U.S. international tax planning for bona fide residents of Puerto Rico.

• Author: Rubinger, Jeffrey L.
• Position: Tax Law

United States taxpayers who are bona fide residents of Puerto Rico are subject to a favorable tax regime. Section 933(1) excludes from U.S. federal income tax income derived from sources within Puerto Rico. (1) In addition, under Puerto Rico's Individual Investors Act (Act 22), these taxpayers are provided with a 100 percent exclusion from Puerto Rican income tax for all interest, dividends, and capital gains (to the extent such gains accrue after the person becomes a resident of Puerto Rico). These benefits are available to bona fide residents of Puerto Rico even though they remain U.S. taxpayers for all other purposes. Furthermore, Puerto Rican corporations are only subject to a 4 percent corporate income tax on both export services income under the Export Services Act (Act 20) and financial services income (such as interest and royalties) under the International Financial Center Regulatory Act (Act 273).

Additional benefits are available to bona fide residents of Puerto Rico who own shares of corporations organized in Puerto Rico. These benefits include a complete exemption from the U.S.-controlled foreign corporation (CFC) rules and the passive foreign investment company (PFIC) rules with respect to their ownership of Puerto Rican corporations. As a result of the "check the box" rules, these exemptions may be extended to income derived in foreign jurisdictions other than Puerto Rico (including U.S.-source, treaty-benefitted income) without that income being subject to tax in the U.S. Finally, with proper planning, it may be possible for bona fide residents of Puerto Rico to repatriate profits in the form of tax-free dividends even if only a de minimis portion of those profits are attributable to earnings that have accrued in Puerto Rico.

Bona Fide Residents of Puerto Rico

A U.S. taxpayer who is a bona fide resident of Puerto Rico for an entire taxable year is able to exclude from U.S. federal income tax under [section] 933(1) Puerto Rican-source interest and dividends, and (possibly) worldwide capital gains. (2) This income also would be excluded from Puerto Rican income tax. A person will be considered a bona fide resident of Puerto Rico for a particular taxable year only if such a person 1) satisfies the presence test; 2) does not have a tax home outside Puerto Rico during the year; and 3) does not have a closer connection to the United States or a foreign country than to Puerto Rico for that tax year. (3)

An individual will be considered to meet the presence test if one of five tests is met: 1) The individual is present in Puerto Rico for at least 183 days during the taxable year; 2) the individual is present in Puerto Rico for at least 549 days during the three-year period consisting of the current taxable year and two immediately preceding taxable years, provided that the individual is present in Puerto Rico for at least 60 days during each of those years; 3) the individual is present in the U.S. for no more than 90 days during the taxable year; 4) during the taxable year, the individual had earned income (meaning wages, salary, professional fees, and compensation for personal services actually rendered) of less than $3,000 and was present for more days in Puerto Rico than the U.S.; or 5) the individual had no significant connection to the U.S. during the taxable year. (4) A person's tax home is considered to be located at his or her "regular or principal place of business." If, due to the nature of an individual's occupation (or because the individual does not carry on a trade or business), the individual does not have a regular or principal place of business, then the person's tax home is his or her regular place of residence. (5)

The closer connection test is a facts and circumstance test. An individual is considered to have a closer connection to Puerto Rico than the U.S. if such individual maintains more significant contacts with Puerto Rico than the U.S. Nine nonexclusive factors are listed as relevant to the determination as to whether an individual maintains a closer connection to Puerto Rico: 1) the location of the individual's permanent home (determined in the same manner as under the presence test); 2) the location of the individual's family; 3) the location of personal belongings, such as automobiles, furniture, clothing, and jewelry owned by the individual and his or her family; 4) the location of social, political, cultural, or religious organizations with which the individual has a current relationship; 5) the location where the individual conducts his or her routine personal banking activities; 6) the location where the individual conducts business activities (other than those that constitute the individual's tax home); 7) the location of the jurisdiction in which the individual holds a driver's license; 8) the location of the jurisdiction in which the individual votes; and 9) the country of residence designated by the individual on forms and documents. (6)

As noted above, the [section] 933 exclusion applies only if the taxpayer is a bona fide resident of Puerto Rico for the entire taxable year. In other words, the exclusion applies only if residence is established on the first day of the year. (7) If the individual...