Act 1 of 31 January 2011 contained a tax reform that introduced a new tax code known as the Internal Revenue Code for a New Puerto Rico (IRCPR). The IRCPR is effective for tax years beginning after 31 December 2010. Act 1 of 31 January 2011 is part of a complete overhaul of Puerto Rico’s system of taxation, which is intended to reduce the tax burden of individual taxpayers and businesses.
Residents of Puerto Rico are subject to Puerto Rico tax on their worldwide income. Nonresidents are taxed only on their income from sources in Puerto Rico and on income treated as effectively connected with the conduct of a trade or business in Puerto Rico. In general, nonresident US citizens are taxed on their Puerto Rico-source income only. Most residents of Puerto Rico are US citizens but are not subject to US federal income tax under Internal Revenue Code (IRC) Section 933, except on income derived from sources outside Puerto Rico.
For purposes of US taxation, under the American Jobs Creation Act of 2004 (AJCA), which was enacted on 22 October 2004, an individual is considered to be a resident of Puerto Rico if he or she satisfies all of the following conditions:
- He or she is present for at least 183 days during the year in Puerto Rico. This determination is made under the substantial presence test.
- He or she does not have a tax home outside Puerto Rico during the tax year.
- He or she does not have a closer connection to the United States or a foreign country than to Puerto Rico.
The 183-day presence test applies for tax years beginning after 22 October 2004.
Under the AJCA, rules similar to the rules for determining whether income is from sources in the United States or is effectively connected with the conduct of a trade or business in the United States apply for purposes of determining whether income is from sources in Puerto Rico. However, any income treated as income from sources in the United States or as effectively connected with the conduct of a trade or business in the United States may not be treated as income from sources in Puerto Rico or as effectively connected with the conduct of a trade or business in Puerto Rico. These sourcing rules apply to income earned after 22 October 2004.
For local purposes, whether an individual is considered resident or nonresident generally is a question of intent, which is determined based on the facts and circumstances of each case. Individuals are presumed to be residents if they are domiciled in Puerto Rico for not less than 183 days in a calendar year.
Under IRC Section 937, which was added by the AJCA, and Treasury Regulation Section 1.937-1(h), effective from 2001, an individual with worldwide gross income of more than USD75,000 must file Form 8898 for the tax year in which he or she becomes or ceases to be a bona fide resident of Puerto Rico, among other US possessions. For married individuals, the USD75,000 filing threshold applies to each spouse separately.
Income subject to tax. Taxable income (or net income) is computed by subtracting allowable deductions and exemptions from gross income. Gross income broadly includes virtually all realized economic gains. However, certain items are specifically excluded by statute from the definition of gross income, including interest on US and Puerto Rico government bonds (state and municipal bonds), life insurance proceeds, gifts and inheritances. Also, some items may be subject to the alternate basic tax.
Education allowances provided by employers to their local or expatriate employees’ children are taxable for income tax and social security purposes.
Employment income. Salary deferred under a 401(k)-type plan may be excluded, subject to limitations, provided the plan is qualified by the Puerto Rico tax authorities.
In general, a nonresident individual who performs personal services as an employee in Puerto Rico at any time during the tax year is considered to be engaged in a Puerto Rico trade or business. An exception to this general rule applies to a nonresident individual performing services in Puerto Rico if all of the following conditions apply:
- The services are performed for a foreign employer.
- The employee is present in Puerto Rico for no more than 90 days during the tax year.
- Compensation for the services performed in Puerto Rico does not exceed USD3,000.
If these conditions are not met, all income, including the first USD3,000, is subject to tax.
Self-employment and business income. Self-employed individuals conducting a business for profit in Puerto Rico are subject to income tax at the rates set forth in Rates.
A nonresident individual engaged in a trade or business in Puerto Rico during the tax year is subject to tax on net income effectively connected with the conduct of the trade or business. The tax rates are the same as those for residents (see Rates). All income, gains and losses from sources within Puerto Rico, including Puerto Rico-source passive income, are treated as income, gains or losses effectively connected with the conduct of a trade or business in Puerto Rico.
