Wealthy foreigners have unique access to US citizenship through the EB-5 visa program. For many, investing $1 million in a US business can lead to a green card and two years later to citizenship. But as a leading immigration treatise notes, “the tax structure of the United States is the principal deterrent to future [immigrants].” Immigrants who accept EB-5 visas must also accept US taxation of their worldwide passive income.
However, for foreigners willing to spend half their time in Puerto Rico, the deterrent can largely disappear. Puerto Rico offers a range of tax incentives and The IRS recognized the importance of “Puerto Rico’s 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 lower cost and pay a lower tax rate.
As described by USCIS, the EB-5 Visa program was created in 1990 to “benefit the U.S. economy by providing an incentive for foreign capital investment that creates or retains U.S. jobs.” Each year, up to 10,000 foreigners receive green cards, and in almost all circumstances, they become US citizens two years later.
Eligibility generally requires a capital investment of $1.05 million in a new or existing U.S. business and that investment create 10 or more U.S. jobs. The investment threshold drops to $800,000 in rural areas and others suffering from high unemployment, including Puerto Rico. Investments can be made directly in US businesses or pooled with other investments through regional hubs.
In 2019, foreigners invested over $5 billion through the program. Nearly 80% of the visas were granted to investors from Asia, and 96% were based on investments in regional centers.
Puerto Rico incentives
Relocating to Puerto Rico offers significant US tax advantages for immigrating investors as well as mainland Americans. Most importantly, Puerto Rico residents pay significantly less tax on gains from sales of worldwide investments and business income earned in Puerto Rico. The benefits available also offer opportunities to reduce taxes on income earned by mainland businesses managed in Puerto Rico.
Lower income taxes
Wealthy US residents pay capital gains taxes at federal rates of 15% and 20%, plus state rates that sometimes add another 10%. This tax can crush the rate of return for even the best performing portfolio. And anyone considering selling a valuable business, this tax may convince them not to sell at all.
Moving to Puerto Rico may change the analysis. Capital gain accrued after relocation is taxed at 0% as seen in 13 LPRA Section 45142(b). The profit accrued before the move is taxed at 15% and only 5% if it results from a sale more than 10 years after the move as noted in 13 CPR Sections 30082 and 45142(a). Thus, expats who expect to sell significant stock after moving to the US can save significant taxes by moving to Puerto Rico.
It should be noted that 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, source of such income is the location of the payer. The same applies to profits from the sale of real estate.
Professionals advising immigrants must consider the maze-like rules that allow the above treatment by exception to exception to exception. Generally, gains from sales of shares by US residents come from IRC Section 865(a)(1).
However, for purposes of the procurement rules, residents of Puerto Rico are treated as non-residents. Thus, gain on sales of shares by a Puerto Rico resident has no US source. This rule is inapplicable unless the recognized gain is subject to tax of at least 10% by a foreign country. Fortunately, the IRS does not apply this rule for residents of Puerto Rico. Bona fide residents of Puerto Rico benefit from significantly reduced taxes on their capital gains.
Lower business taxes
U.S. business income is often taxed at a combined federal tax rate of 37% resulting from the corporate income tax and dividend tax. State and local tax can increase the total rate to over 50%. Operating the business in Puerto Rico or even managing it from Puerto Rico can reduce corporate taxes to 4% and dividend taxes to 0%.
For US tax purposes, a Puerto Rican corporation is treated as a foreign corporation. Unless it is a controlled foreign corporation, its income is not subject to US corporate income tax except to the extent of his US source of income. Limited liability companies in Puerto Rico are treated in the same way.
Generally, Puerto Rican companies are subject of Puerto Rico corporate tax of 18.5% plus graduated surtax. And dividends issued by Puerto Rican companies to residents of Puerto Rico are subject of 15% tax. However, for several types of income and companies, the corporate rate is reduced to 4% and the dividend rate is reduced to 0%.
This applies to export service companies as noted in 13 LPRA Section 45241. An export service company is one that provides non-Puerto Rico services to customers outside of Puerto Rico – see 13 LPRA Section 45221. It must also provide a decree approving her eligibility from the Department of Economic Development and Commerce of Puerto Rico.
The range of eligible services is incredibly broad. The charter specifically lists general services such as business consulting, research and development, as well as specific services such as training, data processing and call center services.
Managing a business on the continent is a particularly attractive service to offer. If the mainland business owner resides and owns a management business in Puerto Rico, he can convert high tax income into low tax income. The mainland business will deduct compensation from the Puerto Rican business for management services, reducing the net income of the mainland business, which is taxed at normal US rates. The Puerto Rican management business will pay tax on this compensation and distribute it, paying a total tax of only 4%.
“Real housing” and opportunities
These benefits depend largely on the taxpayer becoming a bona fide resident of Puerto Rico; see IRC Sections 933 and 937. In general, the taxpayer must reside in Puerto Rico for at least 183 days of the tax year, have no other tax home, and have no closer connection to the US than Puerto Rico. The second of these rules applies the travel expense deduction analysis; see IRC Sections 937(b)(2), 911(d)(3)and 162(a)(2).
The IRS, believing that a number of individuals have relied on tax credits in Puerto Rico without meeting these requirements, recently announced an official campaign to address the discrepancy. Anyone considering using these strategies should take special care to become a bona fide resident of Puerto Rico. Michael Hummel, CEO of Establish, which recently moved its headquarters to Puerto Rico, said, “We did it right and our tax savings allowed us to reinvest heavily in our growth.”
Provided one actually moves to Puerto Rico, one can take advantage of its significant incentives. They will receive citizenship for 20% less through the EB-5 Visa program and, under appropriate circumstances, will reduce their tax rate to 4% from over 50%.
This article does not necessarily reflect the views of The Bureau of National Affairs, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Information about the author
Jeremy Babener is the founder of Structured Consulting and previously served in the US Treasury Department’s Office of Tax Policy. He advises businesses on strategies, partnerships and marketing.
Roberto Santosis president of Trusts & Taxes and advises clients on corporate finance, tax and immigration. He regularly helps clients identify and evaluate investment opportunities.
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