“Puerto Rico Act 22, Individual Investors Act” is one of the campaigns listed on the Internal Revenue Service’s (“IRS”) website. The campaign mainly targets taxpayers who claimed benefits through Puerto Rico Act 22, “Act to Promote the Relocation of Individual Investors to Puerto Rico” (‘’Puerto Rico Act 22’’) but did not meet the requirements of IRC Section 937 with respect to residency in Puerto Rico leading to erroneous exclusion of income subject to United States (“US”) tax on a filed US income tax return or to a failure to file and report income subject to US tax. Additionally, the campaign is focused on the taxpayers who erroneously reported US source income as Puerto Rico source income even if they satisfy the requirements of IRC Section 937. In the framework of campaign, the IRS targets taxpayers through examinations, outreach and soft letters.
Puerto Rico Act 22
Puerto Rico Act 22 was enacted on January 17, 2012 to create tax incentives for relocation of individual investors to Puerto Rico.
Puerto Rico Bona Fide Residency Requirements
The definition of bona fide resident is defined in the IRC Section 937. Generally, in order to be eligible for tax benefits under Puerto Rico Act 22, the following tests have to be satisfied: physical presence test, tax home test and closer connections test.
To satisfy physical pretense test, an individual must be present in Puerto Rico at least 183 days during the taxable year. Even if an individual satisfies the physical pretense test, a taxpayer cannot have a tax home, as defined further, outside Puerto Rico, and an individual cannot have a closer connection, as defined under IRC Sec. 7701(b)(3)(B)(ii)) to the US or to another foreign country.
Generally, tax home, as defined under IRC Sec. 911(d)(3) and Treas. Reg. 1.911–2(b) is a location of individual’s regular or principal place of business or if an individual has no regular or principal place of business, his regular place of abode.
With respect to closer connection test, Treas. Reg. 301.7701(b)-2(d)(1) includes the factors to determine closer connection with a foreign country such as the location of permanent home; the location of individual’s family; the location of personal belongings, such as automobiles, furniture, clothing and jewelry owned by a an individual and his or her family; location of social, political, cultural or religious organizations with which an individual has a current relationship; place of routine personal banking activities, the location where an individual conducts business activities; jurisdiction issuing individual’s driver license; jurisdiction where an individual votes; place designated by an individual on official forms as her/his residence.
Puerto Rico Act 22 – Tax Benefits
Generally, US residents are taxed on their worldwide income. However, individuals who are bona fide residents of Puerto Rico during the entire taxable year, and whose income derived from sources within Puerto Rico are exempt from US federal income taxes on such income under IRC Section 933.
Under Puerto Rico Act 22, qualified individual investors are entitled to income tax exemption on passive income derived from interests and dividends after they become bona fide resident of Puerto Rico. Additionally, qualified individual investors are also eligible for capital gain exemptions provided that capital gain was accrued after individual investors become bona fide residents of Puerto Rico. Realized capital tax gains that accrued before qualified individual investors became bona fide residents of Puerto Rico are subject to lower tax rates. The discussed above tax benefits are available after qualified individual investors become bona fide residents of Puerto Rico but before January 1st, 2036.
In some instances, complex analysis is required in order to determine whether an individual is entitled to the investment’s benefits under the Puerto Rico Act 22. Spending 183 days in Puerto Rico is not enough to satisfy requirements of bona fide residency under IRC Section 937.