Tag Archive for: act 20

Christian Reeves

Puerto Rico Act 22 and Act 20 Residency in 2017 after Hurricane Maria

/0 Comments/in , /by

Puerto Rico residents are receiving relief in all forms. For example, Banco Popular has put a hold on lease and mortgage payments for 3 months and others are following suite.  Moreover, the IRS issued a letter ruling regarding to residency in the territories and meeting physical presence test under section 937(a).

Section 937(a) of the IRC describe how an individual considered a “bona-fide resident” of US territory if he or she meets certain tests. The most common test is if you spend  at least 183 days on the island.

Most Puerto Ricans pay income tax to the local government. So, this rule means that they don’t need to pay the US government, just Puerto Rico. The tax rate in PR is about the same as the Federal rate.

Then, in 2012, Puerto Rico passed Acts 20 and 22. Under Act 20, if you operate a qualifying business from Puerto Rico, you pay only 4% corporate income tax. Under Act 22, if you move to the island, become a resident, and buy a home there, you pay zero in capital gains tax. Act 22 is only available to new residents.

These tax laws are possible in Puerto Rico because of its unique status as a Territory. If Puerto Rico were to become a State, these tax benefits would disappear.

So, for Act 20 and 22, becoming a resident of Puerto Rico means you pay no US Federal taxes on territory sourced income. To meet these test and qualify for tax free status, you must not have a tax home or closer connections in the US. Also, as stated above, you should spend 183 days a year in Puerto Rico.

Before the hurricane, you could count up to 14 days of international travel towards your 183 day requirement in Puerto Rico. If you traveled 40 days abroad, you could count only 14 for Puerto Rico and the rest would be days in the United States (a bad thing).

Due to the catastrophic damage caused by Hurricane Maria, and previously by Irma, the usual 14 day absence period will be extended to 117 days up until December 31, 2017. This gives the resident an exception to the 183 required days.

NOTE that this exception currently only covers tax year 2017! It is not extended into tax year 2018 unless a new letter ruling is issued.

In this Notice the IRS has addressed several issues related to compliance with the presence test for a bona fide resident in a possession (26 CFR 1.937-1). This section lists all the requirements that a resident needs to comply with to satisfy the presence test for a taxable year:

  1. “Was present in the relevant possession for at least 183 days during the taxable year.” Notice 2017-56 has just established an exception due to the hurricane, extending the 14 day absence period to 117 days.
  1. “Was present in the relevant possession for at least 549 days during the three-year period consisting of the taxable year and two immediately preceding taxable years, provided that the individual was also present in the relevant possession for at least 60 days during each taxable year of the period.” Even though the 14 day absence period has been extended to 117 days, I strongly recommend the 549 days are fully completed.
  1. “Was present in the United States for no more than 90 days during the taxable year.” Even though the extension of the absence period should permit the additional days spent in the US, the Notice doesn’t address this particular requisite.
  1. “During the taxable year had earned income in the United States, if any, not exceeding in the aggregate the amount specified in section 861(a)(3)(B) and was present for more days in the relevant possession than in the United States;”. Again, the IRS notice makes no reference to this requisite.
  1. “Had no significant connection to the United States during the taxable year.”

You can take advantage of the extension of the absence period if you have yet to complete the 183 days in Puerto Rico. But be very careful with the compliance of the other presence requirements, specially the earned income and the significant connection to the US. As an example, this last one should take into consideration that you have no principal place of residence in the US, or at least have no homestead exemption.   

For more information on the tax holidays available in Puerto Rico, see: A Detailed Analysis of Puerto Rico’s Tax Incentive Programs

For the latest version of Puerto Rico’s Act 20, see: Puerto Rico Eliminates 5 Employee Requirement

And for information on post hurricane plans, see: What’s Next for Puerto Rico After Hurricane Maria?

