Moving to Puerto Rico Does Not Solve U.S. Tax Problems

Why Moving to Puerto Rico Does Not Solve U.S. Taxation

Moving to Puerto Rico Does Not Solve American Taxation

The United States is one of the only countries across the globe that taxes individuals based on their citizenship (although more accurately, their ‘U.S. Person Tax Status’) and not their resident status specifically. In other words, even if a U.S. person lives abroad, they are still taxed on their worldwide income. Unlike the U.S., most countries only tax individuals on their worldwide income when they are a resident of that country for at least six months in the tax year, but the U.S. government works differently. While technically it is referred to as Citizenship-Based Taxation, the U.S. tax rules apply to any U.S. person who qualifies as a U.S. person for tax purposes, which includes U.S. Citizens, Lawful Permanent Residents, and Foreign Nationals who meet the Substantial Presence Test. As we have written about before, some taxpayers may want to expatriate to give up their U.S. person status but ultimately find that whether it is because their family members will remain in the United States or the exit tax is just too overwhelming, it is not feasible to exit the United States from a tax perspective. Instead, some taxpayers consider moving to Puerto Rico and becoming a Bona Fide Resident of Puerto Rico to avoid U.S. tax, but that too is usually not feasible for most people. Let’s walk through some of the basics about why moving to Puerto Rico does not solve your US tax issue.

Puerto Rico Bona-Fide Residence Test

First, it is important to note that to make Puerto Rico a taxpayer’s home base, they must be considered a Bona Fide Resident of Puerto Rico — and that requires the taxpayer to live in Puerto Rico for a significant amount of time and show significant/substantial contacts with the territory. Just visiting Puerto Rico a few months out of the year is not going to be sufficient to meet the Bona Fide Resident test. In addition, acquiring real estate in Puerto Rico can be costly and there are other taxes involved as well, so from a baseline perspective, it is important to note that Taxpayers will have to have some form of permanent residence in Puerto Rico.

To Exclude Income it Must be PR Sourced Income

Not all income that Taxpayers earn while living in Puerto Rico is exempt or excluded from U.S. tax. Rather, it is limited to income that is Puerto Rico-sourced. There are very specific rules to make sure that the income is sourced in Puerto Rico and most of the time taxpayers will have other sources of income that are not covered under the Puerto Rico sourcing rule and that income will still be taxable by the U.S. government and the taxpayer will still be required to file annual U.S. tax returns.

Prior Asset Gains Still Taxable

We have had taxpayers reach out to us letting us know that some tax promoters are making it seem like if they moved to Puerto Rico they can sell their assets for no capital gains, but that is not how the process works. Typically, to gain the benefit, the taxpayer must qualify under Puerto Rico Act 60 which comes with a whole host of specific requirements that the taxpayer must meet to qualify for the program. In addition (and even under PR Act 60), while potentially some new assets acquired after moving to Puerto Rico that are considered Puerto Rico sourced and can avoid U.S. tax when they are sold, the majority of assets will still be taxable by the U.S. government.

Foreign Income is Taxable Too

Many taxpayers who are considering moving to Puerto Rico already have various sources of passive income both from the United States and abroad. It is important to note, that just living in Puerto Rico will not make income from a foreign country (or U.S. sourced income) sourced as Puerto Rico sufficient to avoid US tax. Stated another way, taxpayers who are considered U.S. persons for tax purposes but have income sources from outside of the United States would still have to pay U.S. tax on that income under the worldwide taxation rules even though they may live in Puerto Rico.

Still have to File FBAR, 3520, etc.

Puerto Rico is considered a territory for U.S. tax purposes. Thus, for some purposes, it may be a benefit because accounts located in Puerto Rico are not subject to FBAR — because they are not considered foreign accounts (similar to accounts located in Guam). Conversely, when a person resides in Puerto Rico, they are still considered a U.S. person and still have to file the FBAR and report their foreign accounts.

Just Move to Puerto Rico with Only Crypto Accounts?

We have taxpayers who reach out to us letting us know that some tax attorneys make it seem like they can just open foreign crypto accounts and that crypto accounts are going to be exempt from reporting. What is important to note, is that while crypto accounts may not (yet) be reportable for the FBAR, crypto/hybrid accounts are still reportable and most crypto accounts that have active trading have a cryptocurrency component as well as a ‘foreign dollar/cash’ component and thus those accounts are reportable as well. So taxpayers looking to move to Puerto Rico solely to avoid taxation on crypto gains should be aware that not only will most of the crypto still be taxable but the reports may be reportable as well.

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. 

This resource may help taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

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.