Is Puerto Rico the New Tax Haven for Americans?

The short answer is YES! For 20 years I have been advising clients that setting up sketchy offshore tax schemes is not in their best interest. I have often said:

“If there was a real offshore tax plan that worked, I would be doing it”

Well as of 2012 when Puerto Rico passed Act 20 and Act 22, now there is! Here is why this is real and why it works.

Why Puerto Rico is a Real Tax Haven for Americans

First we have to understand the very unique position Puerto Rico (PR) is in with respect to the United States. PR is technically ‘owned’ by the United States as a U.S. territory. In 1950 the U.S. congress via (P.L. 81-600) authorized Puerto Rico to have a Constitutional Convention. And in 1952 under (P.L. 82-447) the PR Constitution was approved by Congress and the President giving it full effect, thus allowing for self-government although not independence.

As a US citizen you do not need a passport to visit PR, and the residents of PR all carry American passports and are citizens by birth. For all intents and purposes it is a U.S. State, with one major exception; PR residents cannot vote for U.S. Congressional Representatives or for the President of the United States. And this small fact is what allows for the unique tax situation residents of PR find themselves in.

And here is the key; the U.S. Constitution is very specific that there can be “No Taxation without Representation.”

And for this reason, residents of PR do not pay any U.S. Federal Income Tax – At least most of the time! Instead, the PR government has historically charged PR residents a ‘Hacienda’ tax, which is similar to that of the U.S. Federal Tax Rates. This is still the case today if you live and work in PR as a resident.

However, in 2012 the PR government, in an effort to attract both talent and investment to the island, passed Act 20 and Act 22. And here is where the magic begins. Let’s start with Act 22.

ACT No. 22 of 2012

Act 22 was enacted to attract new residents to Puerto Rico and provides a total exemption from all Puerto Rican income ‘Hacienda’ taxes for all passive income (as defined by PR). To qualify you must meet the following:

1. You must be a bona fide resident of PR.
2. The income must be realized or accrued after you have become a resident.
3. The income must be passive, which in PR is Interest or Dividend income.
4. You must not have been a resident of PR at any time during the past 15 years.
5. You must come in under Act 22 and have your petition personally approved and a contract signed by the PR authority.

Why this works is because, as a resident or PR, you give up your right to vote for Congress and the President, and thus are already immediately exempted from paying many U.S. Federal taxes!

With the passing of Act 22, you are then further exempted from paying the Puerto Rican version of the taxes. The net result is that you are now pay 0% (zero!) on all income derived from passive sources, which in PR is limited to Interest or Dividends.

You might be now saying:

“That’s great for the John Paulson’s of the world who have nothing but stocks and bonds and pay millions of dollars of tax, but I still run a business and earn my income, so how would this work for me?”

This is where Act 20 comes in.

ACT No. 20 of 2012

Act 20 applies to companies vs. individuals. Act 20 allows for creation of a new company in PR that would be subject to a maximum tax of 4% on net income. After the 4% is paid the remainder of the income can be distributed to the owners of the company as a, you guessed it – DIVIDEND! And if the owners are also Act 22 residents, then they would pay 0% tax on that distribution.

In order to qualify a company under Act 20, you must meet the following requirements:

1. The company must EXPORT Puerto Rican services.
2. The company must submit a formal business plan to the PR authority and include the establishment of actual operation in PR, and the hiring of at least three PR residents.
3. The exemption from tax will only apply to the services exported from the company, and not to services provided in Puerto Rico.

With Act 20, it is now possible for someone to establish a company in PR, which provides services to its American affiliate, or to other American or international companies. It may also hold Intellectual Property, which could be licensed back to the stateside affiliate or unrelated company.

Basically between the combination of Act 20 and Act 22, it is legitimately possible for a U.S. taxpayer to reduce or even eliminate both State and Federal taxes.

Let’s Play Devil’s Advocate

So this actually is one of those situations that sound just a little too good to be true. So let’s play Devil’s Advocate:

1) Didn’t the U.S. Virgin Islands try to do the same thing a few years back?

Yes they did. It was a very similar structure as the U.S. Virgin Islands also have the same tax exemption from U.S. Federal taxes as a U.S. territory. It attracted some initial attention and began to get some traction. The Problem with the Virgin Island approach is that they issued a “Certificate of Residency” but did not require, or even encourage, actual residency on the island.

They also did not develop fully the source of income issue. In the end many people ended up simply using the jurisdiction with a P.O. Box, no real residency and income clearly derived from activities in the mainland U.S. performed by U.S. residents.  In other words, it was ill-conceived and easily abused.

The result was a breakdown of the system and ultimately a repeal of the advantageous laws that allowed it.

WHAT PR IS DOING DIFFERENTLY

Puerto Rico has solved the issues by using the U.S. and IRS standard for residency. This means living in the jurisdiction at least 6 months and one day of each year, registering to vote, obtaining your driver’s license and in general looking at your primary ties to the jurisdiction. By using the IRS definition of residency, this ensures that Act 22 residents will be qualified by both PR and the U.S.

 2) What if they change the law, isn’t my deal dead?

This is a real concern, especially considering the U.S. Virgin Island Case. To give certainty to the Act 20 & 22 applicants against a future change in the law, each Act 20 and 22 applicant receives an actual contract with the government of PR for 20 years, with a 10-year extension. This guarantees that those who take advantage of the offer will continue to get it throughout the length of the deal.

Basically saying there are ‘no take backs’.

3) Can’t the IRS just ignore the law and come after anyone who tries to use it?

Actually no, they can’t. Puerto Rico has a clearly defined tax regime with respect to the U.S., which is congressionally authorized and blessed. The IRS cannot simply come in and cherry-pick whom they want to consider a resident and whom they don’t. As long as the person is a legal resident of PR, then they are exempted from any U.S. Federal Income taxes. It doesn’t matter if they also happen to be exempt from the PR Hacienda tax under Act 22. The IRS and the Federal Government are aware of Act 20 & 22 and have made no rulings or comments about it being invalid or somehow inapplicable. In fact, the financial health of PR is of direct interest to the United States and a strong argument can be made that this arrangement is in the interest of both.

In other words, as long as it is done right, this is the real deal!

Who should consider this opportunity?

If you have significant dividend or interest income and pay at least $150,000 in taxes on that income each year, then moving to PR and becoming an Act 22 resident should be a serious consideration.

If you have a business and business income in any form and pay in excess of $350,000 each year in taxes, then you should also explore the possibilities of an Act 20 company combined with Act 22 resident status.

Of course both scenarios assume that living in PR at least 6 months out of the year is attractive. If you are not sure, then I suggest a visit of at least a week. Living in PR is a very much like living in the United States with much of the amenities you are use to, balanced with a Caribbean atmosphere and Latin culture.

It you are already inclined to consider living outside of the United States in Costa Rica, Mexico or elsewhere, and also pay significant taxes, then you are a prime candidate to consider PR.

The cost for setting up these structures is very reasonable in relation to the amount of taxes you can save. An Act 22 petition can run as little as $20,000 and an Act 20 company setup with turnkey operations including the hiring of employees and securing of office space can run between $50,000 – $100,000 depending on the size of your operations.

Additionally, your Act 20 company and Act 22 residency fits perfectly into your International Asset Protection Planning providing a seamless partnership of tax reduction and unbeatable Asset Protection.

To discuss in detail the legal aspects of Act 20 or Act 22, I invite you to contact my office at info@www.lodmell.com, or call 800-231-7112.