If you’re looking for a tax efficient international structure for your business, there are two competing offers: You can setup your business in Puerto Rico or in Panama. Puerto Rico is unique in many regards and offers different benefits compared to Panama or any other foreign country.
I’ll focus on Panama here because it’s one of the best offshore jurisdictions for business. Labor costs are low, internet, IT, and commercial space are excellent, and English speaking talent is available. Most importantly, Panama won’t tax your foreign sourced business income.
For example, let’s say you’re living and working in Panama. You’re customers are in the United States and around the world, but not in Panama. All income earned in this business is foreign sourced to Panama, meaning it’s from sales to persons and companies outside of Panama. Thus, you’ll pay zero tax in Panama on these profits.
If you’re not a US citizen, then this might be the end of it. Your home country probably doesn’t tax non-resident citizens and won’t tax your Panama corporation. Structuring your business in Panama might eliminate worldwide taxation for non-US persons.
If you are a US citizen, your tax picture much more complex. The United States taxes their non-resident citizens, no matter where we live. There are ways to limit and work around this, which I’ll get to later.
I should also note that the US treats all foreign countries the same. It doesn’t matter if you live in Colombia, Mexico, Panama, Costa Rica, Hong Kong or Singapore, the tax rules covered here apply to you so long as you hold a US passport.
Cayman also has an offer similar to Panama. For more on that, see: Move Your Internet Business to Cayman Islands Tax Free
The only exception to US tax rules on Foreign businesses is found in Puerto Rico. As a US territory, Federal tax laws do not apply. The island is free to make it’s own rules, which they have done… and very favorable rules they are.
- To read the US code section on Puerto Rico, see: 26 U.S.C. 933 – INCOME FROM SOURCES WITHIN PUERTO RICO
That is all to say, any business formed in a foreign country, that’s owned by a US person, must comply with US Federal tax laws. Any business incorporated in and operated from Puerto Rico must comply with the tax laws of Puerto Rico.
And this is why Puerto Rico’s tax deal is different from the tax benefits available in all other “tax havens” around the world. This is why Puerto Rico and Panama offer competing opportunities.
Panama vs. Puerto Rico
In most cases, a business with net profits of $300,000 or less will get a better deal from Panama. Those earning well over this amount, which can benefit from 5 employees, will do better in Puerto Rico. The higher your net profits, the stronger the pull towards Puerto Rico
Here’s how to chose between Panama and Puerto Rico as a US citizen.
A US person living in and operating a business from Panama will use the Foreign Earned Income Exclusion to reduce or eliminate US tax on their net profits. You will take out your first $100,000 as a salary reported on IRS Form 2555 tax free. If two spouses are working in the business, both can take about $100,000, thus earning up to $200,000 tax free.
If you earn more than $100,000 or $200,000 after ordinary and necessary business expenses, you have two options. You can take these profits out as additional salary, and pay US tax on that money, or you can leave it in the corporation as tax deferred retained earnings. When the money comes out of the company, it will be taxed in the United States as a non-qualified dividend.
So, a business netting $100,000 to $200,000 can operate completely tax free in Panama. As you surpass this threshold, you get tax deferral, but will eventually pay US taxes on those gains.
The tax deal available from Puerto Rico is basically the reverse of the Foreign Earned Income Exclusion. If you’re living and working in Puerto Rico, qualify for Acts 20 and 22, and hire 5 employees on the island (including yourself), you’ll receive a guaranteed corporate tax rate of 4%.
To sweeten the pot, Puerto Rico has no capital gains tax on assets acquired after you become a resident qualify for Act 22. Also, dividends from your Act 20 company to you (who qualifies under Act 22) are tax free.
The corporate rate of 4% applies to all Puerto Rico sourced income. This is corporate net profit after expenses and after you’ve received a reasonable salary from your Puerto Rico corporation. Your salary is taxed at ordinary rates.
So, to compare apples to apples, let’s say you earn $1 million in Puerto Rico. The first $100,000 is taxable as a salary, so you pay about $35,000 in tax. The remaining $900,000 is taxed at 4%, or $36,000. You then take a tax free dividend with no need to retain earnings and no future US income tax.
Once your income is taxed in Puerto Rico, you pay no additional tax to the United States. This assumes you’re living in and working from Puerto Rico.
If you had earned this amount in California, your tax would have been around 40%, or $400,000. Moving your business from California to Puerto Rico cut your taxes on $1 million from $400,000 to $71,000.
As I said above, if you were living in Panama, your first $100,000 in tax free. In Puerto Rico, your first $100,000 is taxable at ordinary rates.
If a business in Panama nets $1 million, you will eventually pay US tax on the $900,000 in excess of the FEIE. This will be at ordinary rates, so around 40%. Thus, your total tax cost in Panama is $360,000.
For more on this topic, see: Puerto Rico Tax Deal vs Foreign Earned Income Exclusion
Puerto Rico’s tax deal is guaranteed for 20 years. The government of Puerto Rico can’t change it’s mind once you’ve qualified under the law. On the other hand, you’re free to shut down and leave at any time with no consequences (other than losing the tax benefits, of course).
If you are a passive investor, and don’t have an active business, you can qualify for Puerto Rico’s Act 22 and not bother with 20. This would eliminate US capital gains when you sell assets acquired after moving to Puerto Rico.
Act 22 requires you spend a minimum of 183 days a year on the island and buy a home there. You should also cut as many ties to the US as possible. You want to make sure you’re considered a resident of Puerto Rico should the IRS decide to audit you.
This compares well to Panama. If you become a resident of Panama, you can spend 3 or 4 months a year in the United States. If you don’t qualify for residency, then you can only spend 35 days a year in America. If you exceed these numbers, you’ll lose the Foreign Earned Income Exclusion entirely.
For more on Puerto Rico’s tax deal for businesses, see: Puerto Rico is the Top Offshore Business Jurisdiction.
I hope you’ve found this article comparing Puerto Rico and Panama to be helpful. Both are great regions for Americans and solid choices for your business. If you have questions, please contact me at firstname.lastname@example.org or call us at (619) 550-2743. All consultations are free and confidential. We’ll be happy to assist you to find the best jurisdiction for you and your business.