Last Updated July 18, 2020
Dateline: Tbilisi, Georgia
How would you like to remain a US citizen but – legally – only pay 4% corporate tax, zero capital gains, and zero dividends tax?
This is exactly what Puerto Rico has been offering US citizens for just shy of a decade.
This has, of course, created quite the buzz in the offshore world. Many folks view Puerto Rico as the alternative to citizenship renunciation for tax-weary Americans.
But don’t be too eager to believe all the hype.
While Puerto Rico may be the solution for a small group of people, it is not the ultimate remedy that many claim it to be.
Any time a program or other tax incentive reaches a certain level of mass, you will have a lot of people selling you on how easy it is; but easy doesn’t always mean that it is the right fit – if it even fits at all.
The available programs in Puerto Rico have many strings attached and, if those requirements don’t fit perfectly into your business and lifestyle plans, you are better off staying away.
In this article, we will examine Puerto Rico Act 20 and 22 from every angle. We will break down the programs, discuss how the tax incentives work, go over what you must do to qualify, and then give you the pros and cons of Puerto Rico’s tax incentives versus the tax relief you can enjoy by going overseas.
My opinion will certainly go against what some of the promoters of Puerto Rico’s tax incentives are talking about, but for someone who wants to make an informed decision, that is exactly what you need.
So, let’s dive in.
⤅ What Is Puerto Rico Act 20?
⤅ How to Qualify for Puerto Rico Act 20
⤅ Utilizing Puerto Rico Act 20
⤅ What Is Puerto Rico Act 22?
⤅ How to Qualify for Puerto Rico Act 22
⤅ Utilizing Puerto Rico Act 22
⤅ Going Offshore with the FEIE
⤅ Renouncing US Citizenship
They Why of Puerto Rico’s Tax Incentives
The first question we must ask ourselves before we delve into the details of Puerto Rico’s programs is why a US possession would (or even could) offer such dramatically low tax rates to wealthy US citizens in the first place.
As with anything bought and sold in a free market, Puerto Rico’s program exists because there is both supply and demand at play.
Puerto Rico is willing to supply an attractive tax regime because it needs money from investors and businessmen. And there is the demand for lower taxes from these very investors and businessman thanks to the harsh taxes in the United States.
Puerto Rico Needs Money & US Citizens Need Tax Relief
Puerto Rico seemingly cannot escape its debt. US citizens increasingly cannot find any substantial tax relief.
Puerto Rico’s economy has long been dependent on federal subsidies from the US government. When these were cut in 1996, Puerto Rico began incurring large debts.
Puerto Rico now has a ballooning national debt – including $74 billion in bond debt and $49 billion in unfunded pension liability – and a public infrastructure that is built on that debt.
Puerto Rico’s gross national income declined by 14% from 2007 to 2017, unemployment reached 17% in 2010, and 46% of the population lived under the poverty line in 2015.
While tax rates in the United States are not as high as in many other developed countries, they are still quite high and continue to create a substantial tax burden for US citizens.
Unlike citizens from almost every other country on earth, US persons are subject to US tax on their worldwide income regardless of where they live.
Insufficient Domestic Tax Relief
Many US citizens do not want to leave the only country they have ever known but still want a more tax-friendly environment. Moving to a state with zero state income tax does not reduce federal taxes.
What are the Puerto Rican Tax Incentives?
Completely bankrupt and scrambling for money, Puerto Rico has done what many countries do when trying to boost their economy, they have created attractive tax incentives to encourage foreign investment.
Puerto Rico’s main focus has been to draw in US corporations and investors seeking tax relief from US citizenship-based taxation.
Beginning in 2012, Puerto Rico used its special status within the United States to create unique tax incentives that would lure successful employers down to the island to bring capital and create jobs.
Currently, the agreement between Puerto Rico and the United States government allows American investors and corporations (that are willing to relocate to Puerto Rico and establish their bona fide residence there) to only pay tax in Puerto Rico on most forms of income.
Because Puerto Rico has a special status within the United States, folks who take advantage of Puerto Rico’s programs can enjoy huge exemptions on federal income tax and reduce their tax rate by as much as 90%.
The two most popular programs offered by the Puerto Rican government are Act 20 and Act 22.
Act 20, also known as the Export Service Act, targets certain service businesses by offering corporate tax rates as a low 4% and 0% on dividends distributed from the company for qualifying corporations that relocate to the jurisdiction.
Act 22, or the Individual Investors Act, targets high net worth investors with the promise of 0% tax on interest, dividends, and capital gains obtained while residing in Puerto Rico as a bona fide resident.
