The US was barely a country when Benjamin Franklin assured us that death and taxes were the only two sure things in life, even though there were no personal or corporate income taxes then. Since his time, taxes in the US have become complicated and costly. The Internal Revenue Service (IRS) alone employs about 80,000 people.
We could also add that as long as there are rich people and taxes, there will be tax shenanigans, aka evasion. Offshore tax shelters have plagued the IRS for years as people with a lot of money pay smart tax lawyers and accountants to find ways to reduce or eliminate their tax bills.
Some crypto multi-millionaires are no exception. In a continuing game of cat and mouse, the IRS today keeps an eye on offshore havens like the US Virgin Islands. The Bahamas also had its crypto-cringe media moment when Samuel Bankman-Fried was expedited to the US after FTX’s meltdown.
Puerto Rico was a tax-haven option in 2019 with Act 60, a new tax incentive program to lure wealthy people and remote businesses from the US. This act occurred roughly the same time the US Congress identified a large loss of tax revenue as more and more high-net-worth Americans took advantage of off-shore tax shelters.
In January 2021, the IRS issued a press release stating the agency’s intention to investigate tax compliance among Americans who moved to Puerto Rico to take advantage of the new program.
While the IRS didn’t specifically call out crypto traders, some high-profile crypto investors like Michael Terpin have moved to PR. Former crypto influencer Logan Paul publicized his move to Puerto Rico to millions of followers, drawing attention to himself and linking the crypto sector, Puerto Rico, and tax evasion in one fell swoop. Mainstream media picked up on the story to capitalize on crypto clickbait.
In the meantime, more than 5,000 US mainlanders have moved to Puerto Rico over the past decade for tax reasons. Art NFTs have also found support in Puerto Rico’s thriving arts community.
In July 2023, several news outlets reported that the IRS Puerto Rico campaign was growing. In what doesn’t exactly seem like a sweeping sting operation, the IRS indicated that they are investigating about 100 people.
While it may seem like a lot of drama and (ironically) tax dollars spent investigating a small number of people, the outcome has broader implications for crypto taxes and investors.
Let’s take a closer look.
What is Puerto Rico’s Tax Relationship with the US?
Puerto Rico has a unique political status known as an “unincorporated territory.” Puerto Ricans are US citizens and can travel freely between the mainland US and Puerto Rico. However, citizens living in Puerto Rico exist in an odd civic limbo. Puerto Rico has no voting representation in the US Senate and only a non-voting delegate in the US House of Representatives.
The US does not guarantee or provide full federal benefits to citizens living in Puerto Rico. In a controversial ruling in April 2022, the US Supreme Court ruled that residents of Puerto Rico are not eligible for federal SSI benefits.
Conversely, the gray area between citizenship without statehood means that cash-strapped Puerto Rico may enact tax code provisions independently of the US. To attract more businesses and wealthy individuals from the mainland, Puerto Rico passed Act 60 in 2019, which was the combination of some earlier similar tax incentive legislation.
While the program has undoubtedly attracted investment and new wealthy residents, it has also increased inequality and drawn backlash from some Puerto Rican residents who say the outcomes of Act 60 are simply an updated form of colonialization.
What is Puerto Rico Act 60?
In a nutshell, Act 60 is a Puerto Rican tax program granting individuals a 100% exemption on dividends, a 60% exemption on municipal taxes, and no federal taxes on source income earned within the region.
So far, more than 3,600 businesses have taken advantage of the program to avoid paying taxes on dividends from earnings and profits. They are only required to pay a 4% tax for eligible export services and a 100 percent tax exemption on dividends from revenues and profits.
These incentives apply only to income that Puerto Rican companies earn from performing services in Puerto Rico for customers outside Puerto Rico. This has obvious implications for remote workers and even YouTubers.
Individuals can qualify for a 100 percent tax exemption on income from dividends and interest and another 100 percent exemption for all capital gains accrued after establishing bona fide residency in Puerto Rico.
To qualify, individuals must become bona fide residents of Puerto Rico (the most common test being whether the individual resides in Puerto Rico more than 183 days a year) and ensure that all income is earned in Puerto Rico. If the income derives from activities in the US, it is still subject to regular US tax regulations.
IRS General Activities in Puerto Rico
Following the announcement in 2021, the IRS stationed agents and private investigators in Puerto Rico to determine who may be out of compliance and to build cases against them.
Some items the IRS digs into center around residency, how much time the individual physically is present in Puerto Rico each year, and whether profits are generated in Puerto Rico.
The IRS has also sent information document requests asking individuals to disclose their expatriation on Form 8898, the Statement for Individuals Who Begin or End Bona Fide Residency in US Possession. This form gives the IRS an easy way to keep track of anyone from the US mainland living as an expat in Puerto Rico.
Errant taxpayers are not the only ones in the IRS crosshairs. They are also looking for PR-based attorneys, accountants, and other professionals who have assisted taxpayers seeking to evade compliance.
A soft letter is typically the first move the IRS will take. This letter acts as a notice from the IRS requesting more information. It differs from a notice of examination, a much more in-depth process that can take much more time.
IRS Considerations for Puerto Rico Cryptocurrency Ex-pats
For crypto investors claiming Act 60 benefits in Puerot Rico, experts say the best defense is a good offense. The best time to get help is before you receive a soft letter or notice.
Below are some tips recommended by legal experts, who also recommend ensuring you’re working with a qualified professional who understands what needs to be in place to avoid civil or even criminal penalties.
Numbers Game
Experts point out that two things contribute to an increased likelihood of receiving a soft letter or notice of examination. The first is just simple probability. Given that Puerto Rico has a much smaller pool of crypto-active taxpayers compared to the US, your odds of receiving IRS scrutiny are higher.
Crypto as a Hot-button Issue
Some tax law experts theorize that because crypto and tax evasion are hot-button issues, agents may choose to be more stringent in their approach to proof of compliance in an effort to push the questions to litigation. That is because the outcome of litigation tends to be new laws that can clarify the IRS’s position.
Large Tax Payment History Stands Out
The IRS has limited resources and tends to pursue cases that will have the most impact. If you paid a lot of taxes in the past, that may increase the chances that you will be issued a soft letter or notice of examination.
Location Matters
A big part of qualifying for the Act 60 tax break is proving physical presence for residency. Residents must be able to prove that they live on the island for at least 183 days each year.
Geo-locating, cell phone records, and social media posts can make proving your presence in a location easier over time. On the other hand, when those records show an individual spent most of their time outside of Puerto Rico, they can and are used against taxpayers under investigation by the IRS.
As an aside, states are also using these records to void change of residency claims and recapture tax revenue from former residents now claiming residency in a no-income-tax state. New York is a good example.
The US and Puerto Rico Are Not Equal in the Eyes of Tax Law
Taxpayers should recognize the distinctions between US and Puerto Rican tax obligations. Compliance in Puerto Rico does not mean the IRS will agree. The US and Puerto Rico are separate jurisdictions with different regulations and compliance for taxpayers.
Moving Ahead
Most crypto investors don’t have the mixed blessing of a tax bill big enough to consider a move to Puerto Rico. Even a modest crypto portfolio can present major headaches at tax time.
If you trade crypto assets, ZenLedger can help you organize everything for tax time. The platform automatically aggregates transactions across exchanges and wallets, computes your capital gain or loss, and generates the tax forms you must file yearly. You can also find ways to reduce your tax burden through tax loss harvesting.
This material has been prepared for informational purposes only and is not professional or legal advice. Please seek independent legal, financial, tax, or other advice specific to your particular situation.
