Lawmakers Ask for Scrutiny of Puerto Rico Tax Loopholes

Reps. José Serrano (D-NY), Alexandria Ocasio-Cortez (D-NY) Nydia Velázquez (D-NY), and Raúl Grijalva (D-NY) have written a letter to Treasury Secretary Steven Mnuchin asking him to provide “greater oversight” for Puerto Rico’s tax loopholes. They also asked that the Treasury Department calculate the cost to the federal government of the Island’s special treatment for wealthy individuals.

“Since 1954, Federal income taxes have not been extended to income earned in Puerto Rico,” they pointed out in their December 20, 2019 letter. “Rather, the tax goal has been to allow the territorial government to tax the revenue sources directly at levels necessary to overcome the lack of equal treatment in Federal funding programs.”

However, the letter continued, that hasn’t worked out. “In 2012, the territorial government enacted two laws, Acts 20 and 22,” the authors wrote, “with the goal of luring wealthy individuals and businesses providing services in the States to Puerto Rico.  These laws exempt these individuals from almost all local taxation if they ‘reside’ on the island for a majority of the year. Under the laws, numerous tax exemptions and rate reductions are granted until 2035, with little economic justification.  The beneficiaries are not required to make significant specific economic contributions to the territory, or even any contributions that justify any tax savings at all.”

“By ‘residing’ on the island for 183 days per year, these individuals now avoid both Federal and local taxes,” the letter sums up. “This results in tax benefits that individuals and businesses could not obtain anywhere else in the world.  In other words, Puerto Rico has become a tax haven from the Federal government.”

Avoiding taxes

Individuals who can take advantage of Acts 20 and 22 can set up a business in Puerto Rico with as few as one employee living in Puerto Rico (perhaps the business owner) and pay a tax rate of just 4%. Most residents of Puerto Rico pay high local taxes, as well as some federal taxes.

The letter from the federal legislators lists other concerns. “The better treatment of Act 20 and 22 beneficiaries is not limited to taxes: They have also been exempted from territorial inheritance laws, which may have implications for Federal estate taxation. There reportedly are more than 1,600 individuals and firms who have relocated from the States to Puerto Rico in order to avoid Federal, State, and local taxes. A few years ago, a territorial official said that the smaller number of individuals then included two billionaires and that the average net worth of Act 20 and 22 beneficiaries was $7 million. We understand that the IRS is aware of cases in which businesses in the States route their services through ‘front’ firms in Puerto Rico that do no real work. We have also heard of a case in which an individual avoids $60 million a year in Federal taxes through these territorial policies. There are also questions as to whether Act 22 beneficiaries are really present in Puerto Rico 183 days a year as required by IRC § 937.”

The authors point out that these tax evasions don’t provide any financial benefit for Puerto Rico. While the idea was to bring more jobs to the Island and to bring cash into the economy, there is no evidence that either of these goals has been accomplished.

“Acts 20 and 22 have turned Puerto Rico into a tax haven with little to no benefit for the vast majority of Puerto Ricans. The Department of the Treasury should conduct greater oversight over how these tax breaks are being implemented and their impact on federal, state, local, and territorial tax revenues.  Puerto Ricans need greater transparency and accountability regarding these choices,” said Representative José E. Serrano (D-NY).

“The evidence strongly suggests certain tax provisions are lining the pockets of wealthy individuals who partially reside in Puerto Rico, while doing nothing to benefit the people of Puerto Rico. The Treasury Department needs to take a hard look at these provisions so we can determine whether they are functioning as intended or inadvertently allowing the wealthy to skirt tax obligations and depriving Puerto Rico and the federal government of needed revenue,” said Rep. Nydia M. Velázquez (D-NY).

“I am concerned that the people of Puerto Rico are subjected to an unjust tax system that favors the wealthy and business class,” said House Natural Resources Committee Chairman Raúl M. Grijalva (D-AZ). “I will continue to push the Trump administration for answers until they are able to demonstrate that everyday Puerto Ricans are not being hung out to dry by the tax system. We can and should choose a path that generates economic growth and financial stability for the majority of the population,” said Chair Grijalva.

“It is deeply troubling to learn that wealthy individuals are using Puerto Rico as a tax haven to avoid paying their fair share. The Treasury Department must now take necessary action to ensure Act 20 and 22 support the people of Puerto Rico, and are not just another tax giveaway to millionaires and billionaires,” said Representative Alexandria Ocasio-Cortez (D-NY).

Requests for the Treasury

The letter goes on to make seven specific requests of the Treasury:

• Evaluate whether the Sec. 933 benefit should apply to individuals and firms that relocate from the States and obtain Acts 20 and 22 benefits;
• Examine the enforcement of Sec. 937 by the IRS and territorial officials;
• Determine whether Sec. 933 is accomplishing its purpose, specifically in the case of these avoiders of taxes in the States, or whether it should be amended;
• Calculate the revenue costs to the territorial government, as well as to the Federal, State, and local governments;
• Investigate how the Sec. 937 required 183 days a year presence in the territory requirement is being enforced by the IRS and the territorial government and the effectiveness of their monitoring;
• Analyze whether Sec. 937 should be amended to enhance its effectiveness; whether the territorial inheritance law exemption for Act 22 beneficiaries is adversely affecting Federal estate and generation-skipping taxation and whether U.S. law should be amended; and
• Consider whether the territory’s tax exemptions comply with the requirement in its constitution that taxes be uniform.