[Update: In June 2019, Puerto Rico made substantial changes to its tax incentives that came into effect on January 1, 2020. Under this new law – known as the Incentives Code – Acts 20 and 22 have been consolidated into Act 60 and were subsequently renamed. More importantly, the requirements for each program have been adjusted. These changes to the programs are addressed below. We have maintained the original names (Act 20 and Act 22) in this article to make it easier to track the old programs and how they have changed.]
Puerto Rico Act 20 – The Export Services Act
Now known as Chapter 3 of the Incentives Code, Puerto Rico’s Act 20 was originally known as the Export Services Act.
The legislation allows Puerto Rico to offer qualifying businesses that export services from the island nation the opportunity to cut their corporate tax rate to a mere 4%.
In addition, dividends paid out to you from your Act 20 company are completely tax-free.
If you are running a business in the United States and have a high rate of taxation as an LLC or a C-corporation, you can move that business to Puerto Rico and save 90% of your tax burden by simply ticking the boxes for Act 20.
And what are those boxes you will need to tick? As always, the devil is in the details, so let’s break this down into parts.
How to Qualify for a Puerto Rico Act 20 Company
The main premise of Act 20 is incredibly straightforward. We will look at each requirement one by one, but these are the main boxes you have to tick.
- Set Up a Puerto Rican Company
- Establish an Office in Puerto Rico
- Apply for a Tax Concession
Once you do these three things, you will qualify for the 4% corporate tax rate on any Puerto Rico-sourced income.
1. Set Up a Puerto Rican Company
First and foremost, your company must be incorporated in Puerto Rico. If you already have a US company, you do not need to sell your business assets to the new Puerto Rican company to make the transition. Instead, you can do a tax-free reorganization of the company to a Puerto Rican corporation, LLC, partnership, or another juridical person.
However, only exportable service-based businesses qualify, which means that not all businesses can set up an Act 20 company.
The Puerto Rican government understands that they are on a tiny island with limited prospects for internal growth. They want you and your business because you have the know-how and ability to connect Puerto Rico’s economy to the global market.
If they are going to invite you to their shores, they want to ensure that you do exactly that.
Because of this, Act 20 clearly stipulates that the tax incentives will only apply to businesses that provide services from Puerto Rico to outside markets.
What Businesses Qualify for Puerto Rico Act 20?
If provided to markets outside of Puerto Rico, the service-based businesses that qualify for an Act 20 company include but are not limited to:
- Advertising and public relations
- Architectural and engineering services, project management, blueprint production, etc.
- Assembly, bottling and packaging operations for exported products
- Call centers
- Centralized management services (strategic direction, planning, distribution, logistics, and budgetary services)
- Commercial and mercantile distribution of products manufactured in Puerto Rico for export
- Computer software development
- Consulting services (economic, environmental, technological, scientific, managerial, marketing, human resources, computer, auditing, trade, business, etc.)
- Creative services (design, art, media, creative education, etc.)
- Educational and training services
- Electronic data processing centers
- Investment banking and other financial services
- Legal, tax, and accounting services
- Marketing centers (secretarial services, translation, information processing, communications, marketing, telemarketing, etc.)
- Medical, hospital and laboratory services
- Research and development
- Shared service centers
- Storage and distribution centers
- Trading companies
Are There Any Other Ways to Qualify for Puerto Rico Act 20?
Your business must clearly and unequivocally offer its services from Puerto Rico.
This means that many businesses that are commonly run by expats and digital nomads will not qualify. For example, drop-shipping, Amazon FBA, SaaS, app businesses, online ad arbitrage, affiliate marketing, niche websites and e-commerce sold from a personal website will not qualify since the source of the service provided is questionable.
However, if there are different aspects of the business that are service based, you can set up a Puerto Rico Act 20 company to export that specific service – be it marketing, payroll, accounting, logistics, etc. – to your company located outside of Puerto Rico. The Act 20 company will only pay 4% corporate tax and your main business can write off the expenses.
But understand, this will not apply to your entire business structure, only to the part of the company that is set up in Puerto Rico.
You may be working from an office in Puerto Rico to run your FBA business, but only the exported service qualifies for the tax cut, not the profit you earn selling products that are both made and sold outside of Puerto Rico.
I Have a Regular Job; Can I Qualify for Act 20?
You cannot take advantage of Puerto Rico Act 20 as a regular employee.
However, if you can work remotely, you can become an independent contractor and export those same services to your previous employer as a Puerto Rico Act 20 company.
What Businesses Do Not Qualify for Puerto Rico Act 20?
Your business cannot be involved in activities with a nexus in Puerto Rico. This means that you cannot conduct a trade or business providing services to the Puerto Rican market. These activities include but are not limited to:
- Puerto Rican real estate
- Legal counsel provided within Puerto Rico concerning Puerto Rican law
- Lobbying on the laws and regulations of the Puerto Rican government
- Services provided to Puerto Rican residents and local entities
Again, only businesses that render service for the benefit of non-resident individuals and foreign entities will qualify.
