Tax Incentives For Residents And Investors In Puerto Rico

A reader got in touch last week to ask about the “new” Puerto Rico tax incentives program that everyone in the offshore world (as well as Forbes magazine) has been chattering about the last few weeks. I responded to explain that, first, I covered the topic last year in my Simon Letter service…and, second, this isn’t the big deal that some are making it out to be.

The truth is, the incentives aren’t of interest for most people. U.S. citizens resident in Puerto Rico are exempt from U.S. federal income tax. That’s no different than living in another country and being eligible for the Foreign Earned Income Exclusion (FEIE). However, proving legal residency in Puerto Rico to be eligible for the federal tax exemption is slightly more onerous than qualifying for the FEIE. You can’t simply have residency and get the exemption.

In addition to the standard requirement of having an actual residence, you have to be in Puerto Rico for at least 183 days out of 365 (which technically makes you a tax resident regardless of any other status you may have). Again, that’s more of a hurdle than FEIE bona-fide residency status. Qualifying as a bona-fide legal resident of another country for the purposes of the FEIE, you aren’t subject to any restrictions or requirements to do with how long you are in that country. The key is that you are required to pay taxes in that country, have a place to live in that country, and tick some other boxes that prove you’re actually a resident of that country. No specific amount of time spent in the country is mandated.

Therefore, you could be a bona-fide resident of, say, Malaysia but spend only a couple of months in that country each year and travel the world the rest of the time…even spending several months in the United States. Your FEIE status would remain intact. Of course, if you’re qualifying for the FEIE based on the “Days Test,” whereby you have to be in a foreign country for at least 330 days in a year, then you do have a “days” restriction—specifically, you cannot be in the United States and/or in international waters more than 35 days a year. The other tax benefit that Puerto Rico is offering new residents is an exemption from tax on passive income (that is, dividends and capital gains, except those from day-trading).

Tax incentives for business-owners in Puerto Rico aren’t residency-based. Start a services business (consulting, engineering, etc.) in Puerto Rico and you’ll pay only 4% income tax on the profits and no taxes on dividends the company pays out to you—again, regardless of your residency status. Operating a business in other industries from tourism to film, agriculture, and manufacturing also qualifies you for various tax incentives.

These incentives could be appealing if you want to start a business for which Puerto Rico offers everything else you need for success…materials, labor, etc. Of course, many countries offer similar tax incentives for entrepreneurs and investors. Tourism businesses, for example, can qualify for tax-free status in dozens of countries, including Panama and Nicaragua. And export zones where you can bring in goods, process them, and re-export them without paying duty coming or going exist in Belize, Panama, the Dominican Republic, and Nicaragua.

If you’re interested in running a business that would export to the United States, the Puerto Rico tax-incentives program could be interesting to you, as it’d allow you to avoid U.S. import duties. Remember, though, that Panama and Colombia have free-trade treaties in place with the United States and could offer better options. Puerto Rico is getting a lot of good press right now out of legislation passed in 2012. Don’t jump on the fad wagon. Review the specifics of the opportunity as well as other available country options before buying a ticket for San Juan.

Lief Simon