In January of 2012, Puerto Rico passed Act No. 22, offering incentives for individuals to relocate to Puerto Rico. Other beneficial laws passed in 2012 ensured low maximum tax rates for new export services and businesses and for new banking and financial services.
Under the new law, Puerto Rico’s bona fide residents are guaranteed a 100% tax exemption on certain capital gains. The gains or losses from trading in securities and commodity are considered capital unless the trader makes a mark-to- market election under Sec. 475 which treats the gains and losses as ordinary income. Yet, contracts under Sec. 1256 can receive special treatment, applying only to traders who are treated as carrying on a trade or business. Dealers, on the other hand, regularly purchase securities and sell them to customers through the course of their business, representing a continuous regulation of inventory held primarily for resale. At the other end of the scale, investors do not participate in buying and selling securities, but rather buy and sell without affiliation.
Income Exclusion for Bona Fide Residents of Puerto Rico and their Qualifications
Generally, a U.S. citizen or resident remains subject to full federal income tax regardless of domicile. However, the internal revenue code details the specificities for an individual to be regarded as a bona fide resident. Firstly, the new bona fide resident must not have been a resident of Puerto Rico at any time during a 15 year period preceding the effective date of Act. Additionally, according to sec 937(a) and Regs. Sec. 1.937-1, the term “bona fide resident” pertains to a person who satisfies all three tests below (with each consisting of exception cases):
- Presence test: The taxpayer must be present for at least 183 days during tax year in Puerto Rico; yet, if a person’s fails to meet the above criteria, the requirement can also be satisfied by any of the following:
o Was present in Puerto Rico for at least 549 days during 3 year period consisting of tax year and two immediately preceding tax years, provided that the taxpayer was also present in Puerto Rico for at least 60 days during each of these years;
o Was present in the U.S. for no more than 90 days during tax year;
o Did not have more than $3,000 of earned income in U.S. and was present in Puerto Rico for more days than in the U.S.; had no significant connections to the U.S. during the tax year.
- Tax home test: The taxpayer must not have a tax home outside Puerto Rico during the tax year. This test is generally satisfied if the taxpayer’s regular or principle place of business is Puerto Rico. If the taxpayer does not carry on any trade or business, or does, but because of the nature of the trade or business, lacks a regular or principal place, the test is satisfied if Puerto Rico is the taxpayer’s regular place of abode in a real and substantial sense. The IRS uses the following factors to determine the taxpayer’s tax home if he or she does not have a regular or main place of business or work:
o The individual performs part of his or her business in the area of his or her main home and uses that home for lodging while doing business in the area;
o The individual has living expenses at his or her main home that are duplicated because the business requires the individual to be away from that home; and/or
o The individual has not abandoned the area in which both his or her historical place of lodging and claimed main home are located; the individual has a family member or members living at the main home; or individual often uses that home for lodging.
If an individual satisfies all three factors, the tax home is the home where he or she regularly lives. If he or she satisfies only two factors, the individual might have a tax home, depending on all the facts and circumstances. If the individual satisfies only one factor, he or she is an itinerant; the tax home is wherever he or she works.
- Closer-connection test: The taxpayer must not have a closer connection to the United States or a foreign country than to Puerto Rico. The regulation requires that connection of the taxpayer with Puerto Rico, the U.S., and any foreign country should be compared in the aggregate, considering facts and circumstances including location of the taxpayer’s:
o Permanent home; family; personal belongings; personal banking activities; business activities (other than those that constitute his or her tax home); jurisdiction in which he or she holds a driver’s license; jurisdiction in which the taxpayer votes; residence designated on forms and documents; and official forms and documents filed by the taxpayer.
Year of the Move to Puerto Rico
An individual who is a bona fide resident of Puerto Rico during the entire tax year excludes, from gross income for U.S. federal tax purposes, the income derived from sources within Puerto Rico except amounts received for U.S. or agency employee. Again, special rules apply to determine whether the tax home and the closer connection tests are satisfied for the tax year in which the individual relocates to Puerto Rico and confirms the status of a bona fide resident. An individual is eligible to take advantage of these rules if:
- The individual has not been a bona fide resident of Puerto Rico during each of the three tax years preceding the year of the move;
- During the second half of the year of the move, the individual has not has a tax home in, or closer connection to the United States or a foreign country; and
- The individual has been a bona fide resident of Puerto Rico for each of the three years following the year of the move to Puerto Rico.
If the conditions are met, the individual will have satisfied both the tax home and closer-connection requirements for the whole year of the relocation, enabling the benefits of a Puerto Rico-source income.
Trading in U.S. Securities and Commodities by Puerto Rican Residents
Bona fide residents who trade securities and commodities can continue to trade among U.S. markets without merging the income to the U.S. if conditions are met in accordance to the following safe-harbor rules.
The term “engaged in trade or business within the United States” does not include effective transactions in the United States in securities or commodities through independent agents and only applies to taxpayers, except during specific periods throughout the tax year in which the transactions in stocks or securities are affected.
The term “engaged in trade or business within the United States” also does not include effecting transactions in the United States in securities or commodities for the taxpayer’s own account, irrespective of whether such transactions are effected.
A foreign individual, partnership, estate, trust or corporation that effects transactions in the U.S. in stocks or securities for the partnership’s own account or such for the account of such partnership.
These new tax incentives, applicable to new residents and businesses and available under Puerto Rican tax law, in combination with U.S tax provisions, makes it worth considering relocation. If you are interested in learning more about tax advantages for U.S. traders relocating to Puerto Rico and/or how it may affect you, then please contact Larry Horwitz at firstname.lastname@example.org.
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