If Puerto Rico is a US territory, do Puerto Ricans pay US tax? Is it possible to save money by moving to Puerto Rico?
Since the passing of Act 20 and 22 in Puerto Rico, the country has been high on everyone’s list of places to go to save money on tax. These Puerto Rico tax incentives have been a huge draw for those looking to leave the US or any other high tax country.
But is there really a Puerto Rico tax haven?
To answer the first question, Puerto Rico taxes are different than taxes in the United States. Act 20 and 22 are incentives to get new residents and businesses to come to the country and take advantage of the lower Puerto Rico tax rate. However, moving to Puerto Rico isn’t the perfect solution for everyone.
In this article, we’ll discuss
- Do you pay US federal income tax in Puerto Rico?
- What is Act 20?
- What is Act 22?
- What’s the catch?
- What kinds of businesses qualify for Puerto Rico tax benefits?
- How do you qualify?
- Other Options
DO YOU HAVE TO PAY US TAXES IN PUERTO RICO?
Because of citizenship-based taxation, there is nowhere in the world that you can move to in order to get out of paying US federal income tax…. Or is there?
Puerto Rico is a territory of the United States and because of this status, it has a few exceptions. Do Puerto Ricans pay federal income tax? Yes, but no.
Puerto Rico passed two tax incentives (Act 20 and Act 22) that give people huge tax breaks if they move to Puerto Rico. These add to Puerto Rico’s tax advantages and have drawn a lot of attention to the island country. As a bonafide resident of Puerto Rico, you can actually lower your US federal income tax to zero.
(And because Puerto Rico is a territory and not a state there is no Puerto Rico state tax either.)
These incentives are a little complicated and come with quite a few rules before you can qualify.
WHAT IS ACT 20?
Act 20, the Export Services Act, is one of Puerto Rico’s tax incentive laws. This law was made to encourage people to establish a business or move their business to Puerto Rico.
The law includes a 4% fixed income tax rate on income related to the export of goods or services. So if you have a business that exports goods and makes $100,000 in profit, you only owe $4,000.
This money isn’t taxed again. If you are the owner of the company, you can then pay yourself out of the $96,000 that remains, and the best part is that Act 20 also means no dividends tax or tax of profit distributions. This means you won’t have to pay taxes on whatever portion of that $96,000 you keep.
Through Act 20, you pay 0% US Federal Income Tax in Puerto Rico. You heard that right. If you move to Puerto Rico you do not have to pay US federal income tax.
You also have a 100% tax exemption on excise tax and sales and use tax and a 60% tax exemption on municipal license tax.
Act 20 requires that you incorporate in Puerto Rico. If you already have a business set up in the US, you can reorganize the company into a Puerto Rican corporation or LLC. If you are employed by a company, rather than owning it, you can’t qualify for the Act 20 tax incentives.
After you move your business to Puerto Rico, you then need to establish a physical office in the country and apply for a tax concession. It may take a few months before the Office of Industrial Tax Exemption is going to get back to you, but they can apply these tax incentives retroactively so that the 4% tax rate applies for as long as you have been operating in the country.
Once you qualify, these benefits are extended to you for a 15-year period with a possible 15-year extension afterward.
WHAT IS ACT 22?
Act 22 is also known as the Individual Investors Act. Like Act 20, this is one of Puerto Rico’s tax incentives. Act 22 was made to entice new residents to move to Puerto Rico.
Through Act 22, you get a 100% tax exemption from Puerto Rico income taxes on all dividends, all interest, and all short-term and long-term capital gains that were accrued after you became a bonafide resident of Puerto Rico.
There is a misconception when it comes to the part about Puerto Rico capital gains. People assume that this means Puerto Rico has no capital gains and that by moving there you can get out of paying US capital gains completely. If this isn’t true, how do Puerto Rico capital gains work in reality?
The Puerto Rico capital gains tax exemption isn’t applied as soon as you get residence in Puerto Rico. First, you have to be a bona fide resident for an entire taxable year.
The capital gains tax exemption also only applies to Puerto Rican capital gains. If you own stock of a company that is not Puerto Rican, only the appreciation that accrues while you are a bona fide Puerto Rican resident will count. You still have to pay the regular US capital gains tax on the rest of it.
WHAT’S THE CATCH?
Before we get any further, let’s get real.
While these Puerto Rico tax incentives sound like the deal of a lifetime, you might not want to put all your eggs in the Puerto Rico basket just yet.
First, most of the information you’ll find looking up Puerto Rico comes from websites that are trying to sell you on Puerto Rico. These websites are biased. Their goal is to get your business and your money. They’re trying to sell it to you, so of course, they’re going to make it sound as perfect and simple as possible.
If any of these deals sound too good to be true, there’s a large chance that they are. Be careful to not fall for any scams that are out there. In reality, there are many steps and it won’t be a quick process. It usually takes around eight months before you will be approved.
Additionally, there are more things to consider before you move to Puerto Rico, such as: do you actually want to move to Puerto Rico??
Qualifying for Puerto Rico’s tax benefits isn’t as simple as occasionally visiting Puerto Rico, this requires a huge life change. And truthfully, there aren’t any loopholes.
So, if you were planning on scamming the system, think again. It’s not going to work. If you are still interested in taking advantage of the “Puerto Rico tax haven,” we’re going to let you know what it really takes to make it work and what you need to consider, as well as alternatives, in the rest of this article.
WHAT KIND OF BUSINESSES QUALIFY FOR PUERTO RICO TAX BENEFITS?