2. Establish an Office in Puerto Rico
To set up and maintain your Act 20 company, your business must have a physical presence in Puerto Rico – an office. That said, your home can count as your office (if that is what you prefer) granted that it is located on the island.
Fortunately, the government offers a full exemption from personal and real property taxes during the first five years of business operations and a 75% exemption from municipal and state taxes during the same period.
In addition, if your Act 20 company produces $3 million or more in revenue, you must hire a full-time employee in Puerto Rico. If you are a bona fide resident of Puerto Rico, you can count yourself as the ‘employee’ as you actively manage your business.
If you choose to hire someone locally, you can pay as little as $10 an hour. For that price, you likely won’t be hiring high-level employees, but you also shouldn’t hire a stooge who is sitting in a broom closet doing nothing. They must be doing real work.
Under the new law, the Puerto Rican government will audit all participating Act 20 companies every two years, and they will want to see the work that your Puerto Rican employee(s) is doing.
Whether you employ yourself or another individual, your employee(s) must have full social security benefits and all related employee coverage, including full taxation.
3. Apply for a Tax Concession
To qualify for the 4% corporate tax, you must apply for a tax concession and obtain a tax exemption decree. You can submit your application via Puerto Rico’s Single Business Portal, but it is recommended that you use a lawyer to ensure a successful application.
While it can take four to five months for the Office of Industrial Tax Exemption (OITE) to extend the decree, they will retroactively apply the 4% tax rate to your application date.
Under the new law, the decree lasts for a 15-year term with the possibility of another 15-year extension. All tax benefits will be secured during that term.
Again, the 4% tax can only be applied to business income that is Puerto Rican-sourced. If you live and operate your business in the US, your Puerto Rican corporation, while foreign, could technically be engaged in a US trade or business for US tax purposes and subsequently become subject to high US tax rates on a portion of its income. (More on that in a minute.)
If you can avoid doing this and you meet all other qualifications, you may qualify for more than the 4% fixed corporate tax rate. For example, in the case of services that are considered strategic to Puerto Rico, the corporate tax rate could be reduced to 3%.
You will also enjoy 100% tax exemption on distributions from earnings and profits from your Act 20 company, thanks to a 0% dividend tax.
Utilizing Puerto Rico Act 20
There are several different ways you can use your Act 20 company. Each approach has both benefits and limitations regarding lifestyle, income tax, corporate tax, and dividend tax. It is up to you to determine if the trade-off is worth it.
If You Live in the US While Running an Act 20 Company
It used to be that you could set up a Puerto Rican company under Act 20, qualify for the 4% corporate tax, and then become a Puerto Rican non-resident, thereby exempting yourself from all personal income tax requirements in Puerto Rico.
However, the 2018 Trump tax reform changed all this due to the introduction of GILTI – the Global Intangible Low-Taxed Income – which targets US corporations that own Controlled Foreign Companies (CFCs) for US tax purposes.
Under GILTI, the minimum tax for any US-owned CFC is 10.5% (max 21%). So, even though Puerto Rico will only charge you 4% corporate tax, the US will take at least another 6.5% from your CFC if you are a US person.
And GILTI is not the only tax you will need to worry about living in the US. Depending on your tax bracket, any dividends from your company will also be taxed up to 20% by the IRS. You will also need to calculate state and local taxes, and certain individuals will also be hit with a 3.8% surcharge tax for Obamacare.
That is the cost of staying the United States, even with Puerto Rico’s tax incentives.
You can live in the US (or anywhere, really) and run an Act 20 company, but you will lose the majority (if not all) of the tax benefits derived from this particular setup by doing so.
The only way to get around these issues and to reduce the rate to the 4% offered through Act 20 is to become a bona fide resident of Puerto Rico.
If You Are a Bona Fide Resident of Puerto Rico Running an Act 20 Company
The good news is that US citizens can use Act 20 to avoid the new CFC rules and all GILTI implications (even if they own 100% of the shares in their company) if they become a bona fide Puerto Rican resident.
If your business is majority owned by a Puerto Rican bona fide resident (you), it will no longer be considered a US-owned CFC and you will only be taxed at the flat 4% rate applied to your business in Puerto Rico.
The catch is that you have to become 100% compliant with Puerto Rico’s bona fide residence provisions, which means spending at least 183 days in Puerto Rico every year and moving your center of life to the island.
The positive side of this requirement is that you will be one step closer to qualifying for Act 22 as well.
