Why The IRS is Coming for Puerto Rico Act 60

Having acquired the islands of Puerto Rico after the Spanish-American War in 1898, the archipelago remains a territory of the United States to this day.

Puerto Rico allows US citizens, or anybody else with the legal ability to live in the United States, to move to the island and enjoy dramatically lower taxes on income and capital gains.

Act 60, enacted in July 2019, consolidated two previous acts: Act 22, for individual investors, and Act 20, for export services companies. It provides new residents of Puerto Rico with a 100% federal tax exemption from Puerto Rico-sourced income, capital gains,  interest and dividend income. 

The main condition to qualify for the tax incentive is that US citizens become bona fide residents of Puerto Rico and are thus shielded from paying federal income taxes.

To establish bona fide residence, the rules dictate that you must move all the trappings of your life to Puerto Rico: bank accounts, driver’s licence, your primary residence, and your children’s schooling. 

Under the physical presence rules, you must also live in Puerto Rico for at least 549 days during the three years ending with the current taxable year. Another requirement is that you cannot be present in the US for more than 90 days during the year. 

Puerto Rico must be your tax home, which under closer connection rules requires a stronger connection in Puerto Rico than on the US mainland. It effectively means you are physically present in Puerto Rico for 183 days a year.

Under Act 60, you can move or start a new business in Puerto Rico and, if you export services from there, pay a flat 4% tax rate or even less, provided you meet certain requirements. There is no tax on capital gains or dividend income. By moving or starting a business in Puerto Rico and exporting services from there, you can vastly reduce your bill if you satisfy certain conditions.

If you have a location-independent consulting, information technology or e-commerce business, you can move to Puerto Rico and pay minimal corporate tax as long as you export your services from there. 

Any questions? Read our FAQs on the Tax Incentives and Moving to Puerto Rico. 

The IRS is Watching Puerto Rico

In early 2021, the IRS launched renewed efforts focused on auditing US citizens who had moved to Puerto Rico under the previous Act 22. This audit campaign targeted the challenges of Puerto Rico-sourced income earned by a bona fide Puerto Rico resident or a Puerto Rico corporation owned by a bona fide resident. 

The pivotal issue is the source of income. With an exemption for certain income under Act 22, now Act 60, Puerto Rican residents can pay zero tax on Puerto Rico source capital gains.  

They can also obtain an export services decree and pay a 4% tax on certain personal services and corporate income sourced in Puerto Rico. So, the advantages of being a bona fide resident of Puerto Rico are based on the ability to show that some forms of income are Puerto Rico-sourced. 

While US tax law defines what is not Puerto Rico-sourced income (sourced within the US or connected with a trade within the US), it does not explicitly state what Puerto Rico-sourced income is. 

The only definition of Puerto Rico-sourced income applies the same rules but substitutes ‘Puerto Rico’ for the ‘US’ and ‘bona fide resident of Puerto Rico’ for ‘US resident’ when applying source rules. The trouble is that, in recent years, it has emerged that a significant number of wealthy US taxpayers are attempting to avoid certain income taxes by relocating to Puerto Rico under Act 60.

These concerns centre on the ability to avoid certain taxes on Puerto Rico-sourced income and capital gains on based assets once held on the US mainland that have increased in value.

With the increased popularity of the Act 60 incentive, it appears the US government is cracking down on this program. The program has drawn criticism from Democratic House members, much of it focused on the supervisory role of Puerto Rico’s Department of Economic Development and Commerce (DEDC). 

They have demanded that the IRS accelerate its efforts to root out wealthy Americans who, it is alleged, are illegally taking advantage of tax incentives in Puerto Rico.

How the Puerto Rico Act 60 Can Trigger a Tax Audit

Certain forms of income do not qualify for Act 60. While a taxpayer who qualifies under Act 60 can limit capital gains tax on assets that increase in value, this doesn’t include unrealised gains on assets purchased before moving to Puerto Rico.

An IRS press release issued in July 2023 stated: ‘We recently identified about 100 high-income individuals claiming benefits in Puerto Rico without meeting the residence and source rules involving US possessions. These wealthy individuals are attempting to avoid US taxation on U.S. source income, and we expect many of these cases to proceed to criminal investigation.’

