by Gerald Nowotny
I lived in Miami for about ten years during the time that I went to law school at the University Of Miami School of Law, i.e. the Harvard of the South! I also worked in Miami while I went to law school at night and have a good sense of the city. I worked with many Cuban-Americans and every other stripe of Latin American except Paraguayans. You just don’t seem to run into to many people from Paraguay in Miami or elsewhere.
Prior to the fall of Fulgencio Batista in 1959, the Cuban community was very small. By 1960, the Cuban population in Miami was approximately 50,000. By 1980, the Cuban population in Miami was 580,000. By 2000 it was 800,000 and today it is approximately 1.2 million. Add on top of that Nicaraguans, Colombians, Venezuelans, Argentines, and Central Americans, and suddenly you have a very large Hispanic community. It is the only place on the Planet where conversations are routinely in three languages – Spanish, English and half-English and half-Spanish.
I have always joked that Miami is to Cubans what Mecca is to a Muslim. At some point, all Cubans from Chicago or New York or elsewhere will move to Miami or at least spend a lot of time there visiting friends and family.
Politically, the Cuban experience is very different from the experience of Mexican Americans, Central Americans and Puerto Ricans in the U.S.. Most of the Cubans who came here early on were well educated business owners and professionals in Cuba. Among other Latins, Cubans have always been well known to have the golden touch in business matters and being very entrepreneurial. By 1980, over half of the construction companies in Dade County (Miami) were owned by Cubans.
As a result of the Bahia of Cochinos (Bay of Pigs), most Cubans have traditionally been staunch Republicans and very pro-business. Most of the other Latins in the U.S. are Democrats. The bottom line is that Cuban ingenuity and entrepreneurship have put and kept Miami on the map and the gateway to Latin America. Politically, the Cuban community has also been very skilled and sophisticated in comparison to other Latin groups in Miami.
The Cuban migration to Puerto Rico following the Cuban Revolution was relatively small in comparison to U.S. migration. The Cubans in Puerto Rico primarily live in San Juan and have been very successful in business and in the professions, but do not have the degree of political control and influence that they enjoy in Miami. Additionally, Cuban contacts in the U.S. provided substantial assistance to the Cuban community in Puerto Rico in business.
The point here is simple. The Cuban community in San Juan like the Cuban community in Miami, have been very successful in business and the professional fields. While Cuban business owners in Miami “wine and dine” politicians at the local, state and federal level to have some influence on business and economic policy that can benefit Cuban business owners, the answer to the problem may be more straight-forward – Move your business to San Juan and become a Puerto Rican resident.
This article summarizes the tax benefits available under Act 20 and Act 22 with a focus on the special consideration of pointing these benefits out to Cuban-American business owners in South Florida. The economic opportunity and potential tax savings speak for themselves, but there is perhaps no other group of American business owners that more easily make the social and cultural transition than Cuban-Americans.
A direct flight from San Juan to Miami is approximately two hours and forty minutes. It takes about two hours to drive from Miami to Naples and about four hours to drive to Tampa, or an hour and half in traffic to drive from West Kendall to Brickell Avenue in Downtown Miami!
Despiertate Caballero, this planning opportunity has your name written all over it!
Overview of Puerto Rican Tax Considerations and Residency
A. Puerto Rican Tax Basics
Two important pieces of legislation were passed by the Puerto Rican legislature in 2012. Both the Export Services Act (Act 20) and the Individual Investors Act (Act 22) were signed into law by the Governor of Puerto Rico on January 17, 2012.
The definition of a U.S. person under §7701(a) (30), however, does not include Puerto Rican entities. As a result, a Puerto Rican entity is not subject to U.S. income taxation unless the entity is engaged in a trade or business within the United States and its income is considered effectively connected income, or investment income.
Under §933, bona fide residents of Puerto Rico who have Puerto Rico-sourced income are exempt from U.S. taxation. Section 937 defines a bona fide resident for tax purposes. A person is a Puerto Rican resident for tax purposes if the person is present in Puerto Rico for at least 183 days during the taxable year and he or she does not have a tax home outside Puerto Rico and does not have a closer connection to the U.S. or a foreign country than to Puerto Rico
What does it take to become a Puerto Rican resident in order to take advantage of Act 22? How about S50 for the application fee which is less than the cost of dinner in a good restaurant, and meeting three tax tests?For federal income tax purposes the taxpayer will be considered a bona fide resident of Puerto Rico if you meet the following: (i) Substantial Presence Test -the physical presence test (generally spending 183 days in PR, or less than 90 days in the US); (ii) the tax home test; and (iii) Closer Connection Test – the closer connection test for the entire taxable year which means that you can’t have stronger personal connections to another jurisdiction that is not Puerto Rico.