If You Qualify for Both Act 20 and Act 22
When you comply with all the regulations for both Act 20 and 22, you will not only enjoy the 4% corporate tax and 0% dividends tax but also 0% on all interest, royalties, and capital gains.
For example, if your Puerto Rican company makes $100,000, it should pay you a reasonable salary – say $60,000 – for which you would pay the full Puerto Rican personal income tax (which is comparable to US tax rates and includes Social Security and Medicare taxes).
The $40,000 left after taxes is only taxed at the 4% rate and then you can take the rest out of the company as a dividend that is 100% exempt from tax.
If you do not take advantage of Act 22, you will continue to pay the usual US taxes on investment income. So, let’s tackle Act 22 next…
Comfort: Moving to Puerto Rico makes people feel comfortable because of the sense that they are still on US soil. Even though Puerto Rico is a vastly different place where these people have likely never been before, it’s easier for them to digest. They are not leaving the United States or venturing out into the great unknown and all the places that the State Department tells them not to visit.
More time on the US mainland: Puerto Rico’s programs give you more flexibility and time on the US mainland versus going offshore and utilizing offshore tax savings strategies.
You don’t have to renounce your US citizenship: Puerto Rico gives you incredible tax advantages without needing to renounce your US citizenship. You don’t have to renounce to be offshore either, but Puerto Rico’s tax incentives may get you closer to renunciation-level tax rates than other offshore strategies.
Passive Income Savings: The individuals who could benefit the most from setting up a tax strategy involving Puerto Rico are those with large capital gains or who are looking to sell their business several years down the road. Investors in cryptocurrencies, hedge fund managers, and big traders have the most to win by exempting their passive income from tax. Even the Foreign Earned Income Exclusion (FEIE) won’t protect you from taxes on passive income, but Puerto Rico can.
Large Income Savings: If you are making big money, Puerto Rico can also offer more relief than the $107,600 exemption on active income available through the FEIE. With Act 20 and 22, you can take all the money out of your business tax-free (after the 4% corporate tax, of course) instead of keeping it all in your business.
Midway Jumping Off Point: Puerto Rico may be a good option for folks who are hesitant to renounce their US citizenship or who cannot renounce yet because they do not have a second passport. Depending on your second passport strategy, Puerto Rico could serve as a midway jumping off point as the time you spend there while obtaining your second passport could reduce your overall tax liability before renouncing.
Demanding Bona Fide Residence Requirement: While you get more flexibility and time on the US mainland, the main catch to Puerto Rico’s programs is the bona fide residence requirement.
Establishing closer connections locks you into to spending a significant amount of time in Puerto Rico. You must relocate your center of life to the island and spend at least half the year there.
If you’re single, I hope you like dating Puerto Rican girls. If you have a family, I hope you feel comfortable with the infrastructure that is there. There are a lot of great places to live in Puerto Rico, but you must be committed to making it your main home.
If you’re a business owner and you want to set up a bona fide residence somewhere, there are much better places than Puerto Rico where you could establish residence, pay zero tax, and still spend 120 days on average in the US.
With those kind of options, why would you want to be tied down to Puerto Rico?
Corner Cutters: Puerto Rico’s programs are the number one area where I see people cutting corners. People try to pull every scam in the book. I hear it all the time and see comments on my blog and YouTube channel from viewers arguing that you can just pretend that you are living in Puerto Rico and still get the benefits.
And the fact that so many people try to cut corners with these programs could jeopardize their longevity. As someone who insists on doing everything 100% legal, the amount of corner cutting in Puerto Rico is a clear sign to someone like me to just stay away.
Most of the people I have met who are following the requirements still seem to be flying by the seat of their pants a little bit. Overall, it feels like Puerto Rico’s programs attract the wrong people and the amount of fraud taking place is a clear sign that the program will not hold.
After all, Act 20 and Act 22 were brought into existence by the stroke of a pen and they can be gone just as fast. In fact, the recent changes to the law did change these programs to increase transparency and make the application process more demanding.
Technically, once you have secured a decree, your personal benefits will be guaranteed for the next 15 years, but all it takes is for the US government to come in and declare that the party is over for those benefits to go away.
The sheer number of people fudging the lines and cutting corners may be all the justification the US government needs to do just that.
The rules may be more favorable overall, but they are still rules and they must be followed. Failing to meet the requirements for the Puerto Rican bona fide residence test can cost you dearly and nullify every effort made to take advantage of these tax incentives, not to mention put the whole program at risk.
No Anonymity: As mentioned, the new legislation also introduced greater transparency to Puerto Rico’s tax incentive programs. Transparency is the future of offshore, but there are varying levels of transparency depending on where you go.
Puerto Rico is erring on the side of greater transparency, which may be to your disadvantage.
