The Best Jurisdiction for US Citizens and Green Card Holders? Puerto Rico
Puerto Rico Tax Incentives:
1. pay ZERO US federal income tax,
2. only a 4% corporate tax for my businesses and
3. ZERO capital gains and dividends tax.
Puerto Rico is a commonwealth of the US. That means that most things here fall under US federal law, like immigration and customs and border enforcement. But Puerto Rico’s tax system is independent from the US. Puerto Rico has its own tax agency, like the IRS. That’s what makes Puerto Rico unique. It’s a part of the US, but tax-wise, it’s not.
If you’re a regular employee, don’t be discouraged. If you can work anywhere – which is increasingly common these days – see if you can switch to be a contractor for your company. You’ll be able to enjoy the same tax privileges.
How to slash your corporate tax rate to only 4%
1. You incorporate a business in Puerto Rico that’s providing a service. And that service is being sold to people outside of Puerto Rico. Your service could be management consulting, accounting, legal services, information technology services, etc.
2. Regardless of your particular specialty, your businesses’ service – provided to clients anywhere in the world – is considered “qualifying activity” under Act 20. So, your business is eligible for a special corporate tax rate of just 4%.
How to reduce your capital gains and dividends tax to ZERO
1 pack up and move down to Puerto Rico, then your capital gains and dividends are considered Puerto Rican-sourced income.
2. And after you become a bona fide Puerto Rican resident (a process we’ll detail later), you’ll pay… 0% on dividends and capital gains.
Pay yourself a commensurate regular salary.
1. We advise to check with your accountant on this rate.
2. And you can take the rest of your compensation as a qualified dividend, taxed at… 0%.
How to set up an Act 20 company
1. I’ve already covered that your Act 20 company must be a service-based business that exports some type of service to global customers…
2. Next, to actually set up an Act 20 company, you’ll need an attorney to help with the application. All-in, it takes the Puerto Rican government four to five months to approve your tax exemption (which they’ll retroactively date to when you applied).
The three tests to become a bona fide Puerto Rican tax resident - To be exempt of US federal income taxes you have to become a bona fide Puerto Rican tax resident.
1. Physical presence test - This is straight forward. You can pass this test by spending six months per year in Puerto Rico.
2. Tax home test - To pass the tax home test, your tax and business activities need to be located in Puerto Rico. If your primary business activities are located anywhere else in the world, you won’t pass this test.
3. Closer connection test - The final test is more qualitative, and it’s similar to the ‘significant connection’ criterion I mentioned with the physical presence test. Remember, you’re proving to the IRS that you’re not liable for US federal taxes on your qualified income.
Direct taxation of businesses
As previously mentioned, Puerto Rico's tax system is greatly influenced by that of the United States. Puerto Rico taxes domestic entities and their residents on their worldwide income. Like the United States, Puerto Rico allows these taxpayers to claim a credit for certain taxes paid by them to the United States or foreign countries.
Foreign corporations engaged in trade or business in Puerto Rico are taxed like domestic corporations in relation to income generated from being engaged in trade or business in Puerto Rico.
i Tax on profits
Determination of taxable profit
Puerto Rico residents and domestic entities are subject to taxation on their worldwide income. However, not all income is taxable. The PRIRC prescribes a formula to determine what amount of income is subject to taxation. Thus, to determine taxable income, taxpayers are required to compute gross income, gross income less exemptions, adjusted gross income and net taxable income.
Gross income includes:
Gross income excludes those items listed in PRIRC Section 1031.01(b).
After computing gross income, taxpayers must compute gross income less exemptions. These exemptions are contained in Section 1031.02 of the PRIRC. The taxpayer must next identify income subject to other rates of taxation and other allowable deductions, and subtract said amounts from the gross income. This is known as adjusted gross income.
Finally, net income is determined by deducting from gross income allowable business deductions, and a few possible special deductions directly from 'gross income less exclusions and exemptions'.
Corporations are not eligible for the deductions from adjusted gross income allowed to individuals, or personal and dependency exemptions.
Foreign entities and non-residents
Foreigners, corporations, pass-through entities and non-residents that are engaged in trade or business in Puerto Rico are subject to Puerto Rico taxation on their income that is effectively connected with the conduct of such trade or business. The rules to determine if income is 'effectively connected income' (ECI) are found in Sections 1123 (f) and (h) of the Regulation of the PRIRC of 1994, which are still in full force and effect.
In general terms, ECI includes:
Capital and income
Taxpayers may elect to treat income derived from the sale or exchange of their capital assets at a fixed preferential income tax rate, and to have their other income taxed in the regular manner; or included as part of their gross income, and taxed at the corresponding ordinary income tax rate. Currently, the long-term capital gains fixed income rate is 15 or 20 per cent for individuals and corporations, respectively. To qualify as a long-term capital gain, the asset sold must be a capital asset and must have been owned by the taxpayer for more than one year. As in the United States Internal Revenue Code, capital assets are defined by establishing what does not constitute a capital asset.
