Prepare to Defend Against Puerto Rico Civil & Criminal Tax Audits

Prepare to Defend Against Puerto Rico Civil & Criminal Tax Audits

Defending Against Puerto Rico Civil and Criminal Tax Audits

Over the past few years, the U.S. government has taken issue with Puerto Rico Act 60, previously Acts 20/22. The Puerto Rico Act 60 is designed to help boost the Puerto Rico economy after suffering years of natural disasters and other economic issues. There are many aspects to Puerto Rico Act 60, but our focus will be on the individual investor who wants to move to Puerto Rico, become a Bona Fide Resident, qualify for Act 60, and avoid taxes by the Puerto Rico government on certain Puerto Rico sourced income. As you may imagine, many wealthy taxpayers have taken advantage of this opportunity and unfortunately now may find themselves in the crosshairs of the IRS — who recently let it be known that there are 100 potential civil and criminal tax fraud cases involving wealthy American Taxpayers in Puerto Rico.

Let’s look at the basics of how the Act works and what taxpayers may be able to do to avoid potential harsh consequences.

Worldwide Income

The United States follows a worldwide income tax model. That means that taxpayers who are considered to be US persons for tax purposes are required to pay taxes on their worldwide income. This is true, whether the taxpayer resides in the United States or abroad and whether the income is sourced from overseas or in the United States. But, there are some nuances for Taxpayers who reside in certain territories, such as Puerto Rico. If a taxpayer qualifies as a bona fide resident of Puerto Rico Puerto Rico-sourced income is not taxed in the United States but is instead taxed in Puerto Rico. This made Puerto Rico Act 60 a great opportunity to lure US persons seeking to reduce their tax liability.

How Act 60 (20/22) Works

Let’s take a basic example for illustrative purposes only. John is a U.S. citizen who wants to reduce his income tax liability and generates all his income from investments. John does not want to expatriate from the United States and renounce his U.S. citizenship — so obtaining a Golden Visa would not be helpful to him. And, since John is a U.S. citizen, he is limited in making a treaty election to be treated as a foreign resident for tax purposes. Instead, John applied for and was accepted into the Puerto Rico Act 60 program. Under the program, most capital gains generated after becoming a resident of Puerto Rico along with dividends and other passive income are not taxed by Puerto Rico. Presuming that the income is Puerto Rico sourced, the United States would not be able to tax that income either if the taxpayer qualifies as a Bona Fide Resident of Puerto Rico — under the very strict IRS rules. Especially in the world of cryptocurrency and other new investment types, having wealthy taxpayers move to Puerto Rico and take advantage of Act 60 – further increases the tax gap in the United States.

Some Democrats Disagree with PR Act 60

Back in early 2023, a few Democrats banded together to write a letter seeking to have the IRS go after taxpayers who are paying significantly reduced tax because they reside in Puerto Rico — which is both unfair to taxpayers in the United States as well as causing displacement for families in Puerto Rico since with wealthy residents flock to a new location, it tends to inflate real estate prices and values. 

Here is a portion of the letter below:

      • “We write to request that the Government Accountability Office (GAO) conduct an assessment of provisions relating to certain tax breaks provided to individuals and businesses in Puerto Rico under Puerto Rico’s Act 60 of 2019. Specifically, those provisions that exempt individuals from almost all local taxation on Puerto Rico-sourced income if they “reside” on the island for a majority of the year and make minimal economic contributions to the territory. We request that the GAO review these provisions because we are concerned that they have not benefited the people of Puerto Rico and may have led to significant tax avoidance by wealthy individuals “residing” on the island.”

What Puerto Rico Resident Taxpayers Should Do

Taxpayers who are currently living in Puerto Rico and paying little to no tax because they qualified under Puerto Rico Act 60 should be aware that the Internal Revenue Service is currently launching several criminal and civil tax investigations. In addition to the tax issues, there are ancillary issues as well, such as whether the taxpayers are properly reporting their foreign accounts, assets, and investments– because living in Puerto Rico still qualifies as being a U.S. person and so international information reporting on forms such as the FBAR, FATCA Form 8938, Form 5471, and Forms 3520/3520-A are still required.

Some Taxpayers may want to consider getting into compliance proactively by submitting to one of the Offshore Disclosure Programs if they have issues involving foreign accounts, assets, and investments as well — or consider the voluntary disclosure program or reasonable cause as well depending on their specific facts and circumstances.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms and do not qualify for an exception or exclusion to FBAR filing, 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.