What Is the Meaning of Tax Code 977 for Puerto Rico?

U.S. citizens considering a move to Puerto Rico encounter a distinct set of federal tax rules. The United States tax code provides specific treatment for individuals who establish residency on the island. The framework for these rules is based on definitions of residency and the geographic source of income, which together determine an individual’s U.S. tax responsibilities.

Defining Bona Fide Residency in Puerto Rico

To access the tax provisions for residents of Puerto Rico, a U.S. citizen must qualify as a “bona fide resident.” This status is determined by three specific tests outlined in Internal Revenue Code Section 937. Satisfying all three tests within a given tax year is a requirement to be recognized by the IRS as a bona fide resident for federal tax purposes.

The first of these is the Presence Test, which measures time spent on the island. To meet this test, an individual must be physically present in Puerto Rico for at least 183 days during the tax year. Any part of a day spent in Puerto Rico counts as a day of presence.

Next, an individual must satisfy the Tax Home Test. This test requires that the person’s tax home be in Puerto Rico for the entire tax year. A tax home is defined as the main place of work or business. If an individual does not have a regular place of business, their tax home is considered their regular place of abode.

The final requirement is the Closer Connection Test. This test is more subjective and examines whether an individual maintains stronger ties to Puerto Rico than to the United States or any other foreign country. The IRS evaluates various factors to make this determination, including the location of a permanent home, family, and personal belongings. Other considerations include where an individual conducts personal banking, is registered to vote, and holds social affiliations.

Tax Treatment of Puerto Rico Source Income

Once an individual meets the requirements for bona fide residency, they become eligible for a U.S. federal tax benefit under IRC Section 933. This section allows bona fide residents of Puerto Rico to exclude income from sources within Puerto Rico from their U.S. gross income. This exclusion applies only to income tax and does not affect liability for other federal taxes like Social Security and Medicare.

The source of income is determined by where the service is performed or where the asset generating the income is located. For example, wages for work physically performed in Puerto Rico is considered Puerto Rico source income. Profit from a business operating exclusively in Puerto Rico also qualifies as locally sourced.

Rental income from a property situated in Puerto Rico is also considered Puerto Rico source income. This U.S. tax treatment works in parallel with Puerto Rico’s own tax laws, including incentive programs like Act 60, which can further reduce or eliminate local taxes on certain types of income for new residents.

Continued US Tax Obligations

Establishing bona fide residency in Puerto Rico does not eliminate all U.S. federal tax obligations. Income earned from sources outside of Puerto Rico remains fully subject to U.S. income tax. U.S. citizens are required to file a U.S. tax return to report their worldwide income.

A bona fide resident of Puerto Rico must report any income that is not from a Puerto Rican source on a Form 1040. Common examples of income that remain taxable by the U.S. include dividends and interest from U.S. corporations or financial institutions. Rental income from a property in the continental U.S. or capital gains from the sale of U.S. securities are also considered U.S. source income.

Wages earned for services performed within the United States, even for a short period, are taxable by the IRS. A Puerto Rico resident who travels to the mainland for work must allocate their earnings and pay U.S. tax on the portion attributable to the work done in the U.S.