Overview
Last year the IRS announced a new campaign addressed at taxpayers who have claimed benefits through Puerto Rico Act 22, “Act to Promote the Relocation of Individual Investors to Puerto Rico”, without meeting the requirements of IRC section 937, Residence and Source Rules Involving Possessions. The campaign is a key enforcement priority of the IRS’s agenda in 2022.1
The IRS has dedicated significant personnel to find individuals who may be excluding income subject to US tax on a filed US income tax return or failing to file and report income subject to US tax. The campaign also focuses on individuals who have met the requirements of section 9372 but may be erroneously reporting US source income as Puerto Rico source income in order to avoid US taxation.3
The IRS has used examinations, outreach and soft letters to address noncompliance in this area. Issues that often arise in these audits include whether (i) a US person properly established bona fide residency in Puerto Rico under the presence test, the tax home test, or the closer connection test, and (ii) bona fide residents of Puerto Rico have maintained their residency and kept detailed recordkeeping, which requires analyses of both personal data (e.g., personal relationships and affiliations) and quantitative data (e.g., day counts, income figures, credit card data and business details).
Endnotes
1 Under Act 22, dividend and interest income and capital gains are all 100% tax exempt in Puerto Rico, in addition to the exemption from federal income tax. The IRS recently estimated that 23,000 individuals requested exemptions under this law.
2 Section 937 defined the term “bona fide resident” means a person—
(1) who is present for at least 183 days during the taxable year in Guam, American Samoa, the Northern Mariana Islands, Puerto Rico, or the Virgin Islands, as the case may be, and
(2) who does not have a tax home (determined under the principles of section 911(d)(3) without regard to the second sentence thereof) outside such specified possession during the taxable year and does not have a closer connection (determined under the principles of section 7701(b)(3)(B)(ii)) to the United States or a foreign country than to such specified possession.
3 A resident of Puerto Rico is not required to pay federal income tax on money earned in Puerto Rico. Section 933 was developed with the goal of extending to Puerto Rico more flexibility to levy local taxes. The federal government therefore allowed residents of Puerto Rico to earn wages in Puerto Rico without paying federal income tax on those wages.