As of January 2020, the Department of Economic Development and Commerce of Puerto Rico will publish an annual report of all the incentives requested and granted, the dates they were granted, the names of the businesses and shareholders who benefited, the municipality where the business operates, and the jobs the business created.
Accountable to the United States: Puerto Rico is ultimately accountable to the US government. If you are going to move, move somewhere good. Don’t settle because you’re afraid of some monster under the bed outside of the United States. If you can move to Puerto Rico, you can move to Panama or anywhere else on earth.
The key is to live somewhere that is not under the control of Washington, DC.
That doesn’t mean that living in Puerto Rico is a horrible idea, but why live in a bankrupt country under the thumb of the US government – a country that has a long history of excessively demanding tax laws – when you have so many other good options?
The idea that the US government would be excited to see its own citizens take their money and flee to Puerto Rico, a US territory, all while standing idly by and doing nothing is silly.
That is why the idea of moving to Puerto Rico with the goal to save on taxes is troubling to me.
Do you want to go to a country that rolls out the red carpet only when it gets desperate, or because that is the way they do business? I would rather trust my money and my business to a place that wants me but doesn’t need me.
Subject to Change: My biggest beef with Puerto Rico’s program though is that it is undeniably subject to change. In fact, I suspect that if Puerto Rico’s tax incentives gain any kind of momentum, they are going to be dead.
Like so many things, the IRS and Congress will let Puerto Rico attract a few rich people until it gets out of hand and then the tax incentives will be targeted and the programs will disintegrate. We have already seen this process begin with the introduction of GILTI.
And then there’s the potential that Puerto Rico could become an actual US state. While it’s a long shot, that would be the quickest way to kill the program. Just in 2017, Puerto Rico held the latest in a long string of votes on the issue of statehood.
While the odds of Puerto Rico becoming a state are low, the uncertainty reminds me that the best way to distance yourself from the IRS isn’t to go hang out in a US enclave with a tax policy that could fall apart tomorrow.
Not Everyone Qualifies: There are certain businesses that simply do not qualify for Puerto Rico Act 20. It is not a panacea for everyone or every business. And the tax professionals we work with here at Nomad Capitalist agree. If it sounds like you would have to cut a corner to get into the program, just go somewhere else.
Delayed Application Process: Act 60 applications for businesses are currently taking longer than the promised four to five months. If you apply today, it is likely that it will take at least eight months before you are approved.
Alternatives to Puerto Rico Act 20 and 22
Whether your business doesn’t qualify or you are wary of Puerto Rico’s dependency on the US or any of the other cons we have discussed, the good news is that you have an entire world full of other legal tax reduction opportunities just waiting for you to take advantage of their offerings.
Here are the two we recommend most to US citizens:
1. Going Offshore With the FEIE
If you go offshore by simply leaving the United States and living in a foreign country or countries, you can take advantage of the Foreign Earned Income Exclusion (FEIE) and exempt just over $100,000 of active income from your taxes.
Above the roughly $100,000 limit, the strategies become more complicated.
For example, if you make $150K net profit and you set up an offshore company, the first $107,600 (2020 figures) would be exempt from tax under the Foreign Earned Income Exclusion, and the next $42,400 would be subject to 10.5% GILTI, which is very similar to what you would get in Puerto Rico.
At those rates, it’s better to use a foreign structure instead of a Puerto Rican structure because the cost of living is much higher in Puerto Rico than in many other countries where you could be spending your time.
You also won’t have the obligation to be in one place, and there are fewer commitment costs like buying real estate, hiring employees, paying local income tax, etc.
The question is, how much money are you making? If you are making millions of dollars a year and it is important to you to spend time in the United States, then Puerto Rico may be a great deal – you pay between 0-4% and you’re done.
But by going offshore, you have more flexibility.
You can qualify for the FEIE by establishing bona fide residence in any other country in the world. And if your bona fide residence has a friendly tax system that will leave you alone, you will pay zero in that country and then have the US tax with exemptions on top of that.
You will be able to choose where you are going to live rather than be forced into Puerto Rico. And you still get about four months of the year to be in the US.
You can also qualify for the FEIE by passing the physical presence test. To do this, all you have to do is spend less than 33 days in the United States within a one-year period. The rest of your time can be spent in any number of foreign countries.
As long as you are outside of the United States, the US doesn’t really care where you are. There isn’t a provision where you have to have a closer connection. Your tax home is simply wherever you are located. And if you’re not getting into someone else’s tax net, you’ve got life pretty easy.
Are you going to get your income down to 4% by going offshore if you have a large income or a million-dollar business? Close, but probably not quite. Depending on your situation, there may be ways to go to zero, but for most US citizens, no, you’re not going to quite reach Puerto Rico’s benefits.
