The Internal Revenue Service (“IRS”) announced its plan to pursue criminal investigations into potential abuses of Puerto Rico’s Act 20/22/60 tax incentive programs. In a July 14, 2023, release, the IRS revealed that “[t]hanks to Inflation Reduction Act resources,” it has begun a criminal crackdown on Act 20/22/60 participants engaging in a ”[h]igh-dollar scheme in Puerto Rico.” The IRS has “identified about 100 high-income individuals claiming benefits in Puerto Rico without meeting the residence and source rules involving U.S. possessions” and believes “[t]hese wealthy individuals are attempting to avoid U.S. taxation on U.S. source income, and we expect many of these cases to proceed to criminal investigation.”
Background
Puerto Rico’s Act 20 and Act 22 (replaced by Act 60 in 2019) provide generous tax incentives to U.S. companies and individuals who establish a bona fide residence in Puerto Rico. The tax benefits include a tax rate of 4 percent for eligible export services, a 100 percent tax exemption on dividends from earnings and profits, and a 60 percent tax exemption on local municipal taxes, all with a 20-year decree guaranteeing these rates. These tax incentives apply only to income that Puerto Rican companies earn from performing services in Puerto Rico for customers outside Puerto Rico. Puerto Rico also offers tax incentives to individuals who relocate to Puerto Rico, including a 100 percent tax exemption on income from dividends, interest, and capital gains. Under U.S. law, a bona fide resident of Puerto Rico is not subject to U.S. income taxes on income derived from sources within Puerto Rico; bona fide residents of Puerto Rico are only subject to U.S. income taxes on income derived from sources outside of Puerto Rico.
IRS Enforcement Turns Criminal
The IRS sounded the alarm on the abuse of Puerto Rico residency programs several years ago. In an October 21, 2020, press release, the IRS promised to “vigorously pursue any individuals and professionals that fraudulently enrich themselves by abusing government tax incentive programs.” On January 29, 2021, the IRS added Puerto Rico Act 22 to its list of compliance campaigns in response to concerns of abusive tax avoidance, noncompliance, and fraud committed by decree holders. On July 1, 2021, the IRS concluded its 2021 “Dirty Dozen” scams list series with a warning about promoted abusive arrangements, including offshore captive insurance companies domiciled in Puerto Rico. In light of what it perceived to be continuing abuse in this area, Puerto Rico residency programs held their place on the IRS Dirty Dozen lists in 2022 and 2023.
In addition to targeting high-income taxpayers improperly claiming benefits under Act 20/22/60, the IRS will investigate the professionals who assisted the taxpayers at issue. The IRS will attempt to contact and interview accountants, attorneys, financial advisors, and other individuals who promoted the Puerto Rico residency programs.
Finally, along with the criminal investigations, we anticipate a substantial increase in civil promoter investigations and taxpayer audits. Taxpayers and professional advisors contacted by the IRS as part of this enforcement effort should engage experienced counsel before speaking to the IRS.
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