I hope you’ve found this article to be helpful. For more information on setting up your business in Puerto Rico, please contact us at info@premieroffshore.com or call (619) 483-1708. 

tax benefits of puerto rico
Christian Reeves

How to Maximize the Tax Benefits of Puerto Rico

/0 Comments/in , , , /by

The tax benefits of Puerto Rico for Americans are incredible. Puerto Rico is by far the best deal available if you’re willing to move you and your business to the island for a few years. Even if you move only the business, while you remain in the United States, the offer is hard to pass up. Here’s how to maximize the tax benefits of Puerto Rico.

First, here’s a summary of the tax benefits  of Puerto Rico.

Act 20 is the business tax holiday offered by cash strapped Puerto Rico. Under Act 20, a service business with 5 employees on the island will pay only 4% tax on Puerto Rico sourced income. Good candidates include businesses (or divisions of a business) which provide sales and support, internet marketing, graphics design, product research, financial advisory, loan servicing, website and network design and support, call centers, and almost any other “portable” business.

The catch is that you must have 5 full time employees in Puerto Rico. These workers can be at any salary or skill level, but they must be working full time and creating Puerto Rico sourced income. The purpose of Act 20 from the government’s perspective is to offer training and jobs to its people.

It’s possible for the owner of the Puerto Rico business to live in the United States and operate the business remotely. In that case, you (that owner) will draw a salary at fair market value from the Puerto Rico corporation and pay tax in the US on your income.  Only profits attributable to the workers in Puerto Rico is Puerto Rico sourced income.

If the owner of the business is living in the US, you get to defer US tax on the profits of your Puerto Rico company (less the 4% tax paid to Puerto Rico). When you take the money out of the company you will pay US tax on the dividend. If you are a resident of Puerto Rico, you won’t pay tax on that dividend.

Act 22 is the personal tax holiday. If you move to Puerto Rico, become a legal resident, buy a home there, and sign up for Act 22, all dividends from a Puerto Rico corporation to a resident of Puerto Rico are tax free. In addition, you will pay zero tax on capital gains. That’s right, the tax rate on assets acquired after you move to Puerto Rico will be zero.

Those are the basics and there are a number of additional Puerto Rico tax holiday programs that are beyond the scope of this article. For example, Act 73 covers IP development and holding companies. Using this statute, you can get to a tax rate of 4 to 8% on income from IP. Also, a number of tax credits are available.

For an article on this, which briefly compares Act 73 to Act 20, see PWC Summary of Puerto Rico Tax Credits and Incentives. Also, here’s an article about Microsoft using Puerto Rico for IP  (from 2013) and another on Puerto Rico and the Pharmaceutical Industry.

Then there’s Act 273 that allows you to setup an “offshore” bank in Puerto Rico and pay only 4% in tax on profits. This is by far the lowest cost offshore banking license available. For more information, see Puerto Rico Offshore Banking License.

This is all to say that Puerto Rico is working hard to become the offshore center for American entrepreneurs. If your business provides a service or is portable, you should give Puerto Rico a look.  

Here’s how to maximize the tax benefits of Puerto Rico.

To truly maximize the tax benefits of Puerto Rico, you need to move you and your business to the island. If you can combine Act 20 with Act 22, you will have a tax deal unmatched by any other jurisdiction.

You will pay only 4% on your business profits (Puerto Rico sourced active business income) under Act 20. Then you will then withdraw those profits as a tax free dividend at the end of the year under Act 22.

So, Act 20 gets you tax deferred profits held in a Puerto Rico corporation. Act 22 allows you to take those profits out of the corporation tax free.

EDITORS NOTE: On July 11, 2017, the government of Puerto Rico did away with the requirement to hire 5 employees to qualify for Act 20. You can now set up an Act 20 company with only 1 employee (you, the business owner). For more information, see: Puerto Rico Eliminates 5 Employee Requirement

Above I said that the tax benefits of Puerto Rico are unmatched by any other jurisdiction. The reason for this is simple: even fiscal paradises like Cayman and Panama with zero tax rates can’t come close to duplicating the benefits for Americans available in Puerto Rico.

