Puerto Rico’s Act 60 tax incentive, which has attracted high‑net‑worth individuals and crypto traders seeking lower income‑ and capital‑gains taxes, is now the focus of a sweeping IRS audit campaign.
The Treasury’s internal review, disclosed to Congress, found that more than 4,000 mainland U.S. residents and between 12 and 19 firms have taken advantage of the program since its inception in 2012. The IRS estimates that these relocations may have cost the federal government hundreds of millions of dollars in lost tax revenue, noting that the affected taxpayers had paid over $500 million in U.S. taxes during the five years before moving.
How Act 60 works
- Eligibility – U.S. persons (including green‑card holders, EB‑5 investors, etc.) who establish bona‑fide residency in Puerto Rico can qualify for dramatically reduced rates on ordinary income, dividends, and long‑term capital gains.
- Residency requirement – The primary test is physical presence: at least 183 days per year must be spent on the island, plus evidence of a “tax home” and “closer connection” to Puerto Rico (e.g., primary residence, driver’s license, voter registration, local business activities).
- Tax benefits – Qualified residents can enjoy a 0 % tax rate on long‑term capital gains and a 4 % rate on eligible passive income, far lower than the U.S. federal rates that can exceed 37 %.
Why the IRS is cracking down
- The agency’s audit program, launched in late January, targets individuals who claimed the Act 60 benefits without meeting the full residency and compliance standards.
- Audits will examine:
- Days spent in Puerto Rico versus the required 183‑day threshold.
- Documentation of a genuine move, such as leasing or purchasing a home, establishing local banking relationships, and conducting business activities on the island.
- Compliance with U.S. reporting obligations, including FBAR and FATCA filings for any foreign accounts or entities.
- Tax attorneys warn that hundreds of audits are expected, especially for private‑wealth clients, hedge‑fund managers, and crypto traders who previously used the incentive to avoid the Biden administration’s proposed capital‑gains tax hikes.
Common pitfalls
- Half‑hearted residency – Some relocators treated Puerto Rico as a “tax‑only” address, spending only a few weeks per year while maintaining most of their life in the mainland. This approach fails the “closer connection” test and triggers audit risk.
- Incomplete documentation – Without clear proof of a primary home, local driver’s license, voter registration, and business ties, the IRS can argue the taxpayer never truly moved.
- Assuming foreign‑entity structures shield U.S. tax – Even if a U.S. person sets up offshore companies, the IRS still scrutinizes the underlying residency claim; high‑income U.S. taxpayers are already more likely to be audited.
Practical steps for compliance
- Track physical presence meticulously; maintain a calendar or travel log showing dates spent in Puerto Rico versus the mainland.
- Establish substantive ties: obtain a Puerto Rican driver’s license, register to vote, open local bank accounts, and, if possible, conduct part of your business from the island.
- File all required U.S. disclosures (FBAR, Form 8938, etc.) for foreign accounts and entities, even if the income is taxed at the reduced Puerto Rican rate.
- Engage a coordinated team of a CPA, a Puerto‑based tax attorney, and a U.S. international tax specialist to ensure that residency, filing, and reporting requirements are met simultaneously.
- Consider the long‑term commitment – Act 60 benefits are contingent on maintaining residency for the entire tax year; a short‑term “soft landing” does not satisfy the rules.
Alternatives to Puerto Rico
- Full expatriation – Renouncing U.S. citizenship and obtaining a second passport eliminates U.S. tax obligations but involves a complex exit tax and loss of citizenship rights.
- Other low‑tax jurisdictions – Countries such as Panama, Singapore, the United Arab Emirates, or Caribbean nations offer residency programs with favorable tax regimes, but they also require genuine relocation and compliance with local and U.S. reporting rules.
Bottom line
Puerto Rico’s Act 60 remains a powerful tax‑reduction tool, but the IRS is now aggressively verifying that participants meet the full residency and reporting standards. Taxpayers who relied on minimal physical presence or incomplete documentation risk costly audits and penalties. Proper planning, thorough documentation, and a team of cross‑jurisdictional advisors are essential to sustain the benefits without running afoul of U.S. tax law.
