IRS campaign to focus on Puerto Rico Act 22

On Jan. 27, 2021, the Internal Revenue Service (IRS) announced a new compliance campaign focusing on the Puerto Rico Act 22 (now Act 60). Act 60 consolidated various tax decrees, incentives, subsidies and benefits, including Acts 20 and 22. Acts 20 and 22 were intended to incentivize investment in Puerto Rico, promote the exportation of services from companies and individuals providing such services and attract high net-worth individuals to Puerto Rico.

Those taxpayers that meet the requirements of Act 60 are eligible to receive significant tax savings. For example, Act 60 offers a corporate tax rate of 4% to Puerto Rico domiciled companies that export services performed in the territory to people or companies outside of the territory. Similarly, high net-worth individuals may qualify for a total exemption from Puerto Rico income taxes on all interest and dividends realized after the individual becomes a bona fide resident of Puerto Rico.

The Commonwealth of Puerto Rico is a U.S. territory (and generally subject to all U.S. federal laws). However, for federal tax purposes, Puerto Rico is treated as a “foreign country.” The Internal Revenue Code states that U.S. citizens and resident aliens are taxed on worldwide income[1]. However, section 933[2] provides an exception to this general rule. Residents of Puerto Rico receive special tax treatment for Puerto Rico sourced income.

The IRS’s new campaign addresses taxpayers who have claimed benefits through Puerto Rico Act 60, without meeting the requirements of section 937, Residence and Source Rules Involving Possessions. Consequently, the IRS has identified vulnerabilities with certain individuals who may be excluding income subject to U.S. tax on a filed U.S. income tax return or failing to file and report income subject to U.S. tax. As such, this campaign will also address those individuals who have met the requirements of section 937 but may be erroneously reporting U.S. source income as Puerto Rico source income in order to avoid U.S. taxation.

In an effort to enhance voluntary compliance with the tax laws, the IRS partners with foreign jurisdictions, federal, state and municipal governmental agencies. These partnerships often involve some type of formal agreement such as a memorandum of understanding or Tax Coordination Agreement (TCA) that allows for the exchange of taxpayer data. Article four of the TCA between the U.S. and the Commonwealth of Puerto Rico allows for the exchange of information to administer and enforce the tax laws of the respective jurisdiction.