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Home | BakerHostetler

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The IRS will soon begin prosecuting those who take advantage of significant tax breaks without meeting requirements, including those in the cryptocurrency industry.

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Now, before the tax man knocks on the door, is the time for those with a potential issue to take action.

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Long-awaited enforcement actions may be coming soon for those who took advantage of the lucrative tax breaks offered by the Commonwealth of Puerto Rico without meeting the requirements. Prosecutions may also follow for professionals who assisted in potential violations. The IRS and Department of Justice (DOJ) have publicized efforts to investigate those abusing these programs and, of late, have indicated that those efforts have led to current investigations of about 100 individuals.

Puerto Rico’s Acts 20 and 22 (collectively, “Act 60”),<a href="#_ftn1" id="_ftnref1">[1]</a> since their inception in 2012, have encouraged U.S.-based individuals and companies to relocate to Puerto Rico for significant tax benefits. Act 60 was intended to boost the Puerto Rican economy by encouraging mainland U.S. citizens to do business and live in Puerto Rico, <a>and as is the case with many </a>incentive programs, the opportunity and temptation to abuse these programs has led <a>some </a>to do just that.

Benefits and Qualifications of Act 60

Essentially, this regime “results in tax benefits that Americans could not obtain anywhere else in the world.”<a href="#_ftn2" id="_ftnref2">[2]</a> This program allows companies a tax rate of 4 percent for eligible export services and a 100 percent tax exemption on dividends from earnings and profits. However, those incentives apply only to income that Puerto Rican companies earn from performing services in Puerto Rico for customers outside Puerto Rico.<a href="#_ftn3" id="_ftnref3">[3]</a>

Individuals can qualify for a 100 percent tax exemption on income from dividends and interest, in addition to another 100 percent exemption for all capital gains that are accrued after establishing bona fide residency in Puerto Rico.<a href="#_ftn4" id="_ftnref4">[4]</a> More than 5,000 individuals reportedly have moved to Puerto Rico over the past decade for these programs.<a href="#_ftn5" id="_ftnref5">[5]</a> One group in particular that has utilized these opportunities is the cryptocurrency industry. In Silicon Valley, a billboard advertises Puerto Rico as “a tech hub in sync with your vision.”<a href="#_ftn6" id="_ftnref6">[6]</a>

However, in order to truly qualify for these benefits, individuals must become bona fide residents of Puerto Rico (the most common test being whether the individual resides in Puerto Rico more than 183 days a year), as well as ensure that all income is earned in Puerto Rico. If the income derives from the U.S., it is still subject to regular U.S. tax regulations. For years, the IRS has had agents stationed in Puerto Rico assessing whether individuals are abiding by the requirements, focusing on individuals who have misrepresented how much time they spent actually residing in Puerto Rico each year and the source of their income. The IRS has also been sending information document requests and has required individuals to disclose their expatriation on Form 8898, Statement for Individuals Who Begin or End Bona Fide Residency in U.S. Possession<a href="#_ftn7" id="_ftnref7">[7]</a> – which gives the IRS a list of those who may be misusing the program. The IRS is also on the lookout for attorneys, accountants and other professionals who have provided assistance to those misusing these benefits.<a href="#_ftn8" id="_ftnref8">[8]</a>

Enforcement on the Horizon

The IRS’ efforts are ready to come to fruition, with the agency publicizing that it has identified “about 100” high-income individuals who have been benefiting from these breaks and that it expects “many of these cases to proceed to criminal investigation.” The IRS has received help from officials in Puerto Rico, where the program has not been popular. Manuel Cidre, Puerto Rico’s chairman of economic development, has recently stated that he is working with U.S. tax authorities as they investigate the individuals they believe are taking advantage of these programs and that making sure that those taking advantage of these programs are caught is a “priority.” His office has reportedly expelled more than 300 people from the program since 2021, so it is no surprise that Cidre and other Puerto Rican government officials are apt to cooperate with the IRS and DOJ to root out those not in compliance.

Further bolstering these efforts, U.S. House Democrats have asked a congressional watchdog to assess potential violations. The letter asks the Government Accountability Office to assess how many individuals have relocated to Puerto Rico under these programs, how much state and federal tax has been avoided, and the impact on the Puerto Rican economy.<a href="#_ftn9" id="_ftnref9">[9]</a>

This all builds on the IRS’ increased focus in these areas over the past several years. In December 2019, the Consolidated Appropriations Act was signed into law and directed the IRS to submit a report analyzing individuals and businesses that have relocated to Puerto Rico and been granted tax exemptions, as well as to provide policy solutions to minimize revenue losses from tax avoidance and evasion. The IRS issued the report in November 2020, and it included a commitment from the IRS to expand information sharing with the Hacienda (the Puerto Rico revenue service).<a href="#_ftn10" id="_ftnref10">[10]</a> In October 2020, a press release stated that the IRS intended to “vigorously pursue any individuals and professionals that fraudulently enrich themselves by abusing government tax incentive programs,” specifically mentioning Act 20.<a href="#_ftn11" id="_ftnref11">[11]</a> In January 2021, the IRS added Puerto Rico Act 22, Individual Investors Act, to its audit campaign. Also that month, the IRS added U.S. individuals claiming the Act 60 tax breaks to its Large Business and International Compliance Campaign.<a href="#_ftn12" id="_ftnref12">[12]</a>

Also of note is that these tax relief programs have not been popular among native Puerto Ricans. Between the perception that many people are not actually in compliance with the program requirements and therefore not actually becoming a part of and benefiting the economy in Puerto Rico, and the fact that they’re driving up home prices and displacing residents who can no longer afford to live in certain areas,<a href="#_ftn13" id="_ftnref13">[13]</a> there are significant incentives for Puerto Rican officials to work to root out these abuses.<a href="#_ftn14" id="_ftnref14">[14]</a> Further, those who wait for the IRS to come knocking, and who eventually may end up at trial, should expect wholly unsympathetic juries to be evaluating their cases.