Investment income. In general, dividend and interest income is taxed at the regular income tax rates (see Rates). However, dividend income from corporations deriving 80% or more of their gross income from sources within Puerto Rico is taxed at a maximum rate of 15%, but the effective tax rate could be higher as a result of recent amendments to the alternate basic tax system. The first USD2,000 of annual interest income paid on a deposit with a financial institution doing business in Puerto Rico is tax-free for individual taxpayers. In the case of married taxpayers filing jointly, the exclusion will not exceed USD4,000 (for married taxpayers filing separately, the exclusion is USD2,000 each). Interest in excess of the USD2,000 amount is taxed at a maximum rate of 15% if a taxpayer complies with certain conditions concerning withholding tax, but the effective tax rate could be higher as a result of recent amendments to the alternate basic tax system.
Rental operations and certain other activities that generate income are considered passive activities. Income from passive activities is included with other taxable income and taxed at the rates presented in Rates.
A nonresident alien individual not engaged in a trade or business in Puerto Rico is taxed, in general, at a rate of 29% on Puerto Rico-source fixed or determinable, annual or periodical gains, profits and income. This consists of investment income, including interest, dividends, rental income and certain capital gains. Generally, the tax on fixed or determinable income must be withheld at source by the payer. A nonresident alien with income derived from real property located in Puerto Rico, or with gains derived from the sale of real property, may elect to treat rental income from that property as effectively connected with the conduct of a trade or business in Puerto Rico, thereby permitting the deduction of re lated expenses and depreciation.
If received by a nonresident alien not engaged in a trade or business in Puerto Rico, interest on Puerto Rico bank deposits is treated as non-Puerto Rico-source income and is not subject to tax. Nonresident aliens are entitled to the special maximum 10% tax rate on dividends discussed above.
Directors’fees. In general, directors’ fees are considered earnings from self-employment.
Services payments. A withholding tax of 7% applies to payments made to persons for services rendered in Puerto Rico by other persons carrying on a trade or business in Puerto Rico. The withholding applies to payments for services that are not covered by other withholding provisions, including payments of wages subject to income tax withholding.
Taxation of employer-provided stock options. In general, employer- provided stock options are taxed the same in Puerto Rico as they are in the United States, with the following exceptions:
- The exercise of a qualified stock option does not constitute a taxable event in Puerto Rico.
- No alternative minimum tax (AMT) adjustment applies in Puerto Rico.
- No holding period is required for qualified stock options.
- Stock option plans established on or after 1 January 2001 must obtain a ruling from the Puerto Rico Treasury Department to obtain qualified status and beneficial income tax treatment.
Capital gains: Net long-term capital gains (the excess of net gains derived from the sale of capital assets held for longer than one year over losses from the sale of most capital assets held for one year or less) are generally subject to tax at a maximum rate of 15%, but the effective tax rate could be higher as a result of recent amendments to the alternate basic tax system. For sales or exchanges that took place on or before 30 June 2014, the holding period was six months for a gain to be considered a long-term capital gain or loss. For sales and exchanges taking place after 30 June 2014, the holding period is 12 months for a gain to be considered a long-term capital gain. Losses from the sale or exchange of capital assets are limited to 80% of the gains from the sale or exchange of capital assets, plus the net income of the taxpayer or USD1,000, whichever is less.
Young taxpayers. The first USD40,000 of gross income derived by “young taxpayers” from salaries or self-employment is exempt from taxation. For purposes of this exemption, the term “young taxpayer” means individuals resident in Puerto Rico whose age is between 16 and 26 years at the end of the tax year. The amount in excess of USD40,000 is taxed at ordinary tax rates.
Deductions. Nonresident US citizens are allowed the same deductions applicable to residents but, in general, are not allowed any deduction that is allocable or apportionable to income not subject to Puerto Rico income tax.
Deductible expenses and standard deductions. To calculate taxable income, individuals may reduce gross income by using specific deductions or itemized deductions.
In general, deductions allowed in the computation of adjusted gross income are costs and expenses directly incurred in, or attributable to, generating or earning income. The following deductions are included in this category:
- Deductions attributable to rents and royalties (losses may not offset other types of income)
- Losses from the sale or exchange of property
- A portion (not exceeding USD1,000) of the excess of capital losses over capital gains
- Alimony payments
Allowable deductions reduce adjusted gross income. These include mortgage interest on both a principal residence and a second home located in Puerto Rico, charitable contributions (subject to limitations), certain disaster losses, and medical expenses over specified amounts. Nonresident aliens may deduct certain charitable contributions made to various Puerto Rico charitable organizations.
Deductions for part-year residents and nonresident individuals must be apportioned on the basis of income sources.
