15 Things to Know Before Moving to Puerto Rico for Act 20 and Act 22
- Posted: August 2, 2018
- Posted by: Travis Lynk
- Last Reviewed: July 15, 2019
Editor’s note 7/15/19: There are major changes coming to Act 20/22 for applications submitted after 12/31/19; you can read about those changes here.
15 Things to Know Before Moving to Puerto Rico for Act 20 and Act 22
This post was authored by Puerto Rico resident Sean King on 7/24/18.
We did years worth of diligence before moving to Puerto Rico, and it mostly panned out. We absolutely love PR and San Juan, and are so very grateful for the experience and how welcoming everyone has been to us.
However, there are a few things I wish I had known and planned for that simply didn’t come up during our diligence. I’ll post most of them here in case any readers considering a move can benefit from knowing them in advance. (If I have any of these wrong, I welcome being corrected by those more knowledgeable or experienced.)
1. Your Act 20/22 decrees only offer the lower tax rate on certain types of income, not all types.
Act 22 applies only to any interest or dividends, or to any capital gains on the sale of valores. Valores is a Spanish word that translates as “values” or “valuables,” but it can also have the narrow, technical meaning of “securities.” Most decrees, which are, in theory, binding contracts against the Puerto Rico government, currently translate it simply as “investment assets,” which is a pretty broad term. In this case, broad is good. Act 20 only applies to “export services income”—that is, to income earned for providing certain types of pre-approved services from Puerto Rico to persons or entities outside of Puerto Rico. So, don’t make the mistake of assuming that you get the favorable Act 20 and/or 22 rates on all types of income. You don’t.
2. PR taxes its residents on their worldwide income, not just income earned within or sourced to PR.
This means that even income sourced to the mainland (such as for services you provide while visiting the mainland) or to another country (such as for services provided while in another country) must generally be reported on your PR tax return and any resulting taxes calculated there. However, that same income will also generally get reported on your US (or foreign) tax return with any resulting taxes calculated there too. Does that mean you’re effectively double-taxed? No. PR gives you a foreign tax credit against your PR taxes for any taxes you pay to the mainland (or a foreign country), so you don’t end up double paying taxes on this income. But, if PR rates are higher than the mainland or foreign rates, and they often are if the income in question doesn’t qualify under your Act 20/22 decree, you’ll still effectively end up paying the higher of the two tax rates on that income. Again, this only applies to income earned (sourced) outside of PR. Income earned within (sourced to) PR is only reportable on your PR returns (if you are a US citizen, at least) and only subject to the PR tax rates, which are very low if it is a type of income that qualifies under Act 20/22.
3. Act 20 benefits are presently only available to PR business entities (corporations, LLCs, etc.) and not to sole proprietorships.
So, you’ll need to form a new PR entity which will apply for the Act 20 decree. If you presently operate as a sole proprietorship, you’ll need to figure out how to redirect qualifying future income to your new PR entity. This may mean rewriting contracts with your customers/suppliers. In some industries (e.g., the securities industry), redirecting the income to a PR entity may be difficult or impossible due to licensing and regulatory issues. Be sure to think through that in advance.
4. PR requires companies with more than $1 million in gross revenue to report their income using the accrual basis of accounting.
Why? Just because.
5. PR requires essentially all companies with more than $3 million in gross revenue to have audited financials each year.
Why? Just because.
6. You must register your Act 20 business in the municipality(ies) from which it operates, even if you are working from home.
Those municipalities will assess a small tax on its gross revenue generated from within the municipality. Though the rate will be reduced considerably for Act 20 decree holders, it’s not usually zero.
7. Items 4, 5 and 6 above operate together to incentivize maximizing your Act 20 entity’s net income while minimizing its gross revenue.
Think about ways to do that in advance.
8. Assuming your Act 20 entity is owned only by bona fide residents of PR, it should be exempt from US tax withholding for any payments made to it from US persons or companies.
You may need to provide each US payer with a properly completed IRS Form W-8BEN-E so that they know not to withhold. Once done, these US payers should not have to issue your PR entity an IRS Form 1099 each year.