The PRIRC allows taxpayers to deduct net operating losses (NOLs). NOLs are equal to the excess of deductions over gross income, subject to certain exclusions. NOLs have a carryover period of 10 years, and the deduction is limited to 80 per cent of net income. NOLs do not include expenses paid to a related person or home office located outside of Puerto Rico.
If a corporation is acquired, the NOL of said corporation can only be used to reduce the net income of the acquiring corporation derived from the same commercial activity or trade or business that generated the loss. In addition, if a corporation undergoes a change in ownership as defined by the PRIRC, the use of NOLs in subsequent years may be subject to certain limitations.
If a corporation has net capital losses, it can carry over such losses for a period of five years after the year of such losses. However, when capital losses are carried into another year, they are treated as short-term capital losses. If a corporation claims the deduction, the loss is limited to 80 per cent of net income. All other taxpayers can claim capital losses up to the amount of gains in the same taxable year.
Currently, the corporate income tax comprises a 20 per cent tax rate plus a graduated surtax computed on the 'surtax net income'. The 'surtax net income' is basically the net taxable income subject to regular tax less a surtax deduction amounting to US$25,000. The graduated surtax rates are as follows:
|Up to US$75,000||5 per cent|
|From US$75,001 to US$125,000||US$3,750 plus 15 per cent of surtax net income from US$75,001 to US$125,000|
|From US$125,001 to US$175,000||US$11,250 plus 16 per cent of surtax net income from US$125,001 to US$175,000|
|From US$175,001 to US$225,000||US$19,250 plus 17 per cent of surtax net income from US$175,001 to US$225,000|
|From US$225,001 to US$275,000||US$27,750 plus 18 per cent of surtax net income from US$225,001 to US$275,000|
|From US$275,001 and above||US$36,750 plus 19 per cent of surtax net income from US$275,001 and above|
The applicable surtax rate is determined on a consolidated basis for controlled groups and related companies, and the net taxable income of all the entities subject to tax in Puerto Rico within the groups are combined for the determination of the applicable surtax rate.
Corporations are also subject to an alternative minimum tax to the extent that this tax exceeds the regular corporate tax.
Foreign entities and individuals are taxed depending on whether they are engaged in trade or business in Puerto Rico. If they are, their income effectively connected with their Puerto Rico trade or business is taxed as it would be if they were domestic taxpayers. If these taxpayers are not engaged in trade or business in Puerto Rico, Puerto Rico-source passive income received or deemed received is taxed at the following rates:
|Type of income||Individuals*||Corporations†|
|Interest received by a related person, rents, royalties, salaries, annuities, compensations, remunerations, emoluments, distributions by certain types of entities related to real estate,‡ income pertaining to the distributive share of a partner's interest in a partnership, special partnership, LLC, net capital earnings, or other fixed or determinable annual or periodical gains, profits and income (other than insurance premiums or interests)||29 per cent||29 per cent|
|Dividends||10 per cent||10 per cent|
|Income pertaining to the distributive shares of a stockholder in a corporation of individuals||33 per cent||N/A|
|* Section 1091.01(a) of the PRIRC, PRLA T13 Section 30431 † Section 1092.01(a) of the PRIRC, PRLA T13 30432 ‡ Specifically, homeowner associations and any entity created or organised under the laws of the United States, or those of any state of the United States, which, during the taxable year, qualifies as a registered real estate investment company or investment trust under the United States Internal Revenue Code of 1986|
Interest paid to an unrelated foreign corporation not engaged in trade or business in Puerto Rico is not taxable in the hands of the foreign corporation and is not subject to withholding.
The tax rates applicable to individuals for years commencing after 31 December 2015 are as follows:
|Taxable net income||Tax rate|
|Net taxable income less than US$9,000||Zero per cent|
|Over US$9,000 but less than US$25,000||7 per cent of the excess over US$9,000|
|Over US$25,000 but less than US$41,500||US$1,120plus 14 per cent of the excess over US$25,000|
|Over US$41,500 but less than US$61,500||US$3,430 plus 25 per cent of excess over US$41,500|
|Over US$61,500||US$8,430 plus 33 per cent of excess over US$61,500|
Understanding the tax rates of individuals is necessary owing to their applicability to certain business that are pass-through entities.
Based on the principle of self-assessment, taxpayers are required to file tax returns on the 15th day of the fourth month after the closing of their fiscal year. Generally, corporations adopt a calendar year. However, they may elect to have a different fiscal year. A three-month extension to file a return is available. The payment of tax is due on the 15th day of the fourth month after the closing of the taxpayer's fiscal year. Taxpayers may request a six-month extension to pay the taxes owed. The Secretary of the Treasury of Puerto Rico may grant said request, but is not required to do so.
Some taxpayers may be required to file personal property tax returns by 15 May of each year and volume of business declarations by the fifth business day after 15 April.