In addition, deductions are allowed for contributions to individual retirement accounts (IRAs) of financial institutions engaged in trade or business in Puerto Rico (subject to limitations) and for contributions by government employees to certain retirement plans. A deduction of up to USD500 is available for cash contributions to an Educational Contributions Account for the exclusive benefit of a child or relative up to the third degree of blood relationship or second degree by affinity.
The IRCPR reduced the number of categories of filing status to the following three categories:
- Married filing jointly
- Married filing separately
- Individual taxpayer (which includes single, head of household and married not living with spouse)
Personal exemptions. In addition to the deductible expenses discussed above, the following exemptions may be subtracted from adjusted gross income to arrive at taxable income.
|Married, living with spouse and filing a joint return||7000|
|Married filing separate returns||3500|
|Additional personal exemption for veterans||1500|
|Exemption for dependents (unless joint custody or married filling separate)||2500|
Personal exemptions and dependents’ exemptions are not available for nonresident aliens.
Business deductions. Self-employed individuals are entitled to the same deductions as employees and may also deduct business expenses. Self-employed persons generally may deduct directly related ordinary and necessary business expenses. Deductible expenses for business meals and entertainment are limited to 50% of the amount incurred, and this amount may not exceed 25% of gross income. Depreciation on automobiles is deductible, up to the first USD30,000 of the cost of the automobile.Personal exemptions and dependents’ exemptions are not available for nonresident aliens.
A nonresident alien is entitled to the business deductions allowed to a resident, only to the extent that the deductions are related to income effectively connected with the conduct of a trade or business in Puerto Rico.
Optional tax computation for married individuals who both work and file a joint return. If a married couple lives together and if both spouses work and file a joint return, an option exists to pay tax in an amount equal to the sum of the tax determined individually for each of the spouses. The rules applicable to this optional tax computation are summarized below.
Gross income. The gross income of each spouse consists of salaries, wages, professional fees, commissions, income from annuities and pensions, gains attributable to trade or business and distributive shares in the income of special partnerships and corporations of individuals, and other income derived from services rendered by each spouse in his or her individual capacity. All other income is equally divided between husband and wife, regardless of who derived the income.
Exemptions and deductions. The personal exemption of a married couple filing jointly and the dependent exemption are divided equally between the spouses. Deductions for contributions to IRAs, Educational Contributions Account or Health Savings Accounts are allowed to the spouse to whom they individually correspond, subject to the limitations that apply to each particular deduction. All other deductions are divided equally between the spouses.
Tax calculation. The regular tax is determined separately for each spouse in accordance with the tax rate schedule applicable to individual taxpayers and then aggregated.
Rates. The 2016 income tax rates applicable to resident individuals, nonresident US citizens and nonresident aliens engaged in business in Puerto Rico are set forth in the table below. These rates apply to all taxpayers regardless of their filling status. The following are the income tax rates.
Net taxable income
|Exceeding||Not exceeding||Tax on lower amount (USD)||Rate on excess|
The alternate basic tax applies to an individual with adjusted gross income of USD150,000 or more. Many types of revenue, such as certain dividends, interest and long-term capital gains, are preference items. The tax applies only if it is larger than the regular tax. The alternate basic tax is creditable against regular tax, subject to limitations. The tax is determined in accordance with the following table.
Adjusted gross income
Relief for losses. Net principal trade or business losses may be used to offset income from other activities. If each spouse has a principal trade or business, a married couple is considered a single trade or business. Unused operating losses may be carried forward for 7, 10 or 12 years, depending on the year in which they were incurred. The following are the applicable rules:
- For tax years commenced before 1 January 2005, losses could be carried forward for seven years.
- For tax years commenced after 31 December 2004 and before 1 January 2013, the carryforward period is 12 years.
- For tax years commenced after 31 December 2012, losses may be carried forward for 10 years.
Losses from other trade or business activities may offset income only from the same trade or business.
Capital losses are fully deductible against capital gains. In addition, net capital losses of up to USD1,000 a year are deductible against other income. Unused capital losses may be carried forward for 5, 7 or 10 years, depending on the year in which they were incurred. The following are the applicable rules.
- For tax years commenced after 30 June 1995 and before 1 January 2005, the carryforward period was five years.
- For tax years commenced after 31 December 2004 and before 31 December 2012, the carryforward period is 10 years.
- For tax years commenced after 31 December 2013, capital losses may be carried forward for seven years, and these losses are considered short-term capital losses.
A nonresident alien may deduct certain losses from sources within Puerto Rico.