One of the options to get Puerto Rico’s tax advantages is to start a business in Puerto Rico or move an existing business there. However, not just any business is approved. The Puerto Rico business incentives are tied to your business being an eligible service. This is a limited list that includes:
- advertising and public relations
- architectural design
- call centers
- centralized management services
- computer program development
- electronic data processing
- financial services
- graphic design
- hospital and laboratory services
- legal services
- research and development
- storage and distribution
- voice and data telecommunications
And that’s it. Those are your options if you want to move your business to Puerto Rico to take advantage of Puerto Rico’s tax relief. If your business doesn’t fit into one of these categories, you won’t qualify.
This makes things difficult for a lot of digital nomads who are involved in businesses such as e-commerce, affiliate marketing, niche websites, most apps, or software as a service. While these are popular among expats and digital nomads, they aren’t what Puerto Rico is looking for.
HOW DO YOU QUALIFY FOR PUERTO RICO TAX BENEFITS?
To adopt this Puerto Rico tax strategy and have the tax benefits of Acts 20 and 22, you have to pass three tests:
- You have to be a resident of Puerto Rico
- You cannot have a tax home outside of Puerto Rico
- You cannot have any closer connections to any other country
What does that look like?
You have to be a resident of Puerto Rico
If you want Puerto Rico’s tax benefits, you need to be a resident of Puerto Rico. This can’t be a paper residency where you visit Puerto Rico one day a year and call it good. You need to actually live in Puerto Rico.
The physical presence test requires you to live in Puerto Rico for at least a 183 day period during the taxable year in order to qualify as a Puerto Rican resident.
This is why a paper residence won’t work. You can’t just get a residence permit and then move back to Canada or the US or wherever. To get the Act 20 and 22 incentives, you have to live in Puerto Rico.
You cannot have a tax home outside of Puerto Rico
According to the IRS, your tax home is your main place or business or employment, not where you have your family home. This is the place where you are permanently engaged for work.
In addition to living in Puerto Rico for most of the year, you have to work there. This means you can’t say you have your business in Puerto Rico but then continue to work in an office somewhere in mainland United States (or anywhere else in the world.)
No jetting back and forth between the island and Florida. Your office and place of work have to be located in Puerto Rico.
You cannot have any closer connections to any other country
This one sounds how it is. You can’t have closer connections to any other country. What do these connections include? These are big things like your family, your possessions, and your permanent home.
You can’t get away with leaving your family in the US and taking a six-month vacation to a Puerto Rican resort by yourself every year.
This also means that Puerto Rico needs to be the place where you conduct your personal banking activities, the place where you hold a driver’s license, the place where your church is, and the place where you vote.
Puerto Rico has to be your main place of residence if you want to qualify for any of the tax benefits of Act 20 and Act 22. It’s because of this that any kind of loophole really isn’t possible.
Even if you’ve met the 183 days standard that you need to be in Puerto Rico, you can’t just go live somewhere else for the rest of the year and claim that as where you’re from. On all official documents and forms, you have to designate Puerto Rico as your country of residence.
IS MOVING TO PUERTO RICO WORTH IT?
Overall, to qualify for the Puerto Rico tax incentives, you have to commit to really living in Puerto Rico. This might not be a bad option if you’re interested in moving to the small island, but it’s not the best decision for everyone. The Puerto Rico tax relief might not be worth the stress of moving there.
At the same time, a lot of luxuries you have in America or other Western counties aren’t going to be as readily available to you in Puerto Rico. Yes, by moving to Puerto Rico, federal taxes from the US go down to zero, but you get that in exchange for leaving behind a lot of luxuries.
San Juan is the largest city in Puerto Rico and is the capital with a population of around 395,000, which is tiny in comparison to the big US cities. Puerto Rico is also a dangerous area during hurricane season.
Additionally, we aren’t sure how long these laws are going to stay in place. Right now, it’s expected to be around for about 20 years, but that could always change. If you’re looking for a tax solution that’s a sure thing, this probably isn’t the best way to go.
Puerto Rico has a very large amount of debt, which is a huge reason for the tax incentives in the first place. Puerto Rico is also dependent on the US government and federal subsidies which were cut off in 1996.
The country at present is basically bankrupt and a large chunk of the Puerto Rican population lives under the poverty line.
OTHER OPTIONS BESIDES PUERTO RICO
Can you save money on taxes any other way? The answer is yes. There are plenty of options for saving on taxes and lowering your tax obligations.
If you are willing to make the move but aren’t sure about Puerto Rico as a destination, there are other countries around the world with low tax rates that you can make your new home. If you’re interested in a nomadic lifestyle, you can travel between several different countries.
Some Americans feel willing to move to Puerto Rico over moving to Europe, Asia, or South America simply because Puerto Rico is a US territory. I wouldn’t put all my faith in the US government. And it’s because Puerto Rico is a US territory that I wouldn’t use it as a Plan B when trying to protect yourself from the US government.
There are other countries that have governments and economies much more stable than Puerto Rico’s. If you are a US citizen living in a country overseas, you can still get a tax break from the US through the Foreign Earned Income Exclusion or other tax break programs. Or you can renounce your citizenship and be free of US tax obligations completely.
Going offshore and moving overseas (not just south of Florida) can save you even more money than Act 20 and 22 will. If you are making under $100,000, the Foreign Earned Income Exclusion can lower your US federal income tax to zero, and you can move around the whole world and live anywhere you want, rather than being confined to Puerto Rico.
In the end, if Puerto Rico is not the place you envision yourself spending your life, these tax incentives won’t be worth it to you.