If you are a U.S. citizen, you are liable to pay taxes on all of your worldwide income. This can be a huge burden. However, there is a way to minimize the amount of tax you legally have to pay as a U.S. citizen: move to Puerto Rico.
The Long Reach of the IRS
What do the U.S. and the little-known African country of Eritrea have in common? They’re the only two countries in the world in which citizens are taxed on all of their worldwide income, no matter where they live.
People from every other country in the world can just pack up their bags, move to a friendly, minimal-tax jurisdiction such as the Cayman Islands or Singapore, and pay virtually no taxes to their home country. This is not so for U.S. citizens, who have limited options for reducing their tax burden. These options include:
1. Relocating to a state with low taxes
Many Americans do this on a yearly basis. They move from a high-tax state like New York or California to a state with no taxes, such as Florida or Texas. However, although this lets people get out of their state tax obligations, they do not escape federal taxes.
2. Moving out of the country
The Foreign Earned Income Exclusion (FEIE) allows Americans to move to a country with much friendlier taxes, such as Panama, and avoid paying federal taxes on up to approximately $100,000 of income earned from a foreign source. However, investment income that you earn would still be taxed and of course, you would pay taxes on anything above the exclusion limit. There are some deductions that let you invest in tax-free real estate overseas, which bumps up the total possible amount of tax-free income to about around $150,000.
3. Renouncing your American citizenship
While doable, this is a drastic measure that takes proper planning and a real evaluation of the consequences of losing your U.S. citizenship rights. While this may be the most guaranteed option to avoid paying U.S. taxes, it could cause serious rifts in your family and personal life, which could be emotionally draining.
4. Relocating to Puerto Rico
Not long ago, Puerto Rico wasn’t a serious option on the menu for U.S. citizens looking to pay fewer taxes. But recent changes in the government of Puerto Rico have brought new laws that offer sizable tax relief, largely an effort to persuade economically productive individuals and companies to move there. Thanks to the island’s separate tax system, you can now claim exemptions on virtually all of your U.S. federal taxes.
So how exactly do you qualify for these tax incentives, and what do they offer specifically? Puerto Rico has declared that if you haven’t resided on the island in the past 15 years, you are eligible for certain tax incentives. You would need to move to Puerto Rico and become a resident. You then would sign a contract with the government which guarantees you 0 percent taxes on capital gains and income from dividends, in addition to only 4 percent on corporate income tax (if you form a corporation).
Taking a page from Singapore’s game plan, the Puerto Rican government anticipates that by reducing their taxes and making it attractive for productive people to live and work in Puerto Rico, they can create growth and jobs in the economy.
There are two big caveats to the new laws. The first has to do with your business income and the second with your investment income.
The Export Services Act (Act 20)
“Export services” refers to serving customers from abroad only while being located in Puerto Rico. This means you can’t have branches in the U.S. or anywhere else if you want to avoid paying more taxes.
Act 20 lets you reduce your taxes to the aforementioned 4 percent if you meet a variety of criteria. Firstly, you create a company that is Puerto Rican or move your current company to Puerto Rico. Secondly, you must serve customers outside of Puerto Rico by performing services in Puerto Rico.
The IRS primarily determines how to tax income on services based on where the service is physically performed. This would allow you, for example, to consult for clients in California via phone, computer, or other means, as long as you only perform those services on behalf of your company in Puerto Rico.
Additional business models that would fit the criteria include e-commerce stores, consulting, investing services, web design, Internet marketing, legal services, and software development, and more. The great part is, you wouldn’t pay U.S. federal taxes on dividends from the company, as long as you reside in Puerto Rico and not mainland America. When financial tycoon Peter Schiff moved his company to Puerto Rico from California, he reduced his tax burden from 50 percent to 4 percent.
Individual Investors Act (Act 22)
The Individual Investors Act allows a new resident of Puerto Rico to do away with all of their tax burden on investment income. You would owe tax on investments accumulated before moving, however. So if you have an investment that appreciates $50,000 prior to your move to Puerto Rico, you would pay taxes on that. If that investment continues to grow after you become a resident, you would pay no further tax on the growth.
Qualifying for residency
To qualify for residency in Puerto Rico, you need to establish a strong connection thereby meeting three criteria: the physical presence test, the tax home test, and the connection test.
• Physical Presence — You must spend 183 days a year in Puerto Rico to qualify as a resident there.
• Tax Home — The IRS defines your tax home as the primary place of your work, income, or business. Therefore, the best method is to simply live and work in Puerto Rico.
• Connection Test — You must prove you have a closer connection with Puerto Rico than another foreign country or with the U.S. To do this, you can use your Puerto Rican address on all forms, change all of your business addresses to Puerto Rico, attend local events, get rid of homes in the U.S., get a doctor or a lawyer in PR, and learn Spanish.
If you fit the qualifications above and love the idea of living and working in Puerto Rico, then this could be the perfect opportunity for you. You can enjoy a warm climate, beaches, and fewer taxes, as well as a growing business sector that contributes to your financial goals.
How To Pay Virtually No Tax by Moving To Puerto Rico