So, why go offshore?
You get a lot more flexibility.
If you want to live in twelve different places a year and spend one month in each place, you can.
If you want to follow my Trifecta approach and have a summer home, winter home, and a spring and fall home each in a different country, you can.
If you want to take lots of vacations to different countries or spend your summers all over Europe, you can do that without having to put down roots anywhere.
You have the flexibility to change your mind. You’re not getting into one system that forces you to be there.
But this is a decision that each person will make on their own.
For most expats and digital nomads, remaining outside the United States and utilizing the Foreign Earned Income Exclusion with an offshore structure is the better option.
You will have the freedom to be more nomadic and you will not have to deal with the requirements of staying in one place and providing evidence of your tax home and closer connections.
Even if you prefer setting up a bona fide residence somewhere so that you can spend more time in the United States, you can become a bona fide resident in Malaysia or Panama or Georgia and still get great tax benefits, Then, when you want to change your bona fide residence to another location, you can do so with proper notice without sacrificing those tax benefits.
Once you liberate yourself and become open to the notion of doing business ANYWHERE, why go somewhere with as many limitations and drawbacks as Puerto Rico? There are legal ways for US citizens and residents to reduce their US tax obligations by setting up companies and living overseas – Puerto Rico is not your only option.
2. Renouncing US Citizenship
If your goal is to completely exit the US tax system, the only legal out is through citizenship renunciation. And, depending on your net worth and your individual situation, you may get more benefits in terms of selling your assets, a company, cryptocurrencies, and more by renouncing.
I have spoken to several former US citizens who considered moving to Puerto Rico but ultimately decided to renounce their US citizenship; none of them regret their decision and they are happy that they solved their problem rather than merely reducing it.
At my core, I am a pragmatist who believes in finding opportunities to legally lower or eliminate tax. However, I also believe that when the ship is sinking, you shouldn’t simply go up to a higher deck.
If you’re making the kind of money where Puerto Rico’s tax incentives help, spend the $100,00 and buy a second passport and renounce.
I’m not saying that renouncing US citizenship is the only (or best) option besides moving to Puerto Rico, but if you believe that the tax obligations and investment restrictions on US citizens are draconian, it’s time to jump ship.
Puerto Rico Act 22
If you are a US investor, you could be paying as much as 20% in federal taxes on dividends and capital gains, plus state and local taxes, and possibly the Obamacare 3.8% surcharge.
Puerto Rico Act 22 – officially Chapter 2 – Individuals of the new Tax Incentives Code – can eliminate all of that.
All you have to do is move to Puerto Rico, become a bona fide resident, buy a home, make a small annual donation, and voila, all future capital gains on stocks, bonds, and even crypto will be tax free. All dividends, interest, and royalties from Puerto Rican sources will also be free of tax.
There is more to it than that, of course, but that’s the program in a nutshell: zero taxes on all capital gains earned during your bona fide residence in the country.
Because of the incentives provided, Act 22 is an attractive offer for traders, crypto investors, and anyone looking to sell a business or who has a large amount of passive income or capital gains from any source.
How to Qualify for Puerto Rico Act 22
With the tax incentives overhaul of 2019, a couple of new requirements were added to Act 22 beginning in January of 2020. Along with the long-standing bona fide residence requirement, you will now need to buy a home and make a qualifying donation to a local Puerto Rican charity.
Here are the details for each requirement:
1. Purchase a Home
Within two years of qualifying for the individual investors program, you must buy a property in Puerto Rico that serves as your primary residence. You will need to keep this property to maintain your Act 22 decree.
While there is no minimum purchase amount for the home, you cannot rent it out as it must be used as your primary residence.
If you have questions about moving to Puerto Rico, from the logistics to voting to the culture, check out this article covering the most frequently asked questions in regards to moving to Puerto Rico and using its tax incentives.
2. Make an Annual Charitable Donation
Technically, the donation requirement already existed under the old law. Act 60 merely doubled the annual charitable donation amount from $5,000 to $10,000.
The other change is that you must give at least $5,000 to a government-approved charity. The other half can go to any Puerto Rican charity of your choice, as was previously the case.
3. Establish and Maintain Bona Fide Residence
Now we get to the meat of Act 22: establishing bona fide residence in Puerto Rico. But remember, this is also how you will free your Act 20 company from the GILTI tax law in the US.
So, how do you become a bona fide Puerto Rican resident to obtain 0% tax on all capital gains, dividends, interest, and royalties earned during your bona fide residence in the country?
There are three tests you must pass.
- Physical Presence
- No Other Tax Home
- No Closer Connections
In some ways, it is easier to establish bona fide residence in Puerto Rico than in other countries when, for example, seeking to qualify for the Foreign Earned Income Exclusion. This is because you are qualifying as a bona fide resident of a US possession, not just any country.
