Under the Resident Tax Incentive CodeAnchin AlertJuly 12, 2021
The Tax Incentive Code, known as “Act 60”, provides tax exemptions to businesses and investors that relocate to, or are established in, Puerto Rico. The incentives are particularly attractive to U.S. citizens who move to Puerto Rico because they do not need a residency permit, their Puerto Rico income is exempt from U.S. federal and state income taxes and they get to keep benefits such as Medicare and Social Security. Furthermore, the Puerto Rico tax code mirrors the U.S. Internal Revenue Code, making the transition much easier for those who become bona fide residents of Puerto Rico.
The U.S. tax code (Section 933) allows a bona fide resident of Puerto Rico to exclude Puerto Rico-source income from his or her U.S. gross income for U.S. tax purposes. Residents of Puerto Rico do not have to file a U.S. federal income tax return if all of their income is sourced within Puerto Rico. If income was received from sources outside of Puerto Rico, a U.S. federal tax return must be filed if the amount of income earned outside of Puerto Rico is more than the taxpayer's filing threshold. Any U.S. source income is still subject to U.S. taxes at the regular rate, but Puerto Rico source income for an individual may be taxed at 0% for Federal and Puerto Rico purposes. Puerto Rico-sourced income includes interest and dividends from sources in Puerto Rico.
Additionally, bona fide residents of Puerto Rico are not subject to tax on U.S. source capital gains if they acquired the assets after establishing residency. Taxpayers establishing bona fide residency in Puerto Rico will need to maintain the appropriate recordkeeping and obtain appropriate tax advice in order to properly track Puerto Rico source and U.S. source incomes as the taxpayers may have income sourced from both locations, which will ultimately have different reporting requirements.
Who is a Bona Fide Resident of Puerto Rico?
To take full advantage of Act 60’s tax incentives, the most important requirement is that business owners and investors become bona fide residents. The following list comprises some of the basic requirements to be considered a bona fide resident of Puerto Rico. However, each requirement has its own tests/options that allow an individual to meet the standard of becoming a bona fide resident:
- Individual, and likely immediate family, must be present in Puerto Rico (Presence Test);
- Individual does not have a tax home outside of Puerto Rico during any part of the taxable year
(Tax Home Test);
- Individual does not have a closer connection to the U.S. or a foreign country than to Puerto Rico during any part of the taxable year (Closer Connection Test); and
- An individual who begins or ends bona fide residence in Puerto Rico is obligated to fill out the I.R.S. Form 8898 – Statement for Individuals Who Begin or End Bona Fide Residence in a U.S. Possession. A separate file with instructions is provided with the form.
Ownership of a U.S. C-Corporation
Individuals who are bona fide residents of Puerto Rico are eligible for a possession-source income exclusion, and therefore not subject to U.S. income tax on work or business income sourced from within the territory. When a possession corporation is engaged in the active conduct of a trade or business in Puerto Rico, the entire dividend paid to the shareholder will be treated as income derived from that possession and taxed at 0% under Act 60. However, U.S. source income cannot be treated as possession-source income and would be taxed at the ordinary Federal rate, which is currently 37% at the highest tax bracket.
For C-corporations doing work in both the U.S. and Puerto Rico, as long as the amount of work in Puerto Rico meets the established threshold requirement, the dividend is considered to be Puerto Rico-sourced income. If the threshold is not met, residents must determine the amount of work done per location and apply that ratio to the dividend amounts. The portion of the dividend found to be U.S.-sourced will be taxed at 37%. Here, proper bookkeeping is critical in establishing whether the established threshold was met.
Ownership of Puerto Rico Export-Service Company
Aiming to become an international hub of service providers, Puerto Rico encourages businesses and entrepreneurs to connect with clients outside the island. The exports sector, therefore, gets the main tax advantages. If an entity provides services through its Puerto Rico entity to other countries, it is likely an export-service company and can qualify for a 2% income tax under Act 60.
Note that new firms must offer eligible services from Puerto Rico to clients residing outside the island. Tax exemptions will not apply to business done with Puerto Rican entities, and companies in violation can lose the tax exemption status.
With the right structuring, one could essentially lower their combined effective tax rate from as high as 50% to only 2% by moving to the island. Anchin’s International Tax Group can help you to navigate the above tests to make sure you qualify for benefits. We can also assist you with on-island resources to set up a Puerto Rico-based service company. Please contact your Anchin Relationship Partner to discuss these matters further.