Each state has its own tax code but is also subject to federal tax laws. Puerto Rico has a unique tax structure that sets it apart from those in the states. In Puerto Rico, residents generally don’t pay federal income tax on money earned in Puerto Rico, but a special class of relatively recent residents also pay no tax on passive income such as capital gains, dividends and interest along with other benefits. Companies operating on the Island can qualify as Controlled Federal Corporations (CFCs) and pay less corporate tax than normal, too. While the motivation for these special deals was to enhance investment and improve the Island’s economy, Congress has been expressing concern for years that the beneficiaries — people moving from the mainland specifically to take advantage of the tax breaks — are abusing those tax deals to evade paying federal taxes.
What are Puerto Rico’s special tax deals?
The first and oldest special tax deal is the fact that most residents of Puerto Rico don’t pay federal income tax on wages earned in Puerto Rico. This situation was created because although Puerto Rico is a U.S. territory, the United States Internal Revenue Code treats Puerto Rico like a foreign country. Puerto Rican workers still pay some federal taxes, and most residents would actually be better off under the federal tax code, under which they could receive refundable tax credits that would reduce their tax liability or send refunds beyond what the workers paid in.
The other main tax deal is Act 60, which has been in place for more than a decade.
What is Act 60?
The Resident Tax Incentive Code, known as “Act 60” provides tax exemptions to businesses and investors that establish residence in Puerto Rico by living on the island at least half of the year. Promoters of Act 60 boast that taxpayers could essentially lower their effective tax rate to close to nothing by moving to the island. These incentives are particularly attractive to U.S. citizens who move to Puerto Rico because they do no need visas/residency permits to travel to or live in Puerto Rico and their Puerto Rico income is exempt from both U.S. federal and state income taxes.
Companies that provide services from Puerto Rico to clients outside the island pay a 4% corporate tax rate on eligible income, nothing on dividends from that income, and may also have exemptions on property and municipal taxes.
To receive these benefits, participants must live in Puerto Rico for just over half the year, apply for and receive a decree from the Puerto Rican government outlining their benefits, and comply with annual requirements. The requirements are mild. They must have at least one employee living in Puerto Rico — but that can be the owner of the business. They must give $10,000 per year (rising to $15,000 in 2026) in charitable donations in Puerto Rico.
What kinds of abuses take place?
A consultant can set up a company with one employee living in Puerto Rico — himself — and then conduct his business just as he did in the states but pay little to no income tax. He may spend money primarily in the states while traveling there on business and participate no more than a tourist in local community life. This may fulfill the letter of the law but not the spirit. The goal of Act 60 is to bring economic benefits to Puerto Rico.
Act 60 beneficiaries must make charitable donations in Puerto Rico, but there has been a pattern of Act 60 recipients setting up bogus charities. Since the donation cannot be made to the taxpayer’s family, Act 60 residents sometimes donate to one another’s sketchy charities and then spend the donations on perks for the donors.
In addition to these fluid interpretations of the requirements, the IRS has questioned whether Act 60 beneficiaries are actually living in Puerto Rico. The law requires residents to be present in Puerto Rico for 183 days out of the year, but that can include travel days in which only a short amount of time was spent on the island. In addition to the time requirement, the IRS also looks at whether the taxpayer’s spouse or children is present on the Island, whether they use addresses from other homes they own for tax filings, and whether they “show intent” to continue living in Puerto Rico.
Senator Ron Wyden (D-OR), of the Senate Committee on Finance, recently wrote a letter to the IRS questioning whether a Miami law firm has been providing legal opinions designed to help wealthy clients abuse the privileges of Act 60. The firm and most of the clients in question deny any wrongdoing. However, the Senate Committee on Finance has conducted an investigation alongside the investigation underway by the IRS, and they clearly believe that the abuse of Act 60’s provisions is widespread.
Senator Wyden explained in his letter that “[a]s Chairman and now Ranking Member of the Senate Committee on Finance, I have been conducting an investigation of compliance with federal tax law by ultra-high net worth U.S. persons who have established residency in Puerto Rico and obtained an Act 60 tax exemption (hereafter “PR tax grant”). This investigation is examining situations where U.S. taxpayers with appreciated property, owned directly or indirectly through an entity, (i) move to Puerto Rico, (ii) establish residency, (iii) obtain a PR tax grant, and (iv) sell the appreciated property claiming that the gain on the sale of the appreciated property is Puerto Rican source income not subject to U.S. tax. This is a serious misapplication of U.S. tax laws and results in significant underreporting and underpayment of U.S. taxes.”
“The IRS is appropriately seeking to determine whether individuals who have relocated to Puerto Rico are misusing Puerto Rico Act 60 to shelter billions of dollars in income from U.S. taxes. My understanding is that there are dozens of ultra-wealthy investors who received dubious advice from partners at major law firms,”Senator Wyden wrote.
Does Puerto Rico’s unique tax structure invite abuse?
Puerto Rico’s tax laws may be being abused, but do they invite abuse? Senator Wyden appears to believe so. The tax deals being offered are generous and could be tempting.
The special deals are estimated by the Government Accountability Office to have cost Puerto Rico’s territorial government more than 6 billion dollars in lost revenue. The opportunity cost for the United States has not been calculated, but the Senate Finance Committee claims that individual resident investors have avoided paying hundreds of millions of dollars on federal taxes.
Economists question whether the scheme has benefited Puerto Rico as intended. The Government Accountability Office did not find evidence that it has done so. Yet thousands of individuals have benefitted from the tax deals. This may suggest that Act 60 is set up to benefit investors but not the community, or that its requirements are too easy to sidestep.
