Why Is Puerto Rico Considered a Tax Haven?

Puerto Rico’s status as a tax-advantaged jurisdiction is due to its unique position as a United States territory, allowing it to offer tax exemptions recognized by the U.S. federal government. The island’s Incentives Code, known as Act 60, was enacted to attract investment and new residents to stimulate its economy. This framework allows U.S. citizens to reduce their tax obligations on certain income without renouncing their citizenship. The core incentive is the ability for new residents to exempt Puerto Rico-sourced income from U.S. federal taxes. Individuals can maintain benefits like Medicare and Social Security while taking advantage of the island’s tax code.

The Bona Fide Resident Requirement

Establishing bona fide residency is the first step for any U.S. citizen seeking to access Puerto Rico’s tax incentives. The Internal Revenue Service (IRS) uses three tests to determine if an individual qualifies. Failure to meet any one of these tests disqualifies an individual from the tax exemptions for that year.

The first is the Presence Test, which requires an individual to be physically present in Puerto Rico for at least 183 days during the tax year. This is the most common measure used to prove physical presence on the island.

An individual must also satisfy the Tax Home Test, which requires their tax home to be in Puerto Rico for the entire year. A tax home is defined as the main place of business or employment. This means a person’s primary professional and economic activities must be centered on the island.

The final standard is the Closer Connection Test, which mandates that an individual must have a closer connection to Puerto Rico than to the U.S. mainland. The IRS evaluates various factors to make this determination, including:

• The location of a permanent home
• The residence of immediate family members
• The location of personal belongings, such as cars and furniture
• Where an individual conducts banking and voting activities

Social, cultural, and religious ties to the community also contribute to demonstrating a closer connection.

Tax Incentives for Individuals

Once bona fide residency is established, an individual can access benefits under the Individual Resident Investor Tax Incentive, a component of Act 60. For those with a tax decree granted before the end of 2025, the benefit is a 100% tax exemption from Puerto Rico income taxes on locally sourced interest and dividends. New applicants receiving a decree after December 31, 2025, will be subject to a 4% tax on this income.

The incentive also provides an exemption on capital gains. For those with a decree granted before the end of 2025, there is a 100% tax exemption on capital gains accrued after becoming a resident, while new applicants after this date will be taxed at 4%. This applies only to the appreciation of assets that occurs after moving to Puerto Rico. Any appreciation that occurred before establishing residency remains subject to U.S. federal taxes upon sale.

To maintain these benefits, individuals must meet ongoing requirements. This includes an annual donation of $10,000, split into two $5,000 contributions to separate, qualifying nonprofit organizations, with one donation supporting an organization focused on child poverty. New residents must also purchase a residential property within two years of receiving their tax decree to serve as their principal residence.

Tax Incentives for Businesses

Puerto Rico offers tax incentives to businesses through the Export Services Tax Incentive, part of Act 60. This program attracts service-based companies by offering a fixed 4% corporate tax rate on eligible export service income. This rate is much lower than the 21% U.S. federal corporate tax rate.

The program also provides a 100% tax exemption on distributions from the earnings and profits of the business. When the company pays dividends to its owners who are bona fide residents of Puerto Rico, those distributions are not taxed. This combination allows business owners to retain more of their profits.

The benefits are for “eligible export services,” which must be performed from Puerto Rico for customers located outside the island. Qualifying services include:

• Management consulting
• Research and development
• Advertising and software development
• Architectural and engineering services
• Investment banking

The service must be for non-Puerto Rican individuals or entities to qualify.

To qualify, a business must establish an office in Puerto Rico and conduct its operations from there. While most qualifying businesses pay the 4% rate, smaller businesses with revenue of $3 million or less may qualify for a 2% rate for their first five years of operation. After this period, their rate increases to the standard 4%.

Interaction with US Federal Taxes

Becoming a resident of Puerto Rico does not eliminate all U.S. tax obligations, as the benefits apply only to income sourced from the island. Bona fide residents are still subject to U.S. federal income tax on any income that is considered U.S.-sourced.

U.S.-sourced income includes salary from a U.S. mainland employer, rental income from a property in the United States, or gains from the sale of real estate located in the U.S. This income must be reported on a U.S. tax return and is taxed at standard federal rates.

Federal payroll taxes for Social Security and Medicare, known as FICA taxes, continue to apply to all wages and self-employment income earned in Puerto Rico. An employer in Puerto Rico will withhold these taxes from an employee’s paycheck. Self-employed individuals must also pay self-employment taxes to the IRS.

The legal basis for the exemption on Puerto Rico-sourced income is found within the U.S. tax code. This provision allows a bona fide resident of Puerto Rico to exclude income derived from sources within the territory from their U.S. gross income. The tax benefits are a result of an interplay between Puerto Rican and U.S. federal law.