[clamprecht]

Here's something I've been wondering, totally hypothetical but could be real for someone else:

Puerto Rico has this new tax law that basically limits taxes to like 4% or less, if you are a resident of PR. Let's say Bob is an American who expects to have a big exit in 2015 (or he has lots of GOOG stock and wants to sell it). Normally Bob would pay US capital gains taxes (15-20%, maybe 23.8%), plus California taxes (assuming he lives in CA). Instead, Bob moves to Puerto Rico, establishes residency. Then he sells his shares for US dollars, and pays Puerto Rico taxes. Then Bob moves back to mainland US, having saved lots of money.

Is there a flaw in the above situation?

[rincon0404]

Yes, the flaw in the above scenario is that for capital gains that have a cost basis that began prior to becoming resident in Puerto Rico ("built in gains"), you will owe taxes at both the US federal and Puerto Rican levels.

3 scenarios:

If the business was started and sold prior to becoming a Puerto Rican resident, then taxes would be owed at US federal and state levels like normal.

If the business was started while resident on US mainland and then you moved and became resident in Puerto Rico (the OP's scenario), it gets a lot more complicated. Just considering capital gains from a sale of the business to keep it easier, you will owe taxes to both the US and Puerto Rico. These are called "built in" capital gains. You can look up details on this, but taxes are owed to the US and to Puerto Rico at rates that change over time depending on how many years you are resident in Puerto Rico before selling the business. This is the most complicated scenario.

If you start a qualifying Puerto Rican business after becoming resident in Puerto Rico and after having been accepted into Act 22, then you would start with a zero cost basis. This is the best case scenario. When you sell this business, you could owe 0% capital gains. However, during the lifetime of this business, you will still pay FICA taxes (15.3%) on earned income to the US Federal government up to the regular cut off levels, personal Puerto Rican earned income taxes on a portion of your income, and 4% corporate tax on business income. This is the easiest scenario since it starts with a zero cost basis.

Btw, IANAL.

TLDR 1.) Started & sold business in Cali, no capital gains tax benefit. 2.) Started business in Cali and sold after becoming resident in PR, crazy complicated, but taxes do apply at both federal and puerto rican level. 3.) Built and sold business in PR after acceptance into Act 22, and after becoming resident in PR, 0% capital gains tax, but other taxes apply during the lifetime of the business.

For those interested, residency is 183 days per year.

[scrumper]

US citizens overseas are required to declare all income (and capital gains) to the IRS regardless of source. They still have to file returns in the US. Bob will owe tax as a result, but he can probably write off the 4% he payed in PR against his US taxes. He's not a resident of California, so he likely avoids the state tax.

(Note: I don't know specifically about Puerto Rico, but generally the above is the case for US citizens in foreign countries.)

[clamprecht]

That's why I asked about Puerto Rico. Puerto Rico is a territory of the US, so it isn't considered "overseas". If you google it, you'll see what I'm talking about. Here's a link: http://www.marketwatch.com/story/puerto-rico-woos-rich-with-...

[scrumper]

I did Google it, and I found this http://premieroffshore.com/move-puerto-rico-pay-zero-capital...

Which seems to support your idea! "Capital gains are sourced to your place of residence."

Any dividend income would be taxable, since you have to file an IRS return for all ex-PR income, but it looks like not the CG.

Quite a loophole - thanks for prompting the research.

EDIT: There are some quite long-term residency requirements to avoid CG on things you owned before moving to PR though. I don't think it'd work in the year timeframe you asked about.

[rincon0404]

PR is a US Territory. Technically, you never left the country.

"In general, United States citizens and resident aliens who are bona fide residents of Puerto Rico during the entire tax year, which for most individuals is January 1 to December 31, are not required to file a U.S. federal income tax return if they have income only from sources within Puerto Rico." www.irs.gov/taxtopics/tc901.html

There are caveats. One that I know for sure is that if you are self-employed, you still must file & pay FICA taxes to the US federal government.

[nationcrafting]

Read up about it, if you can find the time: the Puerto Rico situation is different than all other foreign countries for US citizens.

[maaku]

Puerto Rico is not overseas, it is part of the US...

[gopi]

In this case Bob would pay IRS 20% tax for the price appreciation happened when he lived in CA. The 4% tax applies only to the price gain during his stay in Puerto rico.

[rincon0404]

This is inaccurate. The 4% number is a figure that applies to businesses that are export related and that apply and receive approval for Act 20. It's a 4% tax on the inc's business income and is unrelated to capital gains.

[clamprecht]

This sounds reasonable - but can you provide a source?

Also, are you talking about federal taxes or california taxes?