Although many may have been under the impression that they would be able to take advantage of these benefits, fly under the radar and avoid scrutiny, this is not the case. The IRS and other agencies have had their eyes on those not abiding by these regulations and are poised to crack down on these abuses. Individuals and companies that think that they may not be – or have not been – in compliance (or accountants and other professionals who have assisted clients in obtaining these benefits) should act now to consult with counsel and consider voluntary disclosure to the IRS.

The BakerHostetler Tax Practice Group provides clients with sound and practical advice in federal, international, tax controversy, employee benefits, private wealth, tax-exempt, and state and local matters. The group’s experience extends to structuring transactions and representing clients in the course of IRS examinations. The Criminal Tax Defense team assists individuals and institutions with assessing and identifying issues of concern and implementing measures to reduce potential exposure. The team has successfully represented clients at each stage of the criminal tax process in administrative IRS investigations, joint IRS-DOJ grand jury investigations, and indictments and prosecutions by U.S. attorneys’ offices. The Blockchain Technologies and Digital Assets team has members across all our core groups, and our attorneys have extensive experience across all sectors of the blockchain and cryptocurrency markets, including investigations, securities law, commodities law, Bank Secrecy Act/anti-money-laundering compliance, tax, privacy, transactions, advertising law, intellectual property and technology design, as well as government affairs, public policy and advocacy across federal departments and agencies and Congress.

Please feel free to contact any of our experienced professionals if you have questions about this alert.

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<a href="#_ftnref1" id="_ftn1">[1]</a> In 2019, Acts 20 and 22 were subsumed into Act 60.

<a href="#_ftnref2" id="_ftn2">[2]</a> Letter from Members of Congress to the Honorable Gene Dodaro, Comptroller General, U.S. Government Accountability Office, July 20, 2023, <a href="https://democrats-naturalresources.house.gov/imo/media/doc/gao_request_letter_for_act_60_puerto_rico_tax_review.pdf">https://democrats-naturalresources.house.gov/imo/media/doc/gao_request_letter_for_act_60_puerto_rico_tax_review.pdf</a>.

<a href="#_ftnref3" id="_ftn3">[3]</a> Act 20, also known as the Export Services Act of 2012.

<a href="#_ftnref4" id="_ftn4">[4]</a> Act 22, also known as the Individual Investors Act of 2012.

<a href="#_ftnref5" id="_ftn5">[5]</a> Jim Wyss &amp; David Voreacos, US Lawmakers Seek Watchdog Review of Puerto Rico Tax Breaks, Bloomberg Law, July 20, 2023, <a href="https://www.bloomberglaw.com/product/blaw/bloomberglawnews/daily-tax-report/BNA%2000000189-7523-da14-addf-7da7caea0004?isAlert=false">https://www.bloomberglaw.com/product/blaw/bloomberglawnews/daily-tax-report/BNA%2000000189-7523-da14-addf-7da7caea0004?isAlert=false</a>.

<a href="#_ftnref6" id="_ftn6">[6]</a> Coral Murphy Marcos and Patricia Mazzei, The Rush for a Slice of Paradise in Puerto Rico, N.Y. Times, Jan. 31, 2022, <a href="https://www.nytimes.com/2022/01/31/us/puerto-rico-gentrification.html">https://www.nytimes.com/2022/01/31/us/puerto-rico-gentrification.html</a>.

<a href="#_ftnref7" id="_ftn7">[7]</a> IRS Form 8898, Rev. Nov. 2022, <a href="https://www.irs.gov/pub/irs-pdf/f8898.pdf">https://www.irs.gov/pub/irs-pdf/f8898.pdf</a>.

<a href="#_ftnref8" id="_ftn8">[8]</a> In 2020, a CPA was indicted and arrested on wire fraud charges in relation to a scheme involving the submission of false information to the government of Puerto Rico in an attempt to assist a company in fraudulently benefiting from Act 20. Press Release, Puerto Rico CPA Indicted and Arrested on Wire Fraud Charges in Relation to Act 20 and Act 22 Scheme, Dept. of Just., Oct. 21, 2020, <a href="https://www.justice.gov/usao-pr/pr/puerto-rico-cpa-indicted-and-arrested-wire-fraud-charges-relation-act-20-and-act-22">https://www.justice.gov/usao-pr/pr/puerto-rico-cpa-indicted-and-arrested-wire-fraud-charges-relation-act-20-and-act-22</a>.

<a href="#_ftnref9" id="_ftn9">[9]</a> Supra note 2, Letter from Congress.

<a href="#_ftnref10" id="_ftn10">[10]</a> See IRS, Report to Congress Pursuant to Pub. L. 116-93 Regarding Interaction of Certain Puerto Rico and U.S. Tax Laws (Nov. 2020) (Tax Notes 2020-43051).

<a href="#_ftnref11" id="_ftn11">[11]</a> Supra note 8, Press Release.

<a href="#_ftnref12" id="_ftn12">[12]</a> See IRS, Large Business and International Active Campaign (Jan. 29, 2021).

<a href="#_ftnref13" id="_ftn13">[13]</a> Supra note 6, The Rush for a Slice of Paradise.

<a href="#_ftnref14" id="_ftn14">[14]</a> The more than 3 million native Puerto Ricans living on the island do not qualify for these tax breaks.

IRS Enforcement Efforts in Puerto Rico Gaining Steam – Wave of Cases Expected

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