Introduction to Act 22 Tax Incentives
Act 22, The Individual Investors Act, provides 100% exemptions on interest, dividends and certain capital gains to eligible applicants who become bona fide Puerto Rico residents.
By attracting higher net-worth residents, Puerto Rico hopes to stimulate the economy with real estate investments, job creation, and general use of local services in addition to simulating the banking sector with capital injections.
Moving to Puerto Rico
Unlike other “tax shelters,” like Singapore or the Cayman Islands, when you become a resident of Puerto Rico you maintain your U.S. citizenship. In addition, you are not required to pay a painful 23.8% exit tax of your unrealized capital gains.
Even though Puerto Rico is a U.S. territory, Section 933 of the Internal Revenue Code of the United States of 1986 (the “US Code”), determines bona-fide residents are exempt from federal tax. By becoming a Puerto Rico resident, they are only subject to federal income taxes on income derived from sources outside of Puerto Rico.
What are the Act 22 benefits?
Qualified individuals are granted a decree that lasts until 2036 providing:
- 100% tax exemption from Puerto Rico income taxes on dividends
- 100% tax exemption from Puerto Rico income taxes on all interest
- 100% tax exception from Puerto Rico income taxes on all short-term and long-term capital gains accrued (after establishing residency)
- In addition, by investing through certain investment vehicles like Trusts, the tax rate applied on interest and dividend capital gains income may be reduced to 0% or 10%, respectively, if it is coming from sources outside of Puerto Rico.
More on Capital Gains
While capital gains derived after becoming a Puerto Rico resident are 100% tax exempt, Resident Individual Investors also receive preferential income tax rates. The following explains the breakdown in more detail:
- Investment income accrued prior to becoming a bona fide resident of Puerto Rico (Non-PR Gain) will be taxed at 10% if realized within 10 years after residency establishment and prior to January 1, 2036. If the gain is realized after the 10 years and prior to January 1, 2036 the tax is 5%.
- Capital gains appreciation on investments that occur after becoming a bona fide Puerto Rico resident can be apportioned to Puerto Rico. Thus the gain qualifies for Act 22 and is taxed at 0%.
- For long term capital gains related to appreciation on investment assets acquired prior to becoming a bona fide resident of PR, The PR tax will be 15% on capital gains realized within 10 years of becoming a PR resident and 5% after 10 years, but before January 1st, 2036.
- All other capital gain on appreciation not addressed in the rules above are subject to a 15% tax rate. However, there may be other ways to reduce the tax rate applied on capital gains due in the US to 0%, 5% or a maximum 10%.
Do I qualify for Act 22?
To reap the benefits of Act 22 in 2016, you must become a bona fide resident of Puerto Rico (new criteria from Act 187-2015 included). To become a bona fide resident, you must pass 3 tests:
– Presence test
– Tax home test
– Closer connection test
Explained in more detail, residents need to meet this criteria:
- Become a bona fide resident on or before the taxable year ending December 31, 2035
- You must not have been a resident of Puerto Rico 6 years prior to the effective date of the Act, January 17, 2012.
- You must be present on the island at least 183 days or half the taxable year
- You must not have a primary tax home outside of Puerto Rico
- You are required to purchase residential property in Puerto Rico within 2 years of residency
- You must show evidence of primary business and personal bank accounts in PR
- You need to satisfy several closer connection guidelines
What are the closer connection requirements?
There are several factors that determine connection to the United States during a tax year and the review process weighs each case individually. In general, you will meet the closer connection requirements if you:
- Do not have a permanent home in the United States
- Have a Puerto Rico voters registration
- Have your spouse and/or children under the age of 18 (if any) not live in the US. This does not include children of a divorce or legal separation or children in the US as students.
- Have your child (children) in school in Puerto Rico, if any.
Other factors come into account such as selling your home and cars in the United States, the location of your belongings, your social/political organizations, address listed on official documents and others.
183 Days – Presence Test in Detail
There’s a little wriggle-room in the half-year resident requirement. To pass the Presence Test, only 1 of 5 of the criteria below needs to be met.
– You must be present in Puerto Rico for 183 days of the tax year; or
– you must be present in Puerto Rico for 549 days during the 3 years including the current tax year and the 2 preceding years; or
– you must be present in the U.S. no more than 90 days during the tax year; or
– have no more than $3,000 of earned income in the U.S. and present in P.R. more than U.S.; or
– have no significant connection to the U.S. in the tax year.
Travel days are considered as a day of presence. For example, if you have a meeting in the U.S. and stay overnight, returning the following day, your travel day (leaving) and return day (arriving) count as days of presence in Puerto Rico.
Travel accompanying a parent, spouse or child undergoing medical treatment requiring in-patient care is considered and day of presence in PR.
In addition, travel days in transit between two points outside the US, days spent as a student within the US, days spent in the US serving as an elective PR representative and days spent in another US possession — such as the US Virgin Islands – count as a day of presence…(read more at PR Business Link)