Wealthy foreigners have unique access to U.S. citizenship through the EB-5 Visa program. For many, investing $ 1 million in a US business may involve a green card and, two years later, citizenship. But as a major immigration treaty observes, “The US tax structure is the main disincentive to prospects. [immigrants]. ” Immigrants who accept EB-5 visas must also accept US taxation of their worldwide passive income.
However, for foreigners ready to spend half their time in Puerto Rico, the disincentive can largely disappear. Puerto Rico offers a range of tax incentives and the The IRS acknowledged the importance of “Puerto Rican efforts to retain and attract workers and businesses”.
By moving to Puerto Rico through the EB-5 Visa program, foreigners can obtain US citizenship at a reduced cost and pay taxes at a reduced rate.
As described of the USCIS, the EB-5 Visa program was created in 1990 to “benefit the US economy by providing an incentive for foreign capital investments that create or preserve US jobs.” Each year, up to 10,000 foreigners receive the green card and, in almost all circumstances, obtain US citizenship two years later.
Eligibility generally requires an equity investment of $ 1.05 million in a new or existing US firm and that such investment creates 10 or more US jobs. The investment threshold drops to $ 800,000 in rural and other areas suffering from high unemployment, including Puerto Rico. Investments can be made directly in a US company or pooled with other investments through regional centers.
In 2019, foreigners invested over $ 5 billion through the program. Almost 80% of the visas were granted to Asian investors and 96% were based on investments in regional centers.
Puerto Rico incentives
Relocating to Puerto Rico offers significant US tax advantages for immigrant investors, as well as continental Americans. More importantly, Puerto Rico residents pay substantially less tax on earnings from sales on world investments and business income earned in Puerto Rico. The benefits available also offer the opportunity to reduce the tax on income earned by mainland businesses managed in Puerto Rico.
Lower income taxes
Wealthy residents of the United States pay capital gains taxes at federal rates of 15% and 20%, plus state rates that sometimes add another 10%. That fee can crush the rate of return for even the best performing portfolio. And for anyone considering selling a valuable asset, that tax could cause them not to sell at all.
Moving to Puerto Rico can change the analysis. The gain accrued after the move is taxed at 0%, as seen in section 13 LPRA 45142 (b). The gain accrued before the move is taxed at 15% and only at 5% if resulting from a sale that took place more than 10 years after the move, as indicated in 13 LPRA Sections 30082 and 45142 (a). Therefore, foreigners who expect to sell substantial stock after moving to the United States can save substantial taxes by moving to Puerto Rico.
In particular, interest and dividends received from continental sources do not receive preferential tax treatment. This parallels the tax treatment of individuals in other countries. For US tax purposes, the source of that income is the position of the payer. The same goes for the gain on the sale of a property.
Professionals counseling immigrants should take note of the labyrinthine rules that allow for the above treatment via an exception to an exception to an exception. In general, the income from the sale of shares by US residents comes from IRC Section 865 (a) (1).
However, for purposes of the procurement rules, Puerto Rican residents are treated as non-residents. Therefore, the gain from the sale of shares by a Puerto Rican resident does not have a source in the United States. This rule is inapplicable unless the recognized capital gain is subject to a tax of at least 10% by a foreign country. Fortunately, the IRS does not apply that rule to Puerto Rican residents. Bona fide residents of Puerto Rico benefit from significantly reduced taxes on their capital gains.
Lower taxes on businesses
US business income is often taxed at a combined federal tax rate of 37%, resulting from corporation tax and dividend tax. State and local taxes can raise the total rate beyond 50%. Running the business in Puerto Rico, or even running it from Puerto Rico, can reduce corporate tax to 4% and dividend taxes to 0%.
For US tax purposes, a Puerto Rican company is treaty as a foreign company. Unless you establish a controlled foreign corporation, your income is not subject to United States corporation tax except for to the extent of its US source income. The limited liability companies in Puerto Rico are treated the same.
In general, Puerto Rican companies are subject to Puerto Rico corporation tax of 18.5% plus a tapered surcharge. And so are the dividends issued by Puerto Rican companies to Puerto Rican residents subject to a 15% tax. However, for different types of income and companies, the corporate rate is reduced to 4% and the dividend rate reduced to 0%.
This is true for export service companies, as noted in 13 LPRA Section 45241. An export service company is a company that provides unrelated Puerto Rico services to customers outside of Puerto Rico, see 13 LPRA Section 45221 It must also secure a decree approving its eligibility from the Puerto Rico Department of Economic Development and Trade.
The range of eligible services is incredibly broad. The statute explicitly lists generic services such as business consulting, research and development, as well as specific services such as training, data processing and call center services.
The management of businesses on the mainland is a particularly interesting service to offer. If the owner of a mainland business resides and owns a management business in Puerto Rico, he can convert high tax income into low tax income. The continental firm will deduct the Puerto Rican firm’s compensation for management services, reducing the continental firm’s net profit, which is taxed at normal US rates. The Puerto Rican management business will pay taxes on that compensation and distribute it, paying a total tax of only 4%.
“Royal residence” and opportunity
These benefits depend heavily on the taxpayer becoming a bona fide resident of Puerto Rico; see IRC sections 933 And 937. Generally, a taxpayer must reside in Puerto Rico for at least 183 days of the tax year, have no other tax location, and have no closer ties to the United States than Puerto Rico. The second of these rules applies the analysis for the deduction of travel expenses; see IRC Sections 937 (b) (2), 911 (d) (3)And 162 (a) (2).
The IRS, believing that a number of individuals have relied on Puerto Rico tax advantages without meeting these requirements, recently announced a formal campaign to address non-compliance. Anyone considering the use of these strategies should pay special attention to becoming a bona fide resident of Puerto Rico. Michael Hummel, CEO of Establish, which recently moved its headquarters to Puerto Rico, said: “We did well and our tax savings allowed us to reinvest heavily in our growth.”
Provided they truly relocate to Puerto Rico, they can take advantage of its substantial incentives. They will gain citizenship for 20% less through the EB-5 Visa program and, under the right circumstances, reduce their tax rate to 4% by more than 50%.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
About the author
Jeremy Babener is the founder of Structured Consulting and previously served in the US Treasury Office of Tax Policy. He deals with consulting for companies on strategy, partnership and marketing.
Roberto Santosis the president of Trusts & Taxes and advises clients on corporate finance, tax and immigration matters. He regularly helps clients identify and evaluate investment opportunities.
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