Puerto Rico Tax Haven Is Alluring, But Are There Tax Risks?

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Waves of people are heading to Puerto Rico, including investors, lawyers, hedge funders, and more. Given the amazing tax benefits, many people are doing it for good reason. The crypto community may be the biggest wave of all, as the fascinating press coverage continues to note. With Zero taxes, golf and beach houses are making Krypto Island a paradise, what could go wrong? Compared to the benefits, probably very little. But as with anything that sounds good, there are some potential qualifiers and hiccups that some may overlook. Incredible tax savings deals aren’t new for new residents jumping through all of Puerto Rico’s essential hoops. However, it is only relatively recently that the island has virtually exploded, with a huge increase in moves and times of economic boom. Real estate prices have virtually risen to the stratosphere. Part of Puerto Rico’s government tax incentive programs requires you to buy a home within the first two years of a move, and you have to pay for the privilege of receiving less tax. just how much less?

  1. Tax-free interest and dividends earned after becoming a resident.
  2. No long-term capital gains tax on appreciation after becoming a resident.
  3. 5% tax on long-term capital gains for appreciation before going for any sale during your first 10 years as a resident.

Among the most glaring qualifiers for the rules is Puerto Rico regarding source income. You only get great benefits on income you receive in Puerto Rico, not everything else—which the IRS can still tax. Many people may prefer to ignore established sourcing rules, and may think that if they live in Puerto Rico, everything Puerto Rico sources income. Another qualification is the rule that your property pre-transferred is still taxed by the IRS. The rules for stocks are pretty clear at this point. The rules for crypto are not as clear, so there are some differences of opinion about how crypto will be treated.

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If you think the IRS is the biggest loser, you’d be right. The IRS and the Puerto Rican government are collaborating to identify those who are cutting corners, or even outright cheating. Even for overworked government agencies, there are bound to be multiple audits. There is even a possibility of some criminal tax cases. In 2020, a major Puerto Rico CPA Indicted and Arrested On an alleged plan to convert US source income to Puerto Rico income. Shortly after, his large US accounting firm exited the Puerto Rico market.

Despite the qualifiers, of course, Puerto Rico’s schedule is incredible. US citizens are taxable on their worldwide income. That unforgiving price tag has prompted some Americans to renounce their citizenship, Going through the exit process with the IRS and the State Department. But given the long list of benefits of being American and the irreversibility of such a decision, it is very difficult for most people to renounce citizenship. Puerto Rico sounds tempting, where you American live, keep your passport, but pay a fraction of the taxes you do now. Puerto Rico is a US Commonwealth, part of the US but still independent in some ways. Its tax system is a hybrid, part US, not part. If you can actually grow yourself and/or your business, you may be able to deduct your income tax.

But you have to be careful. As with any trick, you have to Actually Steps. Your Tax Home—Your Real Home – Must be in Puerto Rico. Like any move from one state to another, it must be real. Try to avoid messy facts that don’t seem like a permanent move. Ideally sell your house, move your family, break up with your old local clubs, etc. After all, if you are ruled later No For being a Puerto Rico resident, the IRS is back in the picture for refunded taxes, penalties, and interest. To qualify, a person must not have been a resident of Puerto Rico in the past 15 years. You must be a resident of Puerto Rico, and you must have lived there at least 183 days a year, or must have completed one of several other tests that are less clear.

Perhaps the hardest overall test to meet—which comes across as a sort of overlay on everything—is the close connection test. Where are your closest connections, Puerto Rico or anywhere else? You will also have to do paperwork, filing an application with the tax authority there. Once it is approved, it is a binding contract to lower taxes as mentioned above. But among the most misunderstood regulations is the web of interactions between federal taxes with the IRS and local taxes in Puerto Rico. In many cases, if not most, you will need to file taxes in two places, with the IRS and with the Puerto Rico Department of Finance.

Still, Puerto Rico hopes to entice those on the US mainland with an income tax of only 4%. Legally avoiding the 37% federal rate and the 13.3% California (or other state) rate is a jaw-dropping advantage. What’s more, there is no tax on dividends in Puerto Rico, and no capital gains tax. To return to the qualifiers, forget about the easy avoidance of US tax on your wealth growth before this You go If you move in with valuable stock or other assets, and Then To sell, pre-move appreciation is still subject to US tax. Only your post-move appreciation will be subject to specific tax regulations in Puerto Rico. The rules for crypto are still being developed, and some of the more daring taxpayers believe that appreciation in crypto will not be divided like stocks.

For stocks, to avoid US tax on all pre-move appreciation, you should generally wait a Filled up ten years Later You go This is hardly a quick solution. What about selling your American real estate? that would be Always Have US source income. Many Americans feel overtaxed, and the Biden administration’s plan probably isn’t helping that trend. State income taxes increase the burden, especially in high-tax states, and especially with a general federal tax rule that you can deduct only $10,000 in state taxes on your federal tax return. Increasingly, when taxpayers are looking to leave a higher tax state for a tax-exempt state, they may be looking at Puerto Rico as well.

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