However, the requirements are still very demanding.
Not only do you need to meet these requirements to become a bona fide resident of Puerto Rico, but you must also maintain that status for an entire tax year before you can receive the benefits offered under Act 22.
Here are the most important details of each test that you will need to follow to prove that you are a bona fide resident of Puerto Rico:
Test 1: Physycal Presence
You must spend at least 183 days in Puerto Rico between January 1st and December 31st of the year prior to being granted your Act 22 decree.
This does not necessarily mean that you have to be in Puerto Rico beginning January 1st or that you must spend 183 consecutive days in Puerto Rico, but your 183 days of physical presence must occur within that year’s timeframe.
For instance, if you decided to move to Puerto Rico in October of 2020, you would not qualify for the 0% capital gains tax in 2021 because you did not spend at least 183 days in Puerto Rico in 2020.
Instead, the 2021 tax year would be the first full tax year for which you could claim residence in Puerto Rico, qualifying you for the exemption in 2022.
There are a few other ways to pass the physical presence test, from spending an aggregate of 549 days in Puerto Rico over a three-year period to spending less than 90 days in the US in a tax year, or from having no significant connection to the US in a tax year to making less than $3,000 in the United States and spending more time in Puerto Rico.
Meeting these other requirements can get tricky, which is why the 183 days is the best rule to go by. And to be on the safe side, you should probably spend more than 183 days in the country. People think they can spend 183 days in Puerto Rico and 182 in Los Angeles and qualify as a bona fide Puerto Rican resident.
That’s not going to work.
It’s not just a numbers game, you also have to prove that Puerto Rico is your center of life. And that means that you need to move there.
You can spend time in the US, but you cannot spend more time in the US than in Puerto Rico and you must always come back to Puerto Rico.
The same can be said of travel to anywhere else in the world. You may be a nomad bouncing around or you may be quasi-nomadic and go to Asia for a month and then Russia, but you always go back to Puerto Rico.
It must be the center of your operations.
If you have other homes, you must prove that your Puerto Rican home is more significant than all the rest. You can do this by building your case to pass the following two tests.
Test 2: No Other Tax Home
Your tax home is the center of all your economic activity. Your office is your tax home, which means that if you are commuting between Puerto Rico and your office back in the US or any other location, Puerto Rico will not be considered your tax home.
You must move your office to Puerto Rico.
This is already a requirement under Act 20 – and according to the IRS, your tax home is your regular place of business or employment – so having an Act 20 company set up in Puerto Rico will also help solidify the case that Puerto Rico is your tax home.
You can still travel to and have bank accounts in the US, but it will not help your case if you run all your financial activity through those accounts or you do all your business while in the US.
You need to show every economic connection possible to Puerto Rico, including movement through your Puerto Rican bank accounts and other business activity conducted while living in Puerto Rico.
Test 3: No Closer Connections
You can build the argument that you have no closer connections to any other place by showing evidence that you have moved the rest of your life to Puerto Rico.
This evidence can include having a permanent home in Puerto Rico, moving your family and personal belongings to the country, and establishing social, political, cultural, professional, and religious ties in Puerto Rico.
You should also obtain a Puerto Rican driver’s license, declare Puerto Rico as your official country of residence on all forms and documents, and register to vote in Puerto Rico. In fact, voter registration is not even an option. You have to vote in Puerto Rico to truly make your case.
Again, the argument that you can spend 183 days in Puerto Rico each year and the other 182 days in the United States is a risky move that could cost you tens of thousands in taxes.
It’s not worth the risk.
Remember, you are building your case to prove that you have moved your whole life to Puerto Rico. Yes, you can spend time in the US, but plan on a few months a year, not a full six months.
Either live in Puerto Rico or don’t do it. I can’t emphasize that enough. Do NOT cut corners.
Having closer connections means having stronger ties with Puerto Rico than the state that you are leaving in the US.
This is not entirely different from what everyone else in the world – the Canadians, Australians, Europeans, etc. – go through when they become tax non-resident in their home country to avoid the Nomad Tax Trap.
You cannot simply leave all the trappings of your old life on the mainland. You have to establish an actual bona fide life in Puerto Rico.
Utilizing the Puerto Rico Act 22
If you are willing to become a bona fide resident of Puerto Rico, make the donation, and buy a home, the next question is how to obtain the Act 22 decree.
You can file for the exemption on Puerto Rico’s Single Business Portal, but it is recommended that you work with a lawyer.
Once you submit the application, you can expect to be approved within three months, at which time they will retroactively apply the tax exemptions to the date of your application.
If you are not already in Puerto Rico at the time of approval, you will have one year to enter the country and claim the benefits before they are canceled.
