Relocating from a U.S. state to Puerto Rico to take advantage of tax incentives, such as those under Act 60, requires careful planning to ensure compliance with IRS requirements for bona fide residency. To qualify as a bona fide resident of Puerto Rico, you must satisfy three tests: the Presence Test, Tax Home Test, and Closer Connection Test. Conducting a self-audit before an IRS or state residency audit can help you confirm compliance and avoid costly penalties. Below is a checklist of best practices to guide your self-audit process, tailored to these tests.
Why Self-Audit?
A self-audit helps you:
- Verify compliance with IRS bona fide residency requirements.
- Identify gaps in documentation or behavior that could jeopardize your residency status.
- Prepare for potential IRS or state audits, which are common for high-net-worth individuals moving to Puerto Rico.
- Ensure you maximize tax benefits under Puerto Rico’s incentives, such as Act 60, while minimizing risks.
Checklist for Self-Auditing Compliance
1. Presence Test: Verify Physical Presence in Puerto Rico
The Presence Test requires you to spend sufficient time in Puerto Rico to establish residency. You can meet this test in several ways, such as spending at least 183 days in Puerto Rico during the tax year or averaging 183 days over three years with a minimum of 60 days per year.
Best Practices:
- Track Your Days in Puerto Rico:
- Use a travel log to record your physical presence, including dates of arrival and departure.
- Maintain supporting documents like plane tickets, hotel receipts, or credit card statements showing transactions in Puerto Rico.
- Consider apps like Monaeo, TaxDay, or TaxBird to track your location automatically and generate audit-ready reports. These apps have helped clients save millions by defending residency status.
- Minimize Time in the U.S.:
- Ensure you spend no more than 90 days in the U.S. during the tax year if you’re relying on the “no more than 90 days in the U.S.” rule.
- Be aware that days spent in the U.S. for specific reasons (e.g., as a professional athlete at a charitable event or as a full-time student) may not count toward U.S. presence.
- Account for Exceptions:
- If you were unable to return to Puerto Rico due to extraordinary circumstances (e.g., Hurricane Maria in 2017), check IRS guidance for exceptions, such as the 117-day credit granted post-hurricane.
- Document any such circumstances with evidence like travel bans or emergency declarations.
- Audit Tip:
- Cross-check your calendar, phone location data, and travel records to confirm you meet one of the Presence Test criteria.
- For midyear moves, ensure you meet the test for the portion of the year after your move (e.g., 183 days in Puerto Rico for the last half of the year).
2. Tax Home Test: Establish Puerto Rico as Your Principal Place of Business
The Tax Home Test requires that your regular or principal place of business be in Puerto Rico during the tax year, with no tax home outside Puerto Rico. Your tax home is generally where you conduct your income-producing activities.
Best Practices:
- Relocate Your Business Operations:
- If you own a business, move its operations to Puerto Rico to generate Puerto Rico-sourced income, which is critical for tax exemptions under Act 60.
- Ensure your office or establishment in Puerto Rico is bona fide, with a physical presence (e.g., leased office space, employees, or equipment).
- Document Work Activities:
- Keep detailed records of work performed in Puerto Rico, such as client contracts, invoices, or timesheets showing services rendered on the island.
- Track working days separately from non-working days to demonstrate that your income-producing activities occur primarily in Puerto Rico.
- Avoid Off-Island Income-Producing Activities:
- Be cautious about conducting significant business activities in the U.S. or elsewhere, as services income is sourced where the work is performed, not where you are physically present.
- If you work remotely for a U.S.-based employer, clarify whether your role can be performed entirely from Puerto Rico to avoid a U.S. tax home.
- Audit Tip:
- Review your employment contracts, business records, and travel itineraries to confirm that your principal place of business is in Puerto Rico.
- For Act 60 participants, ensure your tax exemption decree (e.g., for export services under Chapter 3) aligns with your business activities.
3. Closer Connection Test: Demonstrate Stronger Ties to Puerto Rico
The Closer Connection Test requires that you have a stronger connection to Puerto Rico than to the U.S. or any foreign country during the tax year. This is a facts-and-circumstances test based on your personal, financial, and social ties.
Best Practices:
- Establish Personal and Family Ties:
- Move your family (spouse, children) to Puerto Rico, as their residency status can impact your closer connection. For example, a spouse maintaining U.S. residency could create a closer connection to the U.S.
- Enroll children in Puerto Rican schools and document their attendance.
- Bring sentimental items (e.g., jewelry, heirlooms, pets) to your Puerto Rico home to show it’s your primary residence.
- Update Legal and Financial Ties:
- Change your voter registration, driver’s license, and mailing address to Puerto Rico.
- Open and use Puerto Rico-based bank accounts for primary financial transactions.
