Puerto Rico vs. U.S. taxation
Similar but different
When considering relocating to Puerto Rico one of the first things people note is that Puerto Rico is an unincorporated “US Territory”. Puerto Rico, along with a number of smaller sister islands including Mona, Culebra and Vieques, is governed by the U.S. Congress, but has its own local constitution and elects local government officials.
Those born in Puerto Rico are US citizens, and if you are born in the US and then become a resident of Puerto Rico, you will of course still be a citizen of the United States. However, once you move to Puerto Rico and become a bona fide resident, you will not be able to cast a vote for US President or other elected US officials. So while Puerto Rico is very close to living in the US, there will be other changes to your status.
Taxes in Puerto Rico are different too
Yes, the nuances of implications of Puerto Rico being an overseas territory versus a US state can be a bit confusing! Tax laws are no different.
As a US territory, Puerto Rico has the benefit of US statutory laws, court systems, and banking systems. However, with regards to taxation Puerto Rico is treated as a foreign country, with a few notable exceptions.
Let’s take a quick look at what US taxes you would still be responsible for, versus what taxes specific to Puerto Rico you will now be privy to.
No Filing US Federal Taxes
Tax Season. Happy times, right? Though we hate to take away the joy of filling out your annual Forms, please be aware that once you move to Puerto Rico, you will no longer be required to file a federal income tax return.
Yes, that’s right.
Once you reside in Puerto Rico for the entire tax year, if your only income is from sources within Puerto Rico, you are not required to file a US federal income tax return. However, if you are earning income outside of Puerto Rico – including in mainland USA – you will still need to continue to file that US return.
Puerto Ricans and residents of Puerto Rico are required to pay some U.S. federal taxes, like Medicare and social security,but most residents do not have to pay the federal personal income tax. In general, Puerto Ricans and US citizens who reside in Puerto Rico don’t file federal income tax returns, unless they work for the Federal government.
No worldwide taxation or Exit / Repatriation Tax
The United States is the only country other than Eritrea with a worldwide income tax. Which means US citizens must file and pay taxes whether they reside in the US or not.
The only option for US citizens living abroad is to renounce their citizenship. If you choose this path, you will no longer have to file federal taxes. However, you may need to pay a hefty expatriation tax of as much as 23.8% of your unrealized capital gains when you move to a so-called “tax haven.” That’s a big price you won’t have to pay when you move to Puerto Rico.
OK… so what taxes do I need to pay?
The island imposes a separate local Puerto Rico income tax in place of typical US federal income tax. The personal income tax rate in Puerto Rico is up to 33%. This is applicable to wages regardless of having an Act 20 or Act 22 decree. However, individual investors with an Act 22 decree are exempt from paying taxes on dividends and Capital gains, which could otherwise be as high as 20% for long-term and 39.6% for short-term capital gains.
As mentioned, Puerto Rico residents who earned income from sources outside Puerto Rico are subject to taxes on that portion of their income. Also, if you are not bona fide residents of Puerto Rico during the entire tax year you are required to report all income on your U.S. income tax return.
Consulting an expert accountant familiar with Puerto Rico tax benefits will help you determine your tax obligations.
What about corporate taxes in Puerto Rico?
The corporate tax rate in Puerto Rico is 39%. That may seem high, but in truth, your corporate income tax can be as low as 4% if you qualify for certain tax incentives. This applies whether you have a corporation in Puerto Rico and the 4% is taxed at the corporate level before dividends are paid, or you have a pass through LLC in which you pay 4% on distributions. Considering your (federal plus state) taxes can amount to about 40% while residing in the US, 4% is pretty spectacular tax savings.
The low 4% corporate tax rate available to Act 20 recipients only applies if the business performs in Puerto Rico for clients outside of Puerto Rico—otherwise a higher local income tax may be applicable, and may be almost as high as some US states. Please refer to our Act 20 Guide.
Similarly to personal income earned from sources outside of Puerto Rico, corporations in Puerto Rico are subject to regular U.S. tax rates on their income effectively connected to a trade or business in the United States.
When operating a Puerto Rico corporation, care should be exercised as to the possible applicability of U.S. Internal Revenue Code provisions related to controlled foreign corporations, passive foreign investment companies, and foreign personal holding companies. Learn more about Transfer Pricing for related companies and what the implications of both the US and Puerto Rico trying to capture your tax dollars.
What are you waiting on?
As far as taxation goes, Puerto Rico offers the best of both worlds – keeping your US citizenship, and simultaneously avoiding the high taxes that usually comes along with said citizenship.
Making the leap can be rewarding in a big way – for your lifestyle and financially – but also tricky to navigate. We encourage you to consult a Tax Consultant to help you make the right decision.