IRS Targets Puerto Rican Residency Transactions

In a July 14, 2023, release, the IRS stated that “[t]hanks to Inflation Reduction Act resources,” it has begun a criminal crackdown on Act 20/22/60 participants engaging in a ”[h]igh-dollar scheme in Puerto Rico.”  The IRS has “identified about 100 high-income individuals claiming benefits in Puerto Rico without meeting the residence and source rules involving U.S. possessions” and believes “[t]hese wealthy individuals are attempting to avoid U.S. taxation on U.S. source income, and we expect many of these cases to proceed to criminal investigation.”

Puerto Rico’s Act 20 and Act 22 provide generous tax incentives to U.S. companies and individuals who establish bona fide residences in Puerto Rico. Under U.S. law, a bona fide resident of Puerto Rico is not subject to U.S. income taxes on income derived from sources within Puerto Rico. Bona fide residents of Puerto Rico are only subject to U.S. income taxes on income derived from sources outside of Puerto Rico. Due to concerns regarding potential abuses of the Puerto Rico Act 2022, in January 2021, the IRS included Puerto Rico Act 2022 in its compliance campaigns and added it to the IRS annual “Dirty Dozen” list.

We expect the IRS to criminally and civilly target taxpayers who claimed the Puerto Rico Act 2022 benefits and the advisors and promoters who assisted and advised taxpayers. That focus will include civil examinations, promoter investigations, and criminal investigations. Advisors and taxpayers should consult with an experienced tax controversy attorney before discussing any Puerto Rico transaction with the IRS.

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