In Pursuit of Puerto Rican Tax Incentives
For any of you that have been reading my articles for any time, you know that I am a lover of horn bands, particularly the Tower of Power (TOP). I have seen them perform in different venues multiple times. I have reimagined another life following the Tower of Power from concert-to-concert in the same manner as a “Dead Head” minus the haze of smoke! It is clear when you hear the horns that the horn section has taken music lessons. Reading the group’s fan mail online, I noticed the group’s leader Emilio Castillo, paying homage to a fan that had died for having seen the band a thousand times in concert. I thought, “What an enviable life,” to hear such music so often. A life well lived!
One of the TOP’s soul classics from the early 1970’s is the song, So Very Hard to Go; however, to borrow a lyric from another TOP classic What is Hip, “What is Hip Today may become passe!” This article focuses on a planning strategy to minimize the impact of any potential tax increases in 2021.
So Very Hard to Go
The Commonwealth of Puerto Rico has had a hard time in the last ten years. PR has suffered a combination of devastating events including the Island’s bankruptcy, a hurricane and COVID-19. The Puerto Rican government introduced an incredible tax incentive program in 2012 to attract investment on the Island. All the unforeseen obstacles got in the way in my opinion. 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 or Dubuque, Iowa can benefit from a Puerto Rican tax incentive program by transferring key functions within his business to Puerto Rico without relocating to Puerto Rico (emphasis added). 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. Let me repeat what I just wrote “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! So Very Hard to Go (Not)!
Puerto Rico Me Encanta!
A business that relocates to Puerto Rico can significantly reduce its tax liability provided that the Puerto Rican entity is not engaged in a U.S. trade or business. The top U.S. corporate tax rate in 2018 is 21 percent at the Federal level. Assume another 5-8 percent at the state level. Many pass-through businesses will qualify for the new 20 percent business deduction under IRC Sec 199A. However, most professional service companies will not qualify for this deduction. These businesses might be well served to evaluate Act 20 status.
Under Puerto Rico’s Export Services Act, the corporate tax rate is flat four percent. Additionally, shareholders who relocate to Puerto Rico will have a 100 percent exemption on corporate distributions received from the Puerto Rican company.
Under the Export Services Act, services that are directed to foreign markets may generate income that will qualify for the special tax rate. Services for foreign markets include services performed for nonresident individuals and businesses. To qualify as “promoter services” under the Export Services Act, the net income must be earned, and service performed within the 12-month period ending on the day preceding the day the business commenced operations within Puerto Rico. The term “eligible services” includes a wide range of service-oriented businesses from research and development to investment management.
Significant changes were made to Act 20 on July 11, 2017. These changes eliminated the five-employee requirement and no minimum employee requirements for most businesses. In most cases, this will be the business owner. The new legislation added two new eligible services – (1) Hospital services and laboratories including medical tourism and telemedicine services; (2) Trading companies with no less than 80% of business in PR exporting business.
At least thirty percent of the of the doctors at medical tourism and telemedicine facilities should be Puerto Rican residents. International banks licensed in Puerto Rico under Act 273 also qualify for the special rate