9. Your Act 20 company must pay you a “reasonable” salary each year, and that salary will be taxed to you personally at ordinary PR tax rates.
Said another way, the portion of your company’s profits paid to you as salary each year will not receive the favorable Act 20/22 tax treatment each year.
10. PR does not recognize US based retirement plans such as 401(k)s, IRAs, defined benefit plans, Roth IRAs, etc. as “tax qualified” under PR tax law.
This fact combined with number 2 above means that PR residents will pay PR taxes on gains within these plans/accounts (even within Roth IRAs!) that accrue after their move to PR. Account balances that existed prior to the move to PR aren’t subject to PR tax, as I understand it. Furthermore, PR residents will pay tax on those post-move gains within these US retirement plans at PR tax rates. Act 22 tax treatment would appear to be unavailable for assets owned within these plans, unless those plans can somehow be characterized as grantor trusts under PR law. It’s unclear to me whether those gains are taxed as they accrue within the plan after one’s move or only upon withdrawal from the plan after one’s move. Regardless, this unfortunate fact needs to be planned around. For instance, depending upon one’s circumstances, it may be preferable to cash out one’s US based retirement plans, even Roth arrangements, upon one’s move to PR, pay any tax owed to the IRS on the cash out, and then invest the proceeds in after-tax arrangements that qualify under Act 22. That way, future gains will continue to grow tax free under Act 22—though you will have suffered the one-time US tax on the cash out. There may be other ways of solving or resolving this issue, but my point is that it should be thought through in advance.
11. Notaries in Puerto Rico are legally required to be lawyers.
Said another way, only lawyers can be notaries. Seriously. Why? Because Puerto Rico.
12. You have to have a notary’s/lawyer’s signature to do pretty much anything down here.
To buy real estate, to get a license for medical cannabis, or even to just file your rinky dink San Juan Municipal “Volume of Business” tax return. So, make friends with a good notary. Since, presumably, most people in the PR legislature are lawyers, they apparently want to make sure that lawyers get paid a small piece of every deal by requiring a notary signature on most everything.
13. In Puerto Rico real estate transactions, the notary basically provides the services that a title company would on the mainland, but at a much higher cost.
The fee charged by notaries for real estate mortgage transactions is apparently fixed by statute and is a percentage of the original mortgage balance. This fee gets charged whether you’re doing a bank mortgage or a private mortgage. For a large mortgage, the notary fees can be tens of thousands of dollars. And, unfortunately, a notary must be involved both when you originate the mortgage and when that same mortgage is retired/cancelled. So, some notary gets paid the statutorily mandated percentage twice for every mortgage! How convenient! Alas, without understanding this, I bought a residence down here with a large mortgage that I retired about six months later, costing me tens of thousands in unnecessary notary fees. I should have just paid cash up front, but there were reasons that I didn’t. I’m not complaining, just making sure that you understand the system better than we did.
Just like the government is looking out for the notaries, they are apparently also looking out for the banks.
14. The government won’t take a personal or corporate check for hardly anything (not for tax payments, not for filing fees, not for tickets), no matter how small.
Instead, they demand a certified check or manager’s check, for which you’ll pay a bank a pretty penny and probably waste an hour of your time, regardless of how large of a customer you are for them.
15. The banking services here…well…suck.
Everything is ridiculously slow, and you get charged a pretty penny for everything—for a certified check, to send a wire, to receive a wire (in what other states do banks charges to RECEIVE wires?)—no matter how big or important you are. Plus, the banks here are very nosey. They take AML/KYC and fraud prevention to an extreme no matter who you are. Expect lots of annoying and invasive questioning about large or small checks, wires, etc. The banking experience here is manageable, but don’t expect a mainland type of experience.
Puerto Rico is 90% heaven and 10% hell. So long as you’re prepared for the hell, you’ll love it here. We certainly do. I’m just sharing this information so that you can be prepared for all of this wonderful place, the good and the bad.