Establish tax efficiency for your company: 4% and tax efficiency for individuals 0%. Create a winnin
Updated: Jul 18, 2020
What’s new in 2020?
In late June 2019, Puerto Rico completed a massive overhaul of their tax incentives, enacting the Incentives Code.
The new law does NOT eliminate the existing incentives. It systematizes dozens of incentive acts – Acts 20 and 22 are just the most famous ones – that Puerto Rico has enacted over the years.
The law came into effect on January 1, 2020 and altered previous legislation. Act 22, known as Individual Investor Act, became more costly to comply with.
The mandatory annual donation to Puerto Rican charity increased from $5,000 to $10,000. And within the first two years of living there you now need to buy a home in Puerto Rico.
On the bright side, conditions for Act 20, known as the Export Services Act, remained largely the same. Under the new rules, If your Act 20 company churns $3,000,000 (or more) of revenue a year, you will need to employ a full-time employee in Puerto Rico. And that single employee can be you actively managing your business.
The Acts themselves are not even called Acts anymore.
For example, Act 20 became: Chapter 3 of the Incentives Code – Exportation of Goods and Services.
And Act 22 is now: Chapter 2 – Individuals.
In this blog post, we outline the new requirements, but for easier understanding will keep calling them Act 20 and Act 22.
How to slash your company’s tax rate to only 4%
The first is Puerto Rico’s Act 20, known as the Export Services Act, available to citizens of any country.
It allows you to slash your corporate tax rate to only 4%.
Dividends paid to you personally from your Act 20 company also won’t be taxed AT ALL— but only as long as you are a bona fide resident of Puerto Rico.
The Export Services Act is interesting, because of its extremely broad legislation. Here’s the idea behind it…
You incorporate a business in Puerto Rico that’s providing a service and that service is being sold to people outside of Puerto Rico.
Your service could be research and development, advertising, any kind of consulting, project management, accounting, legal services, information technology services, telemedicine, and much more.
Regardless of your particular specialty, your businesses’ service – provided to clients anywhere in the world – is considered “qualifying activity” under Act 20. So, your business is eligible for a special corporate tax rate of just 4%.
The key to obtaining this 4% corporate tax rate is that you’re providing a service or services exported outside of Puerto Rico.
A clinic providing healthcare services to only Puerto Rican residents wouldn’t qualify. But if you’re providing telemedicine consultations to patients in the mainland US, Europe, or Asia, then your business meets the “qualifying activity” criteria.
Even if your primary business doesn’t fit within the “services” space, there’s a way to qualify for the 4% corporate tax rate.
I know people here, for example, who sell products online through Fulfillment by Amazon (FBA), where Amazon’s customer service centers pack and ship their inventory.
Since marketing is a service, they set up a Puerto Rico Act 20 company to provide that marketing service. Their Puerto Rican Act 20 company exports its marketing services to their FBA business.
The marketing company in Puerto Rico only pays a 4% corporate tax rate, and their FBA business can write off these marketing expenses.
Other people I know have a manufacturing business incorporated overseas, and they also use these Act 20 companies to reduce their taxes.
Some of them use their Act 20 company to provide management services in Puerto Rico, or ‘shared services’ like payroll, accounting, etc. to their manufacturing business overseas.
These management and shared service fees are completely legitimate services to provide. The setup is similar to the previous marketing services example. The Puerto Rican management company pays a 4% corporate tax, and the manufacturing business writes off the management expenses.
Remember, if you follow the proper rules, your Puerto Rican company won’t pay any US tax. So instead of a 21% corporate tax in the mainland US, plus another 20% dividend tax, all you’ll be paying in Puerto Rico is a measly 4% corporate tax. And zero in dividend tax.
This is an absolutely incredible deal.
The Act 20 legislation is very broad. Again, regular employees cannot benefit, but if you can arrange to work remotely, then you can transition to being an independent contractor operating out of Puerto Rico.
As an independent contractor, you’ll now be exporting your services – whatever they may be.
If you have a skill where you can work anywhere – copywriting, digital marketing, telemedicine, investment management, consulting, design, coding, paralegal work, medical transcription, accounting, recruiting, etc. – then you owe it to yourself to check out Puerto Rico’s Act 20.
Note that the new Incentives Code introduced an employment requirement to Act 20 in 2020.
If your Act 20 company churns $3,000,000 (or more) of revenue a year, you will need to employ a full-time employee – a resident of Puerto Rico – working a normal 8-hour day.
That single employee can be you, the business owner actively managing your business.
If your company earns less than that, there is no employment requirement at all, as before.
Act 22: How to reduce your capital gains tax to ZERO
The second piece of legislation is Act 22, the Individual Investor Act.
If you’re an investor based in the US, you’re paying a top 20% tax on dividends and capital gains, potentially the 3.8% Obamacare surcharge tax (for those married filing jointly with over $250,000 in annual income) and a host of state and local taxes.
But if you pack up and move down to sunny and beautiful Puerto Rico, then all your future capital gains on stocks and bonds… become tax free.
The new Incentives Code explicitly includes gains on cryptocurrencies as well when formed correctly with the proper legal wording in application.
Additionally, any dividends, interest, and royalties you may receive from Puerto Rican sources will also be tax-free.
That’s right. The IRS won’t touch any of your investment income.
If you’re expecting big capital gains in the future, you need to seriously consider Act 22. Gains on stocks, bonds, crypto… you will have after your move to the territory, will be tax-free.
If you are sitting on significant gains already, Puerto Rico may still help you. If you spend more than ten years as a resident there, your tax obligation on the portion of capital gain you accrued while still living in the US will also go down… to 5%.
That’s an incredible deal.
Please note that the new Incentives Code made Act 22 more expensive in 2020.
First, in order to qualify for Act 22, you need to make an annual donation to official charities in Puerto Rico, and in 2020, the donation amount increased from $5,000 to $10,000.
Under the new rules, within two years of obtaining your Act 22 decree, you will need to buy a property in Puerto Rico and use it as your primary residence (you can’t rent it out). You will need to keep it throughout the validity of your Act 22 decree.
(There is no minimum purchase price requirement for your residence.)