Soy Boricua - Rethinking Inbound Tax Planning for Wealthy Latin American Moving to the U.S.

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Overview

In case you did not know, Miami is the capital of Latin American. It is the port of entry for Latin Americans from Central and South America. Historically, wealthy Mexicans have liked California and Texas for the proximity to Mexico. Miami is the business center and regional corporate headquarters for Fortune 500 companies doing business in Latin American. In recent years, Brazilians have also discovered that Miami and that is also has beaches like Rio.

English may be the official language of Miami but Spanish is the language of choice for most in Miami. The heavy concentration of Latin American  language, culture and climate makes Miami an easy and comfortable for Latin American who emigrate to the U.S. as a place to live. The proximity to Latin American reduces travel time back and forth to visit extended family

Latin American has had its share of political and economic instability over its history. If you layer corruption, drug violence and kidnap and ransom, it makes the U.S. the perfect choice as a safe haven for many. Many wealthy Latin Americans were educated in the U.S. and have chosen to educate their children in the U.S.

As a practical, it is easy and comfortable for a high profile Latin American to blend into the crowd in Miami or New York. The continued drug violence in Mexico and political and economic instability caused by socialist governments in other Latin American countries is causing many wealthy Latin Americans to consider a permanent move to the U.S.

Puerto Rico passed a series of stunning legislation in 2012 making the Commonwealth highly desirable as a jurisdiction from a tax standpoint. Of course, Puerto Rico offers the language, customs. climate and culture for Latin American. While every Latin American country is separate and distinct from each other culturally and South American culture is different than Caribbean culture, Puerto Rico is more similar to Venezuela than  Alabama is.

Puerto Rican  also has an approved  regional center for the EB5 Visa immigration program which facilitates permanent resident status and U.S. citizenship through investment in businesses that create jobs.

This article will focus on the tax aspects of the PR and why wealthy Latin Americans should emigrate to the U.S. through the PR instead of coming directly to Miami or New York or California. 

Taxation of Wealthy Latin Americans

Wealthy Latin American that are non-resident for U.S. tax purposes are taxable on their U.S.-sourced income that is effectively connected to a U.S. trade or business as well as income that is fixed and determinable or periodic income (FADP). An exemption for portfolio income exists in the Internal Revenue Code. Only Venezuela and Mexico have active income tax treaties with the U.S. None of the Latin American countries has an estate and gift tax treaty with the U.S.

Non-resident aliens (NRA) are not subject to capital gains taxation of intangible personal property (stocks and bonds etc.). NRAs can make an election to treat real estate investments as a commercial activity for tax purposes in order to use deductions. NRAs are subject to FIRTPA, the real estate withholding tax, upon the sale of U.S. real estate. NRAs are only subject to U.S. estate taxation on their U.S.-sitused assets. The exemption equivalent is only $60,000.

In contrast, resident aliens and U.S. citizens are generally taxed on their worldwide income and assets for income and estate tax purposes. The distinction is small but the tax consequences are enormous. Wealthy Latin American taxpayers could  find themselves in a world of hurt following tax reform at the end of 2012. The top marginal bracket for taxpayers with more than $400,000 (single and $450,000 married) increased to 39.6 percent. Taxpayers with adjusted gross income in excess of $250,000 will pick up an additional 3.8 percent on unearned income raising the top marginal bracket to 43.4 percent.

These same taxpayers will also be exposed to the phase out of personal exemptions and miscellaneous deductions. These phase outs effectively raise the marginal bracket by 1-2 percent. Taxpayers in the top marginal bracket will end up with a top federal bracket of 45.4 percent. High income states such as New York and California add an additional 10-13.3 percent bringing taxpayers to a combined marginal tax bracket of 53-56 percent. At least Latin Americans have some reprieve at the state level as Texas and Florida do not impose a state income tax.

While the federal estate tax exemption did not fall to $1 million, the federal estate tax is alive and well with an increase in the top rate to forty percent. President Obama's recent budget  proposal is looking to raise the top marginal bracket to 45 percent.

EB 5 Visa Immigration Programs - A Ticket to Ride

The Immigrant Investor Program, also known as “EB-5,” was created by Congress in 1990 to stimulate the U.S. economy through job creation and capital investment by foreign investors.

All EB-5 investors must invest in a new commercial enterprise, which is a commercial enterprise:

(1) Established after Nov. 29, 1990, or

(2) Established on or before Nov. 29, 1990, that is:

 a. Purchased and the existing business is restructured or reorganized in such a way that a   new commercial enterprise results, or

b. Expanded through the investment so that a 40-percent increase in the net worth or          number of employees occurs

Commercial enterprise means any for-profit activity formed for the ongoing conduct of lawful business including, but not limited to:

a. A sole proprietorship

b. Partnership (whether limited or general)

c. Holding company

d. Joint venture

e. Corporation

f. Business trust or other entity, which may be publicly or privately owned

The investment must create or preserve at least 10 full-time jobs for qualifying U.S. workers within two years (or under certain circumstances, within a reasonable time after the two-year period) of the immigrant investor’s admission to the United States as a Conditional Permanent Resident. individual must invest $1 million or at least $500,000 in a Targeted Employment Area (high unemployment or rural area).

Puerto Rican Tax Basics

Puerto Rico (“the PR”)is an unincorporated territory of the U.S. and is subject to most federal laws unless “locally inapplicable”. The currency of the PR is the U.S. currency. No passport is required for travel to the PR for U.S. citizens. The banks in the PR are regulated by the U.S. Federal Deposit Insurance Corporation.

The definition of a U.S. person under IRC Sec 7701(a)(3) does not include Puerto Rican entities. As a result, Puerto Rican entities are not subject to U.S. income taxation unless the business is engaged in a trade or business within the U.S.- effectively connected income (ECI); or investment income that would be subject to a withholding tax  with an exemption for portfolio interest.