Estate and gift taxes
Puerto Rico estate and gift taxes are imposed at a fixed rate of 10% on the net taxable value of property transferred at death or by gift.
For estate and gift tax purposes, a resident of Puerto Rico generally may transfer property located in Puerto Rico tax-free because a deduction is allowed for property located in Puerto Rico in de termining the value of the gross estate.
Gift tax. For a resident, gift tax is imposed on the value of transfers of property located outside of Puerto Rico. For a nonresident, gift tax is imposed on the value of property located in Puerto Rico only.
A tax is imposed on the value of all taxable gifts made during the tax year and in all prior years. The gift tax is computed by applying a fixed 10% rate to taxable gifts made during the calendar year. Donors are entitled to an annual exclusion of USD10,000 to each donee from taxable gifts.
Various deductions are also allowed. A credit against gift tax may be claimed for gift taxes paid to the United States or to foreign governments.
If the gift tax is not paid by the donor, it may be assessed against the donee to the extent of the value of the gift received by the donee.
Estate tax. Estate tax is computed by applying a fixed 10% rate to the taxable estate. For a resident, the taxable estate is defined as the gross estate (generally the fair market value of the transferred property, wherever located, on the date of transfer or gift), less allowable deductions. Various specified deductions, including a deduction for property located in Puerto Rico, are allowed, and a fixed exemption of USD1 million is also granted. The USD1 million exemption is prorated among all assets included in the estate based on their fair market value.
Tax credits are permitted for certain amounts that were included in the estate of a previous decedent, as well as for estate taxes paid to the United States or foreign countries.
Nonresidents are subject to Puerto Rico estate tax on estate property located in Puerto Rico only. Certain deductions and exclusions are allowed. A nonresident US citizen decedent is allowed a minimum exemption of USD30,000, and a nonresident alien decedent is allowed a USD10,000 exemption.
The Puerto Rico estate tax is limited to the maximum credit allowed under the rules of the government of the decedent. This rule applies, for example, to Puerto Rico residents who are subject to US estate taxes. Residents of Puerto Rico who were born or naturalized in Puerto Rico are subject to US estate and gift taxes on assets located in the United States only.
The following three principal social security taxes are levied under US federal law:
- The Federal Insurance Contributions Act (FICA)
- The Self-Employment tax (SE tax)
- The Federal Unemployment Tax Act (FUTA)
In addition, Puerto Rico levies its own unemployment tax, as well as a disability tax and a workers’ compensation insurance contribution.
FICA. For 2016, FICA tax is imposed on wages at a total rate of 15.3%, which includes a 2.9% Medicare tax. The combined tax rate for employee’s wages is 7.65%, which is composed of a 6.2% component for Old-Age, Survivors and Disability Insurance (OASDI) tax and a 1.45% component for hospital insurance (Medicare). For 2016, OASDI tax is imposed on wages up to an OASDI wage base of USD118,500. An additional Medicare tax of 0.9% is imposed on wages exceeding USD200,000. No limit applies to the amount of wages subject to the Medicare portion of the tax.
SE tax. SE tax is imposed on a US citizen’s or resident alien’s self-employment income after deductions for business expenses. The 2016 rate is 15.3% on the first USD118,500 of self-employment income. No limit applies to the amount of income subject to the 2.9% Medicare portion of the tax. Self-employed individuals must pay the entire tax but may deduct 50% as an adjustment to gross income on their federal income tax returns. Individuals who are subject to both FICA and SE tax first deduct employment in come from the 2016 net available base before determining SE tax. Therefore, a self-employed individual who also has FICA wages of USD118,500 is subject to the additional Medicare tax only.
FUTA. FUTA tax is imposed on an employer’s wage payments to employees for services performed within the United States, which is defined to include Puerto Rico. This tax is levied without regard to the citizenship or residence of an employer or an employee. The tax rate is 6% on the first USD7,000 of wages for each employee. Self-employed individuals are not subject to FUTA. A credit for the amount of state unemployment insurance paid to the government of Puerto Rico is available.
Puerto Rico employment taxes. The maximum 2016 Puerto Rico unemployment tax rate is 5.4% on the first USD7,000 of an employee’s wages. The rate may be lower, depending on the employer’s rating, which is based on the employer’s history of layoffs. This tax may be credited against the FUTA tax.
A disability tax is imposed on the first USD9,000 of an employee’s wages. The rate is 0.6%, with 0.3% paid by the employer and 0.3% paid by the employee.
