It has been said that the only things you can’t escape in life are death and taxes. While moving to Puerto Rico won’t help you live forever, it’s one of the few places on earth where Americans can legally escape many forms of taxation. Intrigued? You should be.
Most countries tax their citizens on a residency basis. For example, if you are a Swedish citizen living in Thailand, you will owe taxes to Thailand, but not to Sweden. But the U.S. has a system of global taxation, meaning that if you are an American living in Thailand, you’ll still have to pay U.S. taxes. While there are deductions and exceptions, it’s nearly impossible to escape the IRS—unless you live in Puerto Rico.
That’s because Puerto Rico falls in an interesting legal grey area. It’s part of the United States, but it’s a territory, not a state. Puerto Rico doesn’t receive voting representation in Congress and Puerto Ricans—while being American citizens—can’t vote in federal elections. But they also don’t pay many federal taxes. Puerto Rico has the power to tax their residents, but, in an attempt to lure investment, they slashed the rates for new residents to next to nothing. And, since Puerto Rico is part of the United States, any American can move there and become a resident. All of this creates an unusual and fascinating tax loophole:
Americans who live in America pay U.S. federal taxes. Americans who live in foreign countries pay U.S. federal taxes. But Americans who move to Puerto Rico often don’t have to. With the correct tax planning, new Puerto Rico residents could legally pay a tax rate close to 0%.
How to move to Puerto Rico
To gain and maintain your residency you’ll need to move your primary address to Puerto Rico, but you’ll only need to spend a minimum of 183 days in Puerto Rico per year. The rest of the time you can travel to other parts of the United States, or the world.
Beyond physically moving you’ll need to fill out some important paperwork. Act 22, also known as the "Individual Investors Act" is behind many of the tax advantages, and to receive the benefits you’ll need to apply for a tax exemption decree. If your application is approved, your individual tax exemption decree will have the full details of your exact tax treatment, which may vary from person to person.
If you control a corporation, you’ll need to look at Act 20, which provides for a 4% corporate tax rate—far below the 35% tax rate on the mainland United States. If you are an entrepreneur with, say, an online business, you may be able to relocate to Puerto Rico and attain large tax savings. Of course, your exact situation will vary and tax law is very complicated, so don’t use this article as legal advice.
What’s the catch?
There are a few. First, you won’t be able to vote in federal elections. If you have strong opinions on who should be President, drop them, because you’re losing your federal voting rights while you’re a resident of the island.
Second, Puerto Rico runs on Spanish. While you might be able to get by on English, it won’t feel like the rest of the United States.
Third, Puerto Rico is in the midst of an economic crisis and also has relatively high rates of violent crime, so safety may be an issue.
Fourth, salaried employees in regular jobs are basically out of luck. While you likely won’t have to pay U.S. federal income tax, you’ll face Puerto Rico income tax rates, which aren’t much better than U.S. federal rates. Which means that if you convince your boss to let you move to Puerto Rico and work remotely, you won’t really see any tax breaks once you get there.
The tax breaks mostly apply to capital gains, investment, and business income. That makes Puerto Rico’s tax benefits only truly available to investors or business owners.
All capital gains earned after moving to the island are tax free. Capital gains you earned before moving to Puerto Rico are subject to a 10% Puerto Rico capital gains tax and a 23.8% federal tax rate--if you sell before 10 years are up. But if you wait at least 10 years to sell, you’ll only have to pay a 5% Puerto Rico capital gains rate, and nothing to the federal government.
Which makes Puerto Rico an interesting option for eyeing retirement, and potentially especially for those considering early retirement. Say you’ve got an IRA that’s earning interest tax-free each year, except on the money withdrawn. If you move to Puerto Rico, after 10 years your withdrawals will only be subject to 5% capital gains tax—a fraction of what you’d pay between federal and local capital gains in the U.S. Plus, any gains you’ve realized on new investments since moving to the island are taxed at 0%, bringing your effective tax rate on capital gains even lower. For seniors, this could mean more cash on hand in retirement. For early retirees it could extend your runway considerably, allowing you to retire earlier than you’d thought.
Capital gains taxes on property are also generally taxed at 0%. This means investors can achieve huge tax savings by moving to Puerto Rico, and has important implications for retirees, assuming they can wait 10 years to cash out their long-term capital gains.
Should you move?
Puerto Rico is essentially a legal tax haven, which means the primary benefits apply to those who would normally owe a lot of taxes. If you want to calculate what you might save by moving to Puerto Rico, simply look at your last tax return. But remember, a significant portion of Americans pay little to no income or capital gains taxes. Unless you make or inherited large amounts of money, moving probably makes little sense from a tax benefit perspective—although it would be a good way to brush up on your Spanish.
There are also more personal questions you’ll need to ask yourself: Is moving all the way to Puerto Rico to save a bit on your taxes really worth it? Is it unpatriotic to pay such a low tax rate?
If you’re a high net worth individual or run a successful business that is mobile, then moving to Puerto Rico may relieve you of a significant tax burden. Whether the savings are truly worth it, however, is a question for you.