By now it should already be well that I grew up in the Panama Canal Zone. However, my Latin "thing" didn't happen until I was in the 10th grade. One of my football teammates played congas in a Salsa band in Panama City. Another baseball teammate and friend whose parents were Puerto Rican and Panamanian (the perfect genes for being a Salsero!) was a huge fan of the Fania All-Stars. The Fania All-Stars were a gathering of the best recording acts in Afro-Cuban (Aka Salsa) signed with the Fania record label. In the decade of the 1970s, anybody who was anybody in Afro-Cuban music (aka Salsa) was signed with Fania Records.
One of my big regrets as a cadet at West Point was missing the opportunity to see the Fania All-Stars perform at Madison Square Gardens, the night before I went home for Christmas break. For the record, I met Celia Cruz when she was alive and saw her perform in Miami and the Bronx with Johnny Pacheco and Tito Puente. The Bronx concert should get me extra credit! I have corresponded with Willy Colon. Are you impressed yet? One of the best things was seeing my older brother Willy move on Jimmy Hendrix to discover this great music. If you love horns, it does not get better than classic salsa. For exceptionally great horns, I urge you to listen to Orquesta de la Luz, a salsa band from Japan that was the rage in the decade of the 1990s.
This article focuses on a combination of techniques, the use of a Puerto Rican tax-exempt company and the loan method of split dollar life insurance. What’s different in this approach is the fact that the business owner does not need to relocate to Puerto Rico. However, I am not going to trace the path the way that I usually do in my articles to legally accomplish the tax benefits of Puerto Rico without relocation. This information is the “secret sauce” that taxpayers need to pay for. Nothing personal, just business! The combination of the loan method of split dollar provides a mechanism for repatriating profits from the Puerto Rican tax exempt company to a trust-owned life insurance for the taxpayer’s benefit.
Puerto Rican Tax Incentives
Puerto Rico has always benefited in the past from offering corporations a myriad of tax incentives for creating Puerto Rican operations. Puerto Rico has played an important part in the global tax planning of many large multinational corporations particularly pharmaceutical companies. Large corporations have effectively utilized double tax treaties for decades to minimize their global taxation. Double tax treaties have facilitated foreign taxpayers in their inbound investments within the United States. However, American individual and small business taxpayers have not had the same opportunity to utilize offshore corporations due to the tax rules dealing with controlled foreign corporations and passive foreign investment companies and foreign trusts. The U.S. government has tried to find and close all offshore planning opportunities.
The case of Puerto Rico is an interesting one. As a commonwealth, the Island has always teetered between statehood and independence. More recently, a combination of devastating events including the Island's bankruptcy, a hurricane and Covid 19, Puerto Rico is still standing tall and fighting for its survival. The Puerto Rican government introduced an incredible tax incentive program in 2012 to attract investment on the Island. At the same time, Puerto Ricans were moving to Orlando and Tampa, "Gringos" were moving to San Juan. Despite the setbacks (bankruptcy, hurricane, and global pandemic), the programs have shown promise. In my view, the Number 1 problem, is that the business owner or investor cannot make the sale to the spouse to move to Puerto Rico. No one would ever turn their back on significant tax incentive programs but for the dilemma, " How do I convince my spouse to move?"
Sophisticated tax planning has created a path to achieving this result. A taxpayer from Birmingham, Alabama can benefit from a Puerto Rican tax incentive program by transferring key functions within his business to Puerto Rico without relocating to Puerto Rico. The Puerto Rican exempt company is taxed at only four percent with no Federal or state taxation. Furthermore, the business owner can repatriate the profits of the Puerto Rican exempt company without taxation. No one had to learn Spanish, and no one had to learn to dance! More importantly, no one goes to jail!
B. Puerto Rican Tax Basics
Two important pieces of legislation were passed by the Puerto Rican legislature in 2012. Both the Export Services Act (Act 20) and the Individual Investors Act (Act 22) were signed into law by the Governor of Puerto Rico on January 17, 2012. In July 2019, the Puerto Rican legislature passed Act 60 which consolidated the programs and added important property and municipal tax benefits.
The definition of a U.S. person under §7701(a) (30), however, does not include Puerto Rican entities. As a result, a Puerto Rican entity is not subject to U.S. income taxation unless the entity is engaged in a trade or business within the United States and its income is considered effectively connected in