Puerto Rico's Act 20 and 22 just made offshore tax havens obsolete!
07 August, 2017
On July 11, 2017, Puerto Rico became the top offshore tax haven for US citizens, period. If you're running an online business, improvements to Puerto Rico's Act 20 and 22 have made offshore tax havens obsolete. Puerto Rico has the lowest tax rate and is now the best deal out there. Puerto Rico has made an offer that can't be matched by any foreign country.
As you read through this article on Puerto Rico's Act 20 and 22, please note the following:
- This post describes changes to Puerto Rico's Act 20 and 22 that were signed into law on July 11, 2017. For a detailed summary of the changes, see: Changes to Puerto Rico's Act 20 and Act 22.
- Because Puerto Rico source income is excluded from US Federal tax (IRC Section 933), the US territory of Puerto Rico can offer US citizens a tax deal that can't be matched by any foreign country.
- Puerto Rico's Act 20 is focused on online and other service businesses. Act 20 requires you to provide a service from Puerto Rico to persons and companies outside of Puerto Rico. My claim is that Puerto Rico is now the top offshore tax haven for internet and service businesses owned by US citizens that net more than $250,000 a year.
With that said, here's a summary of the tax deal available under Puerto Rico's Act 20 and 22.
Puerto Rico's Act 20 gets you a 4% corporate tax rate on business income earned from work performed on the island. The net profits of a business providing a service from Puerto Rico to companies or persons outside of Puerto Rico is taxed at 4%.
If the owner(s) of the business live in Puerto Rico, they can take distributions tax free. That is to say, dividends from an Act 20 company in Puerto Rico are tax free when paid to a resident of the Territory.
And here's the big change for July 2017: When Puerto Rico's Act 20 was first passed in 2012, the law required a minimum of 3 employees. Then, in December of 2015, this number was increased from 3 to 5.
The requirement of 5 employees locked out 90% of would be applicants. Many entrepreneurs wanted to move to the island and start a new business. But, few wanted to be locked in to 5 employees.
Sure, the online marketer was happy to spend 183 days a year in paradise. But, he didn't want to be locked into 5 employees. Likewise, she didn't care for the office and infrastructure such a business would require.
Online service companies (affiliates, SEO, PPC, sales, publishing, etc.) are built around flexibility. They leverage very low cost contractors in India and have no interest in hiring workers at $20 an hour. This is especially true for millennial entrepreneurs. They demand their freedom… they hate taxes, but they hate structure even more.
On July 11, 2017, Puerto Rico eliminated the 5 employee requirement. Now, anyone can move themselves and their online business to Puerto Rico and exchange their 35% Federal tax rate for Puerto Rico's 4% rate. See: Puerto Rico Eliminates 5 Employee Requirement
Service businesses can now qualify for Puerto Rico's Act 20 with only 1 employee… and that one employee can be the business owner. Simply take your laptop to Puerto Rico for 183 days a year, become a resident of the territory, and cut your tax rate to 4%.
This 4% rate applies to the net income in your business after you pay yourself a reasonable salary. Most take a salary of $50,000 to $100,000 and leave the rest of the profit in the corporation. Your salary is taxed at about 30% and the remaining profits are then distributed as a tax free dividend.
Because you must pay tax on your salary, Puerto Rico's tax deal is meant for those making significantly more than $100,00 a year. The primary benefit of Puerto Rico is the 4% rate on profits in excess of your salary. If you are netting $100,000 or less, you can do better offshore than you will in Puerto Rico.
Let's say you're living and working in Panama. You earn $100,000 a year and qualify for the Foreign Earned Income Exclusion. You pay zero Federal tax after taking the FEIE. If that business was in Puerto Rico, you'd pay PR tax at 30% on the first $50,000 and 4% on remaining $50,000, or a total of $17,000.
Let's say that same business earns $500,000. If you're operating in Panama you take the FEIE on your first $100,000 and pay US tax at 35% on the remaining $400,000, or $140,000 in tax. Put that business in Puerto Rico and your tax is 30% on $50,000 and 4% on $450,000, for a total of $33,000.
The more you earn the bigger the benefit is of Puerto Rico over the FEIE. This is why Puerto Rico is the undisputed king of tax havens for online businesses earning more than $250,000. For more, see Panama vs. Puerto Rico.
And we're not talking about tax deferral here. Puerto Rico's offer is for tax free!
You can hold foreign sourced profits in excess of the FEIE in an offshore corporation tax deferred. When you take them out you'll pay US tax at ordinary rates because this is usually a nonqualified dividend.
With Puerto Rico's Act 20 you pay 4% and nothing more. You will never pay tax to the US on these profits. Even when you shut down the business and move back to the United States, no tax will be due. No repatriation tax, nothing.
Finally, it's easier to qualify for Puerto Rico's Act 20 than it is for the Federal Foreign Earned Income Exclusion. To qualify for the FEIE, you must be out of the US for 330 out of 365 days or a legal resident of a foreign country. Most are forced to use the 330 day test in their first year.
With Puerto Rico, all that's required is that you move from your current state to Puerto Rico and spend 183 days a year there. You must be a resident of Puerto Rico, but this is a lower hurdle than the legal residency test of the FEIE. Moving from California to Puerto Rico is the same as moving from California to Texas or Florida (or any tax free state).
For these reasons, Puerto Rico's Act 20 has made offshore tax havens obsolete for US citizens operating an online business earning more than $250,000 a year.
And Puerto Rico's Act 22 has made these tax havens obsolete for passive investors and traders. To support Act 20, Puerto Rico passed Act 22 to attract investors and high networth individuals.
Move to Puerto Rico, buy a home within 2 years, qualify for Act 22, and pay zero capital gains tax on assets acquired after you receive your decree. Yes, that's right… you can eliminate US tax on capital gains entirely. No fancy life insurance policies or other expensive tools required.
This tax holiday applies to publicly traded stocks and any passive income that is "Puerto Rico sourced." It does not apply to interest income or real estate based in the United States. The focus of Act 22 is on passive investors - hedge fund and stock market investors.
As of July 11, 2017, the requirements to qualify for Act 22 are:
- Move to the island and become a resident of Puerto Rico,
- Open a bank account in Puerto Rico,
- Spend at least 183 days a year on the island,
- Buy a home within 2 years, and
- Donate at least $5,000 a year to a charity in Puerto Rico (new for 2017).
Again, Puerto Rico's Act 22 is unique. No foreign country can offer to eliminate US tax on capital gains. If you move to Panama, you'll still pay US tax on your stock transactions. Only Puerto Rico sourced income is excluded from the US tax laws! For more, see How to stop paying capital gains tax.
I hope you've found this article on why I believe Puerto Rico's Act 20 and 22 have made offshore tax havens obsolete. Once Act 20 eliminated the employee requirement, the doors were opened to high net worth entrepreneurs with a portable business.
For more information, please contact me at email@example.com or call us at (619) 550-2743. We'll be happy to assist you to set up your business in Puerto Rico. All consultations are free and confidential.
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