From a central government perspective, the Department of the Treasury is in charge of collecting taxes in Puerto Rico. The Municipal Collection Revenue Center (CRIM) collects property taxes. Finally, the department of finance of each municipality may impose and collect, subject to the authorisation of the government, additional taxes and fees such as construction fees and the municipal licence tax.
Ordinarily, a four-year statute of limitations after the return is filed applies for the Department of the Treasury to assess income, payroll, withholding, and sales and use taxes.
If a taxpayer assumes a position with respect to certain tax issues, and the Department of the Treasury, CRIM or the department of finance of a municipality disapproves of such position, the taxpayer may challenge the position taken by the tax authority. The process to challenge the tax position taken by the taxing authority varies on the type of tax at issue. However, in general terms, the taxpayer requests an administrative proceeding and then, if he or she disagrees with the outcome of such proceeding, the taxpayer may challenge it in the court system.
Prior to assuming a tax position, taxpayers may, if certain requirements and formalities are met, request the Department of the Treasury to rule on a particular issue. The ruling issued by the Department will be binding for both the taxpayer and the Department.
No tax grouping rules exists in Puerto Rico. Therefore, consolidated returns cannot be filed by corporations.
ii Other relevant taxes
Sales and use tax
Puerto Rico imposes a sales and use tax of 10.5 per cent on the sale, use, storage or consumption of a taxable item. This tax is paid by consumers; however, it is collected and remitted to the Department of the Treasury by merchants, who act as withholding agents for Puerto Rico.
Real property tax
Puerto Rico real property is subject to an annual real property tax. This tax is computed based on property values that date back to the fiscal year 1957–1958 (which was the last time that a general appraisal was conducted by the government). The tax assessment is made as of 1 January of each year by CRIM by discounting the current fair market value of the property to the 1957–1958 values. The applicable tax rates range from 8.03 to 11.83 per cent depending on the municipality where the property is located. Property taxes collected by CRIM are deposited into a trust fund at the Government Development Bank for Puerto Rico.
Personal property tax
CRIM requires the filing of a personal property tax return every year by 15 May. The rate varies from approximately 5.8 to 9.5 per cent of the reported value depending on the municipality, and may change from year to year.
In Puerto Rico, payroll taxes are imposed in the form of income taxes, Federal Insurance Contributions Act taxes, federal unemployment taxes, Puerto Rico employment security taxes, disability taxes, workmen's compensation premiums and chauffeurs' insurance premiums.
Puerto Rico employees are subject to income tax withholding on their payroll. They must also pay US social security and Medicare taxes. The obligation to withhold these taxes and remit the payment to the appropriate government entities belongs to the employer.
Puerto Rico unemployment tax is paid by the employer. This tax is imposed on the first US$7,000 of total wages paid to each employee during the calendar year, based on an experience rating system. Moreover, the employer must also pay a 1 per cent special tax on the wages subject to unemployment tax. However, the special tax together with the experience-based tax cannot exceed 5.4 per cent.
Puerto Rico provides all employees with disability insurance. This insurance is funded by imposing a contributory tax on the first US$9,000 of the total wages paid during the year (0.6 per cent). Half of this tax is paid by the employer and the other half is paid by the employee.
Employers are also responsible for paying the premiums for workmen's accident compensation insurance. This insurance is compulsory, and is for employees who suffer injury, become disabled or lose their lives owing to a job-related accident. The premium is based on total wages paid during the government's fiscal year. The applicable rates vary among industry types. By paying the insurance, the employers enjoy immunity from work-related accidents.
An employer with one or more drivers is subject to the chauffeurs' social security tax. The tax is imposed on both the employer and the employee as follows: every employer must pay US$0.30 per week or fraction thereof for each covered employee; and every employee must pay US$0.50 per week or fraction thereof.
Municipal licence tax
Any individual or entity engaged in trade or business in Puerto Rico is subject to municipal licence tax. This tax is paid to all municipalities in which the individual or entity conducts business. If the business is non-financial, the tax may be as high as 0.5 per cent of the gross volume of business the company received or accrued during the year.
A separate tax return must be filed on or before 15 April of each year. This return is filed with each of the departments of finance of the municipalities where the entity is engaged in business, and reflects the volume of business realised by the corporation during the accounting year prior to the filing of the return. An extension of the time period for the filing of the returns is available, but an estimated payment must accompany such request.
Some products are subject to a special excise tax, including cigarettes, fuels, crude oils, vehicles, alcoholic beverages, cement, sugar and plastic products. The applicable tax depends on each product.
Act 154 of 2010 adopts new source income rules and imposes a temporary excise tax on certain purchases by non-resident individuals, corporations or partnerships of products manufactured in Puerto Rico; and services related to said products by entities affiliated with the purchaser.
Construction excise tax
The municipalities may impose an excise tax on construction. The construction excise tax rate varies from municipality to municipality, but is generally around 4 or 5 per cent of the cost of the project. Costs of the project incurred for work performed outside Puerto Rico should not be subject to the construction tax, and the construction of certain projects is not taxable.