Tax Heavyweight Says Congress Should End Puerto Rico Tax Incentive

Over the last year or so, the scheme that I’ve said “no” to more than anything else involves Puerto Rico. Back in 2012, Puerto Rico—a US territory—enacted tax incentives designed to entice hedge fund managers and other wealthy immigrants into relocating there from the mainland US.

The specific law I criticized is Act 22. Anyone who becomes a bona fide resident of Puerto Rico is now eligible for the following benefits, courtesy of Act 22:

• 100% tax exemption from Puerto Rico income taxes on all Puerto Rico source dividends and interest payments.
  
• 100% tax exemption from Puerto Rico income taxes on all short- and long-term capital gains accrued since becoming resident in the territory.
  

By itself, this exemption isn’t particularly noteworthy. But the US Tax Code provides that bona fide residents of the territory need not pay federal income tax on “income derived from sources within Puerto Rico.” 

Together, Act 22 and the federal tax incentives are a big deal, because they provide a way for wealthy US citizens or green card holders who are now paying federal income taxes as high as 39.6% (plus the 3.8% Obamacare tax) to relocate to Puerto Rico and potentially cut their federal income taxes to zero. And they can do so without needing to expatriate (i.e., give up US citizenship).

Now, I don’t have anything against cutting taxes. But I was skeptical that Act 22 would remain in effect and even more skeptical that Puerto Rico would honor the contracts it signed with wealthy investors guaranteeing that they would pay no income tax for the next 20 years. I thought then, and still believe, that either: 

• Congress will repeal or substantially restrict the federal incentives for Puerto Rico; or
  
• Puerto Rico will repeal Act 22; or
• The courts of Puerto Rico will overturn the incentives on the grounds that they violate the territory’s constitution.

But until a few months ago, I hadn’t found anyone else who shared my skepticism about Act 22. Financial publishers were flocking to Puerto Rico to promote its tax incentives the way gamblers gravitate to Las Vegas. And there was absolutely no serious questioning—from anyone—about the incentives. Should you move to Puerto Rico to take advantage of these incentives? That’s up to you. After all, I could be wrong—Act 22 could well stay in effect indefinitely—but before you pack your suitcase, understand why a lot more people are leaving the territory than are moving to it.

  This article gives a good summary. But remember, when too many people start exploiting a loophole to save on federal taxes, the loophole usually closes. It’s happened before in Puerto Rico and it could happen again.