Now, let’s go back to the big draw of Act 22 and focus on how the tax incentives work once you have established your bona fide residence and obtained the decree.
This is where a lot of people get confused. They think that they can simply move to Puerto Rico and then sell their business or their crypto investments without having to pay any capital gains.
That’s not how it works.
Remember, it is 0% on capital gains earned during your bona fide residence in Puerto Rico. In other words, only capital gains earned after you become a bona fide resident will benefit from the 0% rate.
This requires a pro-rata allocation of any assets that you owned prior to establishing your bona fide residence in Puerto Rico. Only the portion of the appreciation that accrues while you are a bona fide resident is considered Puerto Rican source.
For example, if you have held crypto for a year before you qualify for Puerto Rico Act 22 and you then live in Puerto Rico for another two years before selling your crypto investments, you will have to pay regular US capital gains tax on all gains made in the first year.
Only the amount that accrued while a bona fide resident qualifies for the 0% rate.
The same applies to anyone looking to sell a business. If a client came to me today who was considering moving to Puerto Rico to take advantage of Act 22 to sell his business and evade the capital gains tax, I would have to give him some bad news.
If he has owned his business for long, his time spent in Puerto Rico would barely make a dent. If he wants to sell his business the moment that he establishes his bona fide residence, he is not going to get any tax relief at all. He is going to pay tax in the US for all the time that he ran that business as a US person.
Act 22 is better suited for someone who wants to sell their business or assets in five years or more. It is not for someone trying to pull a fast one and evade taxes altogether.
It is also important to note that it does not matter if you have been offshore. The pro-rata allocation is based on the time that you were a US person versus a bona fide Puerto Rican resident.
If you have been living as a nomad offshore and you move to Puerto Rico, become a bona fide resident, and later sell your business, the time you spent offshore utilizing the Foreign Earned Income Exclusion still counts as being a US person. You would still be subject to the full capital gains tax with the pro-rata deal.
For instance, if you’ve owned your business for five years while traveling as a nomad, decide to move to Puerto Rico, and then sell your business five years later, you will pay tax on half the capital gains in the US and half in Puerto Rico at the 0% rate.
If, however, you spend more than ten years living in Puerto Rico before selling your investments or business, your taxes on any capital accrued while still a US person will go down to 5%.
Any time less than ten years, and you only get an exemption on what you earn while a bona fide resident of Puerto Rico. Therefore, as always, it’s worth getting off your tuchis and doing something today.
It’s Worth a Call
For my money, becoming tax resident in Puerto Rico to cut your US tax bill is the right choice for a very small percentage of the population seeking friendlier shores.
For the average entrepreneur, Puerto Rico never made a lot of sense.
Set aside the potential risks, the paperwork, and the fact that you still need to pay some tax to take advantage of the program. You also need to live in Puerto Rico – really, truly live there.
I’ve spoken to several people who were sold on the program by some fancy pants tax guru in a skyscraper, and none of them were ecstatic with their choice.
Treating symptoms rather than causes isn’t good in medicine, and it isn’t good when deciding to go offshore either. Finding a solution that gives you the end result you want – from a better, cheaper lifestyle to lower taxes – generally means looking beyond shiny objects like Puerto Rico.
The entire goal of internationalization is to protect yourself from threats from insolvent nations like the United States. Fleeing to a territory of the United States to solve your tax problems seems like a precarious situation, at best.
My five magic words are not “go where you’re treated a little bit better”; they are “go where you’re treated best.”
Still, there may be some unique cases where Puerto Rico really is the best option for you.
As with anything that involves offshore and US tax, the answer is, “It depends.”
If you are single and want to be traveling, offshore is probably the better option, even if you have to pay a couple of percentage points more in tax. And you will still be saving a substantial amount.
If you have a family, Puerto Rico may be a more realistic consideration. It comes down to whether you want to settle down somewhere overseas or whether Puerto Rico works for you. Is that lifestyle adjustment worth it to have the tax savings or would you rather have more freedom with a bit more complicated plan?
That is why it’s worth getting on a call with someone who’s not trying to sell you Puerto Rico or any particular strategy.
Puerto Rico could work for a limited number of people who understand the law and who are actually willing to follow it, but there are a lot of potential minefields and you will need to work with someone who is willing to walk you through them rather than turn a blind eye to the many issues that could come up with Puerto Rico’s tax incentives.
If you need help designing your offshore plan and determining whether Puerto Rico is the right option for you, feel free to reach out to our team.
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The Nomad Capitalist team has helped hundreds of people create and execute holistic offshore plans to help them legally reduce their taxes, become dual citizens, and live the Nomad Capitalist lifestyle of success