- Update official forms (e.g., Form W-9 or W-8BEN) to reflect your Puerto Rico address.
- Minimize U.S. Connections:
- Convert any U.S. home to a rental property and retain documentation like a brokerage agreement or rental income to show it’s not your primary residence.
- Avoid spending more than 30 days at a U.S. residence, as this could be deemed a closer connection.
- Limit affiliations with U.S.-based organizations (e.g., religious or athletic clubs) and join Puerto Rico-based equivalents.
- Engage in Puerto Rico’s Community:
- Make charitable contributions to Puerto Rico-based nonprofits, as required for Act 60 Resident Individuals ($10,000 annually).
- Join local social clubs, religious organizations, or community groups to demonstrate integration.
- Audit Tip:
- Compile a “Closer Connection Inventory” listing all ties to Puerto Rico (e.g., home, family, bank accounts) versus the U.S. or other countries.
- Ensure your Puerto Rico home is available continuously, not just for short stays, and document ownership or lease agreements.
4. General Compliance and Documentation
Beyond the three tests, additional steps ensure overall compliance and audit readiness.
Best Practices:
- File Required Forms:
- File Form 8898 (Statement for Individuals Who Begin or End Bona Fide Residence in a U.S. Possession) if your worldwide income exceeds $75,000 in the year you move to or from Puerto Rico. Submit by the Form 1040 due date to the IRS address in Austin, TX.
- Attach Form 8840 (Closer Connection Exception Statement for Aliens) to your tax return if claiming a closer connection to Puerto Rico as a nonresident alien.
- File Puerto Rico tax returns if required by local tax authorities, especially for Act 20/22/60 participants.
- Maintain Robust Documentation:
- Organize all records in a secure, accessible system (e.g., cloud storage or physical files).
- Retain documents for at least four years, as IRS audits may cover multiple years, especially for midyear movers.
- Include calendars, phone records, utility bills, and lease agreements to support your residency claims.
- Consult Professionals:
- Work with a tax advisor experienced in Puerto Rico residency to conduct a mock audit of prior years.
- Coordinate with local accountants or lawyers to ensure compliance with Puerto Rico’s tax incentive requirements, such as purchasing a residential property within two years for Act 60 Resident Individuals.
- Prepare for State Audits:
- High-tax states like New York, California, or New Jersey aggressively audit residents moving to Puerto Rico, reclaiming significant tax revenue.
- Use location-tracking apps to counter cell phone tracking by state auditors, who rely on such data to challenge residency.
- Understand Income Sourcing:
- Puerto Rico-sourced income (e.g., dividends, capital gains accrued after becoming a resident) is exempt from U.S. federal tax under IRC §933, but U.S.-sourced income remains taxable.
- Document the timing of asset acquisitions to ensure capital gains are Puerto Rico-sourced (e.g., gains on securities acquired after moving).
5. Common Pitfalls to Avoid
- Assuming 183 Days Is Enough: Spending 183 days in Puerto Rico satisfies the Presence Test but not necessarily the Tax Home or Closer Connection Tests.
- Keeping a U.S. Home: Maintaining a U.S. residence, especially if used frequently, can create a closer connection to the U.S.
- Neglecting Documentation: Without travel logs, receipts, or bank statements, you may struggle to prove residency during an audit.
- Ignoring State Audits: States like New York win over half their residency audits, costing taxpayers significant fees and settlements.
- Misunderstanding Income Sourcing: Income from services performed outside Puerto Rico is not exempt, even if you’re a bona fide resident.
- Failing to File Forms Timely: Late or missing Forms 8898 or 8840 can invalidate your residency claims unless you provide clear evidence of reasonable efforts to comply.
Final Recommendations
- Start Early: Begin tracking your presence, tax home, and connections as soon as you plan your move to Puerto Rico.
- Conduct Annual Self-Audits: Review your compliance at the end of each tax year to catch issues before filing.
- Leverage Technology: Use location-tracking apps and cloud-based document storage to streamline record-keeping.
- Seek Expert Guidance: Engage a tax professional familiar with Puerto Rico’s tax incentives and IRS residency rules to navigate complexities, especially for Act 60 participants.
By following this checklist, you can confidently establish and maintain bona fide residency in Puerto Rico, maximize tax benefits, and be well-prepared for any IRS or state audit.
📞 Contact Us
For assistance with your compliance or to schedule a consultation, feel free to reach out to us:
- 📧 Email: [email protected]
- 📞 Phone: 787-473-8985
- 🌐 Website: www.bonnllc.com
We’re here to help you navigate this procedure of moving down here and ensure you remain compliant while maximizing your benefits!
Disclaimer:
The information provided is for informational purposes only and should not be considered legal or tax advice.