Premiums for workers’ compensation insurance are borne solely by the employer and are based on total wages paid. The rate varies, depending on the occupation of the workers.
Tax filing and payment procedures
The Puerto Rico tax system is based on self-assessment. Puerto Rico taxpayers must file annual tax returns with the Bureau of Returns Processing of the Puerto Rico Department of the Treasury.
Nonresident individuals engaged in a trade or business in Puerto Rico must file tax returns if their gross income exceeds USD5,000.
Taxes are generally collected by employer withholding on wages and salaries and by individual payment of estimated taxes on in come not subject to withholding. Normally, tax due in excess of amounts withheld plus estimated tax payments made must be paid with the return when filed. The taxpayer claims a refund of an overpayment of tax by filing the annual return. Substantial penalties and interest are usually imposed on a taxpayer if a return is not filed on time or if tax payments, including estimated payments, are not made by the applicable due date.
Returns may be selected at a later date for an audit by the Puerto Rico Bureau of Audit. Failure to adequately support amounts claimed as deductions on the return may result in the disallowance of deductions and in a greater tax liability on which interest or penalties, or both, must be paid from the original due date. In general, taxpayers must maintain supporting documentation for at least four years after a return is filed. Evidence of income tax payments should be maintained indefinitely.
The due date is 15 April for calendar-year taxpayers and three and one-half months after the year-end for fiscal-year taxpayers. An extension of time to file a tax return may be obtained, but it is not an extension of time to pay the tax. To prevent interest and penalties from being charged on unpaid tax, taxpayers must pay any tax due by the due date of the return.
Double tax relief and tax treaties
Residents of Puerto Rico are taxed by the Puerto Rico government on their worldwide income. Puerto Rico is a part of the United States, and most US laws apply in Puerto Rico. However, under special legislation, Puerto Rico-source income derived by individuals residing in Puerto Rico is generally exempt from US individual income taxation. Income from sources outside Puerto Rico derived by individuals residing in Puerto Rico is subject to US taxation.
A foreign tax credit is available to prevent double taxation of Puerto Rico residents subject to US or foreign tax on non-Puerto Rico-source income. Generally, the foreign tax credit permits a taxpayer to reduce Puerto Rico tax by the amount of income tax paid to the United States or to foreign governments. The credit is limited to the lesser of the following:
- The actual US or foreign taxes paid or accrued
- The Puerto Rico tax applicable to the non-Puerto Rico-source taxable income
Separate limitations may apply for situations in which non-Puerto Rico-source income is derived from more than one foreign jurisdiction.
Double tax treaties entered into by the United States do not apply in Puerto Rico. A protocol to the treaty between the United States and Spain states that the US and Spanish governments should meet to extend the treaty’s coverage to Puerto Rico, but this has not yet occurred. Puerto Rico may not enter into separate tax treaties with foreign governments.
The Internal Revenue Service (IRS) and the Treasury Department of Puerto Rico have established a mutual agreement procedure to resolve inconsistent treatment of tax items. Requests for assistance under this procedure should be addressed to the Tax Treaty Division of the IRS.
The rules concerning eligibility for visas that allow foreign nationals to work in Puerto Rico are identical to those for the continental United States. Therefore, please refer to the US chapter in this guide for information on the requirements and procedures needed to obtain a visa in Puerto Rico.
Family and personal considerations
Marital property regime. The marital property (conjugal partnership) regime in Puerto Rico applies only to married couples. Under this regime, Puerto Rico recognizes that property acquired during marriage is subject to division and equitable distribution, and therefore constitutes marital property. Puerto Rico recognizes as separate property, distinguishable from marital property, any property acquired before marriage and all property derived by either of the spouses during the marriage through inheritance, gift or devise. The regime applies unless the spouses execute a marriage contract by public deed before the marriage.
Driver’s permits. Any person with a valid driver’s license is authorized to drive in Puerto Rico for up to 120 days from the date of arrival. After this period, the individual must apply for a Puerto Rico license. The following are the basic requirements:
- Completed application form
- Three photos of the applicant
- Medical exam
- Original and copy of the applicant’s social security card, driver’s license, certificate of birth, visa and US passport or residence card
- Written exam
- Fee of USD11
Puerto Rico offers driver’s license reciprocity with the following states of the United States.
Florida Maine Tennessee
Illinois South Dakota Wisconsin
Individuals from the above states need fulfill only the first four of the requirements listed above.