(1) The Individual Investor’s Act
Under the Individual Investors Act, neither capital gains (long-term or short-term), interest, nor dividends are subject to Puerto Rican taxation. Dividend income is subject to U.S. federal income taxation for U.S.-sourced dividend income, as is interest income unless the interest income is exempt under the portfolio interest exemption. Long-term capital gains derived by the resident individual investor that (1) were deemed to have accrued before the individual became a Puerto Rican resident and (2) are recognized within the first 10 years after the date the individual becomes a resident, will be taxed at a 10 percent rate.
If the gains are recognized after the 10-year period but before January 1, 2036, the gains will be taxed at a 5 percent rate. Gains considered to have accrued after the investor becomes a Puerto Rican resident will receive a 100 percent exemption. Dividend and portfolio interest income are exempt from Puerto Rican taxation under the new law.
(2) The Export Services Act
A business that relocates to Puerto Rico can significantly reduce its tax liability provided that the Puerto Rican entity is not engaged in a U.S. trade or business. The top U.S. corporate tax rate is 35 percent to 40 percent for most corporations, assuming a federal rate of 35 percent and a state rate of five percent. Under Puerto Rico’s Export Services Act, the corporate tax rate is flat four percent. Additionally, shareholders who relocate to Puerto Rico will have a 100 percent exemption on corporate distributions received from the Puerto Rican company.
Under the Export Services Act, services that are directed to foreign markets may generate income that will qualify for the special tax rate. Services for foreign markets include services performed for nonresident individuals and businesses. The term “eligible services” includes a wide range of service-oriented businesses from research and development to investment management.
A business (service provider) must request and obtain a tax exemption decree on or before December 31, 2020. The decree has a 20-year term and may be renewed for an additional 10 years providing certain conditions are met. During the period of the exemption, the business will enjoy a four percent tax rate on its export services income and a 100 percent exemption on the distributions of earning and profits from the services income. The business will also be eligible for a 100 percent property tax exemption during the first five years of operation and a 90 percent exemption after the fifth year.
In many cases, a business may have multiple owners and is often the case, the business owner cannot convince the spouses of his fellow shareholders to move to Puerto Rico. Surprise! It is possible to structure a new Puerto Rican corporation with the business owner that becomes a Puerto Rican resident. The new corporation can be structured so that the new Puerto Rican corporation is not treated as a controlled foreign corporation for tax purposes allowing the Puerto Rican corporation to be taxed at four percent instead of 39.6 percent or 35 percent.
It seems pretty obvious (to me at least!) that the new tax benefits of Act 22 for Cuban-American business owners in South Florida are a great opportunity. First, the Cuban presence in the PR business and professional community has been very substantial over the last fifty years, and the Cuban community in San Juan is politically influential. Second, the proximity to Miami is opportunistic. It is as close to Miami by plane as driving to any other major city in Florida from Miami. Third, the local culture in San Juan is as close to Miami as any other place on the Planet. Fourth, taking advantage of Acts 22 and 20 does not require relinquishment of your American citizenship. The “abuelos” (grandparents) do not have to roll over in their graves in shame. Fifth, the requirements for residency for the Decree and favorable tax treatment do not make Miami off limits. The half year requirement (183 days) are not consecutive.
As a Cuban-American business owner, you have to weigh the probability of favorable tax reform and how it impacts your business and investments. While it is true that Florida does not have a current state income tax, the difference between the federal rate 39.6 percent and the Medicare surtax (3.8 percent) is more than ten times greater than the level of taxation under Acts 22 and 20.
Think of the money that business owners can save on political contributions and lobbying politicians. The tax benefits of under Puerto Rico Act 22 and Act 20 translate into “dinero en el bolsillo” or money in your pocket. Start packing!
Gerald Nowotny – Osborne & Osborne, PA
266 Lovely Street
Avon, CT 06001