Yes, I know that a 0% tax rate in Panama and Cayman Island is less than 4%. But, because Puerto Rico is a US territory, it can offer a deal on dividend distributions that foreign countries can can’t match.

So long as you are a US citizen you will pay US taxes… unless you live in Puerto Rico.

An American living in Cayman or Panama will pay US taxes on all capital gains and dividends received. They will also pay US tax on any salary earned over the Foreign Earned Income Exclusion Amount of $101,300. They won’t pay tax to Panama or Cayman, but they will owe the IRS big time if they make more than $100,000 a year.

That same person living in Puerto Rico will pay tax on any salary earned, 4% on business profits, and then be eligible to withdraw those retained earnings from the corporation as a tax free dividend.

Let’s say you have a business with net profits of $2 million. You can set up in Cayman or Panama and take out a salary of $100,000 per year tax free. The rest of the money will stay in the corporation tax deferred. When you withdraw the $1.9 million, you will pay US tax at about 40% (Fed and State), or $760,000. You get tax deferral by operating offshore, but, one of these days, you must pay the piper.

If that same business were operated from Puerto Rico under Act 20 and Act 22, you would pay PR tax on your salary of $100,000 at about 30%. Then 4% corporate tax on $1.9 million for a total of $106,000. Your net effective rate is 5.6% and goes down towards 4% as income increases.

To sweeten the pot further, Puerto Rico’s Act 20 comes with a 20 year guarantee. Considering how the political winds are blowing against offshore tax structures, a guarantee from a US territory is very valuable.

As I said above, Puerto Rico requires 5 full time employees. If you don’t need that many people, or your profits are closer to $100,000 than $1 million, then a tax free jurisdiction offshore might be more efficient. Here’s an article on Moving Your Internet Business to Cayman Islands Tax Free.

I’ll close by considering how you might carry the tax benefits of Puerto Rico forward once you leave the island.

Ok, you’ve setup your business with 5 employees in Puerto Rico under Act 20. You also took the plunge and moved to Puerto Rico under Act 22. A few years have passed and corporation has $5 million dollars in retained earnings.

You’ve had enough of island life and this business venture has run its course. It’s time to stop the carnival, take your winnings, and return to the US of A.

As I said above, you can take out that $5 million in retained earnings tax free. This is because you are living in Puerto Rico, qualify under Act 22, and the dividends are coming from a Puerto Rico company. The only tax paid was 4% to Puerto Rico for the right to operate your business from their jurisdiction.

You can now return to the US with your $5 million in hand with no taxes due to the IRS. The money is free and clear.

Of course, once you move back to America, giving up your Act 22 status, any interest or capital gains you earn from this $5 million in savings will be taxable by the Feds and your State.

There is one way to carry forward the benefits of Puerto Rico…

Invest some of that $5 million in to a single pay premium offshore life policy before you abandon Puerto Rico.

By moving your savings earned under Act 22 in Puerto Rico in to a tax deferred single pay premium life insurance policy you can continue to defer US tax on any capital gains generated by that money. Basically, you can create a multi-million dollar tax deferred savings account or a massive defined benefit plan without any of the retirement account rules.

Your cash will grow tax deferred inside the life insurance policy, just as it did in Puerto Rico. If you need to use some of that money you can borrow against the policy. Of course, your focus should be on building a tax preferred investment portfolio.

Should something happen to you, this life insurance policy will pass on to your heirs tax free (with a step-up in basis). In this way, it’s possible for you to provide a family legacy without ever paying more than 4% in US taxes.

I hope you have found this article on maximizing the tax benefits of Puerto Rico helpful. Please note that we at PremierOffshore.com are not investment advisers nor do we sell insurance products. I will be happy to introduce you to an expert in this area.

For more information on moving you and/or your business to Puerto Rico, please contact me at info@premieroffshore.com or call (619) 483-1708. I will be happy to work with you to build a tax efficient operation in Puerto Rico.