Under IRC Sec 933, bona fide residents of the PR that have PR-sourced income are exempt from U.S. taxation. IRC Sec 937 defines a bona fide resident for tax purposes. A person is a PR resident for tax purposes if present in the PR for at least 183 days during the taxable years and does not have a tax home outside of the PR and does not have a closer connection to the U.S. or a foreign country than the PR.

Businesses that relocate to the PR can significantly reduce their taxable income providing the PR entity is not engaged in a U.S. trade or business. The top federal corporate tax rate is 35 -40 percent for most corporations assuming a federal rate of 35 percent and a state rate of 5 percent. Under the Export Services Act, the tax rate is 4 percent. Additionally, shareholders that relocate to the PR will have a 100 percent exemption on corporate distributions.

Under the Export Services Act, services that are directed to foreign markets may qualify as services under the Export Act. Services for foreign markets include services performed for non-resident individuals and businesses. In order to qualify as “promoter services” under the Export Act, the net income must be earned and service performed within the 12-month period ending on the day preceding the day the business commenced operations withinthe PR.

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 4 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 is also eligible for a 100 percent property tax exemption during the first five years of operation and 90 percent after the fifth year.

Existing businesses that become eligible for benefits under the Export Services Act only receive the special tax rate (4%) on the portion of net income that exceeds the average net income for the three years preceding the request for a tax exemption decree. This aspect of the law is designed to prevent existing businesses from becoming tax exempt without a corresponding increase in economic activity in the PR.

The Individual Investors Act

Under IRC Sec 933, interest and dividends that qualify as PR-sourced income are excluded from the income of a “resident individual investor (an individual who has not been a resident of the PR for the past years before his first year of residence in the PR). Long term capital gains derived by the “resident individual investor” that were deemed to have accrued before the individual became a PR resident and are recognized within the first ten years after the date the individual becomes a PR resident, will be taxed at a 10 percent rate.

If the gains are recognized after the ten 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 U.S. resident will receive a 100 percent exemption. Dividend and portfolio interest income are exempt from PR taxation under the new law.

Estate Taxation in Puerto Rico

IRC Sec 2209 provides that Puerto Rican residents are not subject to U.S. estate taxation at death providing the Puerto Rican resident acquired his U.S. citizenship by virtue of his birth in the PR or his naturalization as a U.S. citizen in the PR.[1] Puerto Rico administers its own estate and gift tax system which largely parallels the U.S. system. Hence, the wealthy Latin American that becomes a U.S. citizen by virtue of his naturalization as a Puerto Rican resident should only become subject to U.S. estate taxes on his U.S.-sitused assets in a manner similar to an NRA. Effectively, only property in the PR is subject to Puerto Rican estate taxes. Foreign investment that is not non-PR-sitused or U.S. sitused will subject to a maximum estate tax of 10 percent based on

The Strategy

Facts

Juan Valdez is a wealthy coffee farmer from Bucaramanga, Colombia. Two decades worth of "narco-trafico" drug violence and kidnap threats on members of his family have caused Juan to reconsider his family's future in Colombia. He was able to sell his farm that has been in his family for three generations for $20 million.

He would like to move permanently to the U.S. under the EB 5 Immigrant Investor program as a move towards permanent residency and U.S. citizenship but is concerned about the implications of taxation on his worldwide income and assets. He had intended to move to Miami which has a large Latin American and Colombian community where Spanish is widely spoken. He will primarily live off of his investment income until he starts or purchases a business.

Solution

Juan hears about the new tax incentives under the Export Services Act and Individual Investors Act. He also understands that Puerto Rico has a regional center for EB 5 investment. Juan moves his family to Puerto Rico under the provisions of the PR Individual Investors Act. He obtains a Puerto Rican Driver’s license and will register to vote in the PR once he has permanent status.

The Valdez family will purchase a home in Puerto Rico and enroll their children in the best English speaking school on the Island. They will consider the PR their tax home. The families will spend six months of the year in Miami and New England while the children attend summer camp in both locations. Ultimately, the children will attend Prep School in New England. San Juan  is a two hour and forty minute flight from Miami.

Under the Individual Investors Act, he will not be subject to U.S. or Puerto Rican income taxation on his passive income. Prior to moving to the PR, he created a Cayman Islands Trust. His brother Julio is the settlor of the trust with Juan and his children as the beneficiaries. His substantial investment portfolio should not be subject to U.S. or Puerto Rican estate taxation as be becomes a Puerto Rican resident and naturalized U.S. citizen through the EB 5 visa program.

Summary

The decision to become a U.S. citizen or permanent resident comes with a high cost in terms of income and estate and gift taxation. For wealthy Latin Americans the bar is not nearly as high if instead of moving to Miami, they move to Puerto Rico - Isla del Encanto. The PR offers everything in terms of language, culture and climate that a wealthy Latin American could desire without the large "haircut" for taxation.

The Puerto Rican government has done a brilliant job creating incentives for businesses and high net worth individuals to move to the PR and become PR residents. It is my prediction that the PR will become the new Florida (only much better from a tax perspective). Travel to the PR is easy and accessible. Many wealthy Latin Americans and their advisors should consider the PR option based on the tax and cultural considerations.


[1] See IRC § 2209

 

Topics:  EB-5, Estate Tax, Export Services Act, Individual Investors Act, Non-Resident Aliens, Non-Resident Income Taxes, Tax Planning, Visas

Published In: Finance & Banking Updates, Immigration Updates, Tax Updates, Wills, Trusts, & Estate Planning Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Gerald Nowotny, Osborne & Osborne, PA | Attorney Advertising

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