Qualifying for Act 60 is not the same as obtaining a Golden Visa because you must be a bona fide resident of Puerto Rico. Moreover, to qualify for PR Act 60 as a bona fide resident of Puerto Rico, you must be physically present there for the majority of the time with limited travel to the US. Failure to comply with these requirements can render all your income subject to US taxation.

Because you are still a US person, even if you qualify for Act 60 in Puerto Rico, you can’t avoid Reporting Foreign Bank and Financial Accounts (FBAR). The requirement to file an FBAR annually is not negotiable. Similarly, the Foreign Account Tax Compliance Act (FATCA) requires the filing of Form 1040 for US-sourced income and Form 8938 for foreign-sourced income that meets the threshold requirements.

According to reports, the IRS is pursuing cases involving assets such as cryptocurrency where taxpayers have intentionally acted with wilful or fraudulent intentions. 

In the cryptocurrency space, traders and stock investors with capital gains and dividend income in the form of passive income could move to Puerto Rico and reduce their taxes. However, that does not include income realised before they moved. 

The issue was covered on Bloomberg Tax in an article titled ‘IRS Probes Puerto Rico Tax Breaks That Lured Crypto Traders, Fund Managers’, which says thousands of individuals and corporations that moved to Puerto Rico anticipate audits on residence and source income. 

It seems that the chickens have come home to roost for those who are looking for tax loopholes in Puerto Rico. Like it or not, the tax man is better at enforcing tax collection than people are at avoiding it. 

That’s why at Nomad Capitalist, we always encourage people to follow the rules – if you do, Puerto Rico is still an attractive option for US citizens to reduce their taxes legally. 

The Benefits of Moving to Puerto Rico

For US citizens, moving to Puerto Rico is a way to stay on US soil and reduce their tax burden. If you don’t want to renounce your US citizenship and want to be closer to the US mainland, with the option of visiting easily, Puerto Rico ticks a lot of boxes. 

You may be considering moving offshore and want to test the waters first. Moving to Puerto Rico is ideally suited to dipping your toes and testing if offshore living makes sense.

It’s not as aggressive a move as going to the Caribbean, the UAE, or other low-tax countries. It does not require you to invest substantial sums in a golden visa. However, you are required to purchase a home there and donate US$5,000 to two different Puerto Rican organisations. You will also be required to show that you actually live there, have moved your life there and have boots on the ground there.

It appears that this is an issue for many. Establishing ties in Puerto Rico requires a serious approach. To follow the rules and ensure you get the tax incentives, you’ve got to move there. Even complying with the physical presence requirement of spending 183 days there is not enough.

Unless you can show that Puerto Rico is your centre of economic interest, where you have the most substantial ties, you will fall foul of the tax man.

It’s not only how many days you spend there but also about your genuine economic and social activity in Puerto Rico and the lack of it in the US.

That’s why having a team of experts on your side when you’re going to Puerto Rico is essential. At Nomad Capitalist, we put together a team of people in Puerto Rico and the US mainland who handle your banking, companies, property, and lifestyle needs. That way, when you make the move to Puerto Rico, you know you’re getting holistic advice that actually solves the problems.

Closing Down the Puerto Rico Loopholes

Whether through a lack of adequate compliance checks by the Puerto Rico authorities or wilful bending of the rules, some people take advantage of loopholes to avoid taxes by illegally claiming Act 60 incentives.  Now, the IRS has caught up with those gaming the system and is beginning to crack down. 

Act 60 was intended to encourage mainland US citizens to live and do business in Puerto Rico to boost its economy. Unfortunately, the temptation and opportunity to abuse the Act 60 incentive program have led some to do just that. In fact, the current situation has promoted speculation that Puerto Rican tax incentives won’t last for much longer. 

For now, you can still lower your taxes by moving to Puerto Rico. You also have the option to renounce US citizenship to lower your taxes or move overseas to obtain a second passport.

Wherever you decide, it must be structured properly.

It takes planning to ensure the ideal mix of location, lifestyle, tax planning and asset protection strategies work in harmony to achieve your goals.

You will need to incorporate the best solutions among all available options. It’s what we call ‘going where you are treated best’, and it looks different for each of the 1500-plus high-net-worth people we’ve helped. 

Our global team of over 60 professionals and country-specific advisors leaves no stone unturned in helping you win personal and financial freedom. And we’re very good at what we do. 

So, if you’re a US citizen reviewing your options, take the first step towards your new life here.