This week’s question came from Robert in North Carolina.
Dear Ambassador Nagel,
I have been hearing more and more each year about the benefits of Puerto Rico’s Act 20 and 22. What is your thoughts on this program for a US Citizen with a business in the US?
Puerto Rico is an amazing opportunity for US citizens to reduce their corporate tax to 4% and their personal income tax on capital gains to 0% (yes, zero percent!).
However, it takes a great deal of effort and commitment to achieve these tax benefits. If you want to pay 4% corporate tax on your ordinary business income and zero on capital gains, you need to work for it. You must leave the comfort of the United States and move you and your business to Puerto Rico.
And Puerto Rico is not a “fix all” for your current investments. Act 22 won’t help you with gains in US real estate or with cryptocurrency you purchased before moving to the island. This is because:
1) Puerto Rico’s Act 22 applies to Puerto Rico sourced income. Puerto Rico sourced income is gains on passive investments like stock and bitcoin, but not real estate in the United States, which is US sourced income.
2) Puerto Rico’s Act 22 applies to assets acquired after you become a tax resident of the territory. It does not apply to gains on passive assets purchased before qualifying for Act 22. You can prorate gains after you move and special rules apply to assets held for at least 10 years while you were a resident of PR.
So, I’ll say it again, Puerto Rico’s tax incentive programs are amazing in the right circumstances. If you’re a day trader, or buying and selling regularly, Act 22 is great. If you’re setting up a hedge fund or cryptocurrency exchange that will operate throughout the United States, Puerto Rico is the place to be.
On the other hand, if you have appreciated assets, Puerto Rico doesn’t help you. Those gains accrued while you were a US resident and will be taxed in the United States.
With that said, let’s take a step back and review Puerto Rico’s Act 20 and 22.
Puerto Rico Act 20
Puerto Rico’s Act 20 allows you to operate a qualifying business from the territory and exchange your US corporate tax rate (21% to 32% depending on your state) for Puerto Rico’s 4% rate. This 4% tax rate applies to Puerto Rico sourced ordinary business income.
Puerto Rico sourced business income is earnings and profits from work performed in Puerto Rico by residents of Puerto Rico. Income generated from work performed in the United States is not PR sourced income. Capital gains from investments are not ordinary business income that qualifies for Act 20.
A qualifying business is one that provides a service from Puerto Rico to persons or companies outside of Puerto Rico. Most Act 20 agencies are internet marketing firms or some other online business selling in to the United States and abroad. The only limitation is that you can’t do business with locals (residents of Puerto Ricans).
There are provisions of Act 20 for export businesses. However Trump’s new tax laws have called those rules into question. I’ll leave that for another day. For more on Act 20, see: Good News from Congress for Act 20 Business in Puerto Rico.
Note that Puerto Rico’s Act 20 is for businesses netting more than $500,000 a year. This is because you must first draw a salary from the business, which is taxed at ordinary rates. Then the balance of the corporate profits are taxed at 4%. For the reasons why, see: Foreign Earned Income Exclusion vs. Puerto Rico’s Act 20.
If you’re living and working in Puerto Rico, you can those profits out of your PR corporation as a tax free dividend. This means that the only tax paid in Puerto Rico on corporate profits is 4%. You will not pay PR or US tax on the dividend distribution if you are a resident of the territory.
Puerto Rico Act 22
Puerto Rico’s Act 22 was passed to bring high networth individuals to the territory. To qualify for this tax incentive, you must be approved by the government, buy a home within your first few years of residency, and spend a minimum of 183 days a year on the island.
If you travel, you can count up to 30 days abroad as time in Puerto Rico. In that case, you must spend more time in PR than you do in the United States and PR must be your home base. To protect yourself from audit, you should break as many ties to the US as possible and create as many connections to Puerto Rico as you can.
As a resident of Puerto Rico, you’ll pay zero tax on assets acquired after you become a resident and sold before January 1, 2036. This tax incentive covers appreciation in passive assets during your period of residency.
For more on Act 20 and 22, see: Changes to Puerto Rico’s Act 20 and Act 22.
I hope you’ve found this answer to be helpful. For more information on Puerto Rico, you can contact my firm at firstname.lastname@example.org. We are experts in the intricacies of Puerto Rico’s tax incentives and will be able to assist you in any ways needed.
Ambassador Joel Nagel