How are Retirement or Pension Plans Taxed in Puerto Rico?

Are Your Retirement or Pension Plans Taxed in Puerto Rico?

Are Your Retirement Plans Taxed in Puerto Rico?

When an individual is considered a US person for tax purposes, that means that the United States has a right to tax them on their worldwide income. From a baseline perspective, it does not matter if the taxpayer resides in the United States or resides outside of the United States. Likewise, it also does not matter if the income is sourced from the United States or sourced abroad.  The tax status of the person though may impact the overall tax liability. That is because depending on whether the U.S. person is a U.S. citizen or resident can impact whether or not they may be able to apply certain treaty elections when they reside in a foreign country, or the income is sourced from a foreign country. When it comes to Puerto Rico, the rules are different. That is because technically Puerto Rico is not a different country from the United States and in some tax scenarios is considered part of the United States. The question then becomes whether a retirement plan is taxed by Puerto Rico.

Sourcing Rules: Puerto Rico Pension vs. Non-U.S. Pension

When it comes to retirement, there are many different types such as public versus private and employment versus non-employment. But, from a baseline perspective, when it comes to taxation a key important point is to determine whether or not it is a pension that is sourced from the mainland in the United States or whether it is from Puerto Rico. That is because of a resource from Puerto Rico and the taxpayer qualifies as a Bona Fide Resident of Puerto Rico, then they may qualify to not have to pay US taxes on that Puerto Rico retirement income.

Not a Bona Fide Resident of Puerto Rico

When a person is not considered a bona fide resident of Puerto Rico, the tax filings can be complicated. That is because depending on what the sourcing rules are for the specific type of retirement income that will determine whether the taxpayer has to file a Form 1040 or if they have to file a form 1040 and a Puerto Rico tax return as well.

As provided by the IRS:

• • • “An individual who is not a bona fide resident of Puerto Rico for the tax year may have to file tax returns with both Puerto Rico and the United States. U.S. citizen or resident alien. If you are a U.S. citizen or resident alien but not a bona fide resident of Puerto Rico during the tax year, you must generally file the following returns.

      • A Puerto Rico tax return reporting only your income from Puerto Rico sources. Wages for services performed in Puerto Rico, whether for a private employer, the U.S. government, or otherwise, are income from Puerto Rico sources.

      •  A U.S. tax return reporting income from worldwide sources. Generally, you can claim a foreign tax credit for income taxes paid to Puerto Rico on the Puerto Rico income that is subject to Puerto Rico taxes and not exempt from U.S. taxes.”

Bona Fide Resident of Puerto Rico

If the taxpayer qualifies as a Bona-Fide Resident of Puerto Rico, then the rules are different. In this type of situation — presuming that the taxpayer can meet the stringent requirements of being considered a bona fide resident of Puerto Rico — then they may be able to avoid U.S. taxation on their Puerto Rico-sourced income. 

26 U.S.C. Section 933

• • • ‘The following items shall not be included in gross income and shall be exempt from taxation under this subtitle:

      • (1) Resident of Puerto Rico for entire taxable year:

        • In the case of an individual who is a bona fide resident of Puerto Rico during the entire taxable year, income derived from sources within Puerto Rico (except amounts received for services performed as an employee of the United States or any agency thereof); but such individual shall not be allowed as a deduction from his gross income any deductions (other than the deduction under section 151, relating to personal exemptions), or any credit, properly allocable to or chargeable against amounts excluded from gross income under this paragraph.”

IRS Publication 1321

• • • “Who Must File

      • In general, section 933 of the U.S. Internal Revenue Code requires that U.S. citizens who are bona fide residents of Puerto Rico during the entire taxable year, but who receive income from sources outside Puerto Rico and/or receive income as a civilian or military employee of the U.S. Government in Puerto Rico, must file a U.S. Federal income tax return. The income you receive from Puerto Rico sources is not subject to U.S. income tax. Because some of the income is exempt (under Code section 933) a part of the itemized deductions or a part of the standard deduction amount on your U.S. return must be allocated to that exempt income. This computation must be made before you can determine if you must file a U.S. tax return, because the minimum income level at which you must file a return is based on the standard deduction for your particular filing status.”

Nonresident Alien

For taxpayers who are considered non-resident aliens of the United States, the tax rules are different. That is because they are not subject to U.S. tax on their worldwide income, but rather only subject to U.S. tax on their US sourced income. Likewise, they may also have to pay taxes on Puerto Rico income as well.

As provided by the IRS:

• • • If you are a nonresident alien of the United States who does not qualify as a bona fide resident of Puerto Rico for the tax year, you must generally file the following returns.

      • A Puerto Rico tax return reporting only your income from Puerto Rico sources. Wages for services performed in Puerto Rico, whether for a private employer, the U.S. government, or otherwise, is income from Puerto Rico sources.

        • A U.S. tax return (Form 1040-NR) according to the rules for a nonresident alien. See the Instructions for Form 1040-NR.

FBAR and FATCA

Taxpayers who have foreign retirement plans are still required to file international information reporting forms such as FBAR and FATCA, even if they reside in Puerto Rico.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.