Tax incentives in Puerto Rico have made the island the new offshore tax haven. These tax benefits seem to incentivize Americans to be willing to move to the island.
Generally, when U.S. citizens move their business to a foreign country, they pay U.S. federal income tax on their business profits and capital gains tax on their investment profits. However, residents of Puerto Rico do not pay U.S. federal income tax on their Puerto Rico-sourced income— earnings and profits from work performed in the territory. Section 933 of the Internal Revenue Code excludes Puerto Rico-sourced income from U.S. taxation. Puerto Rico residents pay only Puerto Rico tax on their profits and capital gains.
In consequence, Puerto Rico is free to establish their own tax rate and it has done so by enacting Act 20 and 22. Act 20 is a corporate tax holyday that establishes a 4% corporate tax rate on any Puerto Rico-sourced business income earned inside an Act 20 company. Puerto Rico-sourced business income is defined as any earnings and profits from work performed in the territory. Under Act 20, a service business with at least one employee on the island will pay only 4% tax on Puerto Rico-sourced income. This employee can be the business owner himself. Act 20 only applies to service-based businesses, such as advertising and public relations, auditing services, call centers, consulting, etc.
Act 22 is the personal tax holiday. To qualify for Act 22 tax holidays, an individual must be a resident of Puerto Rico and spend a minimum of 183 days a year on the island. Puerto Rico’s Act 22 gives individuals a zero percent tax rate on capital gains on assets acquired after they move to Puerto Rico and become a legal resident. In addition, all dividends from a Puerto Rico corporation to a resident of Puerto Rico are tax-free.
To maximize the tax benefits of Puerto Rico, many Americans have moved to Puerto Rico and have combined Act 20 with Act 22, by paying only 4% on Puerto Rico business profits and withdrawing those profits as a tax-free dividend at the end of the year. So, Act 20 gets you tax deferred profits held in a Puerto Rico corporation and Act 22 allows you to take those profits out of the corporation tax-free.
Many other tax havens, such as the Cayman Islands, impose a zero percent tax rate and look very attractive. However, Americans must still pay U.S. taxes on all capital gains and dividends received. On the contrary, if investments are made in Puerto Rico, which is a U.S. territory, a person living in Puerto Rico will pay 4% on business profits, and then be eligible to withdraw those retained earnings from the corporation as a tax-free dividend.
Puerto Rico’s Act 20 comes with a 20-year guarantee. In addition, you can now return to the U.S. with profits earned in Puerto Rico with no taxes due to the IRS. The money is free and clear. However, if you move back to America, you give up your Act 22 status, and any interest or capital gains you earn from your tax savings will be taxable by the Feds and your State.
With these rules and the great climate, Puerto Rico seems more than ready to welcome new investors. However, if you are thinking of moving to Puerto Rico, check to see if this is a good option for your own particular circumstances.