How Act 60 Decree Holders Can Maximize After Tax Returns by Selling Stocks Before the Dividend Date
- Posted: June 5, 2021
- Posted by: Travis Lynk
- Last Reviewed: July 12, 2021
Many U.S.-based companies and individuals are moving to Puerto Rico, a small U.S.-owned island in the Caribbean. Puerto Rico is known for its sunshine, enjoyable lifestyle, and lucrative Act 60 tax exemption program. The Act 60 program boasts a 4% corporate tax rate and a 0% capital gains tax rate for qualifying individuals and corporations. These tax savings are especially enticing when compared to the steep proposed federal income and capital gains tax hikes.
Although Puerto Rico has offered generous tax incentives for companies and individuals since 2012 with its earlier Act 20 and Act 22 programs, the Act 60 program is growing at an unprecedented rate. Furthermore, tax savings are not restricted to hedge fund billionaires; anyone who trades in securities can take advantage of the program’s 0% capital gains tax rate.
Under the Act 60 program, stock capital gains are taxed at the 0% capital gains rate, but dividend income from U.S. companies is considered U.S.-sourced and taxed accordingly. Still, there is an ingenious way for Act 60 decree holders to avoid paying the dividend tax and maximize their returns.
In this article, we discuss how the declaration and payment of dividends has a specific and predictable effect on market prices. Then, we explain how Act 60 decree holders can use dividends to lower their tax liability while maximizing financial returns.
Many companies distribute profits to shareholders by issuing dividends. Dividends are issued from a company’s retained earnings, and the amount in dividends that each investor receives depends on their ownership stake in the company. Investors with a greater stake in the company will receive more of the company’s profits.
Dividends can affect the price of their underlying stock. Once a company issues a stock dividend, the stock’s share price drops by the amount of the paid dividend because new shareholders will not be eligible to receive the dividend.
The following image shows one way in which dividends could affect stock prices:
This example is hypothetical, and market activity and pressures can alter the stock price. Still, issuing dividends does affect the stock price: before the ex-dividend date, the stock price increases by the price of the dividend; after the ex-dividend date, it decreases by the price of the dividend.
Implications for Act 60 Investors
Because they usually receive a 0% capital gains tax, many Act 60 decree holders invest heavily in stocks and securities. However, any dividend income they gain from the stocks of U.S.-based companies such as Microsoft is considered ordinary U.S. income. Dividends are sourced to the location of the payer (in Microsoft’s case, the state of Washington), which means that Act 60 decree holders do not receive tax breaks in these cases.
Nonetheless, Act 60 decree holders who hold dividend stock can still pay the 0% capital gains tax rate and maximize their returns by selling their stock just before the ex-dividend date and repurchasing it immediately after. The following example shows how an Act 60 decree holder might apply this strategy.
Suppose that a company issues dividends on a quarterly basis and has stock worth $100.00. The company announces that it has had a strong quarter and will issue a $1.00 dividend to all stockholders for each stock they hold. As a result, many investors rush to buy the stock before the ex-dividend date. In anticipation of the ex-dividend date, the stock increases by $1.00.
However, our Act 60 investor does not want to receive the dividend because it will be taxed as ordinary U.S. income. Although the investor holds company stock, they sell it before the ex-dividend date and receive $101.00. After the ex-dividend date, the company’s stock price drops back down to $100.00 because investors who purchase the stock after the ex-dividend date will be unable to receive the dividend. Meanwhile, the Act 60 investor repurchases the stock at $100.00 and earns a $1.00 (or 1%) return.
By applying this strategy, Act 60 investors avoid receiving the dividend, which would be taxed, and hopefully earn a profit, in the form of a non-taxable capital gain, equivalent to the dividend from their sale. They should keep in mind, however, that they will only earn such a profit if the stock price increases in anticipation of the dividend.
Disclaimer: Neither PRelocate, LLC, nor any of its affiliates (together “PRelocate”) are law firms, and this is not legal advice. You should use common sense and rely on your own legal counsel for a formal legal opinion on Puerto Rico’s tax incentives, maintaining bona fide residence in Puerto Rico, and any other issues related to taxes or residency in Puerto Rico. PRelocate does not assume any responsibility for the contents of, or the consequences of using, any version of any real estate or other document templates or any spreadsheets found on our website (together, the “Materials”). Before using any Materials, you should consult with legal counsel licensed to practice in the relevant jurisdiction.
Read MoreApril 21, 2020
Read MoreAugust 2, 2018