Last Updated February 8, 2022
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 incentives and Act 22 incentives 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, this might be what you need.
So, let’s dive in.
The 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 supply and demand are at play.
Puerto Rico is willing to supply an attractive tax regime because it needs money from investors and businessmen for its economic development. And there is a demand for lower taxes from these very investors and businessmen thanks to the harsh taxes in the United States.
1. Puerto Rico Needs Money
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. The good news is that Puerto Rico has exited bankruptcy following the largest public debt restructuring.
The Puerto Rico government has been incapable of collecting a large portion of its taxes and administering its affairs to adequately deal with and repay its debts.
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.
The strongest storm to hit the island in almost 90 years, Hurricane Maria, devastated Puerto Rico in 2017, leaving nearly 3000 dead and over $90 billion in damages to the island.
2. Us Citizens Need Tax Relief
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.
Trump Tax Reform
The 2018 Trump tax reform severely limits the extent of many offshore benefits such as the FEIE, tax credits, and foreign corporations, making it practically impossible to eliminate your taxes living overseas.
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. But moving to a state with zero state income tax does not reduce federal taxes.
Puerto Rico seemingly cannot escape its debt. US citizens increasingly cannot find any substantial tax relief.
Enter the Puerto Rican tax incentives.
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 is Act 60.
Act 20, also known as the Export Service Act, targets certain service businesses by offering corporate tax rates as low as 4% to qualifying corporations that relocate to the jurisdiction. Exempt businesses will enjoy a 75% exemption on the municipal and state property taxes. Companies that qualify as “Small and Medium Businesses” will also enjoy a 100% exemption on municipal and state property taxes during their first five years of operation.
Act 22, or the Individual Investors Act, targets high net worth investors with the promise of 0% tax on interest, dividends, rental, short-term and long-term 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.]
Puerto Rico Act 20 – The Export Services Act
What Is Puerto Rico Act 20?
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%.
And when combined with Act 22 – which means that you must become a bona fide resident of Puerto Rico – 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 source 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, Pass-through entity like a partnership, or other juridical people.
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, advertising, research, 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 Puerto Rico business incentives activities include but are not limited to:
- Puerto Rico real estate tax incentives
- 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 from a foreign country 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 taxes and state taxes during the same period.
In addition, if your Act 20 company annually 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 tax exemption 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 Puerto Rico 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%.
And if you also qualify for Act 22 as well, you can enjoy a 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, Puerto Rican 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 in 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 residents.
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 Act 60
When you comply with all the regulations for Act 60, you will enjoy the 4% corporate tax and the 0% dividends tax.
For example, suppose your Puerto Rican company makes $100,000. In that case, 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, even if you are living in Puerto Rico. So, let’s talk about Act 22 here.
Alternatives To Puerto Rico Act 60
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, you still have an entire world full of legal tax reduction opportunities just waiting for you. Read more about the alternatives here.
It’s Worth A Call
For my money, becoming a 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.