IRS Cracking Down on High Net Worth Individuals Fleeing to Puerto Rico

The IRS’ focus is now on private wealth clients, hedge fund managers, and cryptocurrency traders who are fleeing to Puerto Rico in an attempt to escape President Biden’s proposed capital gains tax increases as well as take advantage of Puerto Rico’s significant tax breaks. In late January, the country’s tax collector quietly coordinated a campaign that examined individuals, dating back to 2012, who took advantage of tax incentives that were designed to lure high net-worth individuals and corporations to Puerto Rico. This campaign showed that about 4,000 mainland US residents and firms had moved between 2012 and 2019. This led to hundreds of millions of dollars in lost tax revenue for the U.S. government. The IRS is anticipating more audits now that the deadline has passed. Many tax attorneys that have advised clients on federal tax income issues with respect to Puerto Rico have already started receiving requests for information.

The taxpayers who may have excluded income subject to U.S. tax, or failed to file and report income altogether when they moved to Puerto Rico, are the biggest issue for the IRS at this moment. They are also targeting those who claim to be bona fide residents of Puerto Rico but may be claiming U.S. income to evade taxes. The IRS’ push is taking place as Biden’s proposed tax increases have triggered moves by America’s wealthiest from high-tax states such as New York and California. Hedge funds like Izzy Englander’s Millenium Management and ExodusPoint Capital Management have already moved to establish subsidiaries on the island.

Although campaigns by the IRS often take years to organize, agents can detect factual patterns that indicate a significant loss of revenue due to noncompliance. In Puerto Rico’s case, much of the focus will be on establishing whether individuals are truly island residents and whether they properly sourced income to Puerto Rico.

Unlike other IRS efforts, this campaign’s originated when Congress requested a report from the agency in their 2020 appropriations bill concerning Puerto Rico’s tax laws. The IRS’ report to Congress calculated that more than 1,924 applicants had been granted tax benefits under the Exports Services Act, formerly Act 20, as of March 2020. Act 20 offers entities a 4% corporate rate on business income and a 100% tax exemption on dividends. That provision, along with the Individual Investors Act, has now been consolidated into a new incentive law to attract individuals and investments to the island.

Individuals will have to prove their Puerto Rican residency to the IRS as a key factor in claiming the tax benefits. Meaning, taxpayers must live on the island for a minimum of 183 days annually every year to be considered a bona fide resident. Maintaining a residency in the eyes of the IRS goes beyond simply leasing an apartment in the popular Dorado Beach. It includes bringing your main possessions, joining local clubs, updating your voter registration status, moving with your spouse, and enrolling your children in the island’s schools. Although, moving doesn’t necessarily make someone exempt from filing U.S. tax returns; even if someone has qualified for tax incentives from Puerto Rico. Another detail to note is that only income from a Puerto Rico source is eligible for exemption, not a foreign source. In many of the audits, the New York Department of Taxation tries to determine an individual’s “true intentions.” This means a taxpayer must provide clear evidence that they’ve really moved to another state which includes the sale of their home in New York, closing any businesses, and relocating their belongings. Problems arise when people claim to have moved but can’t supply any supporting evidence.

Talley’s experienced team of tax professionals provides comprehensive tax compliance and consulting services so you can preserve, enhance, and pass on your wealth and assets to the next generation. We welcome the opportunity to discuss the current options available to you. For more information, contact us today.