A Look at Puerto Rico's Act 60 and Residency

Recent reporting suggests that the IRS is looking at taxpayers who have claimed tax benefits afforded by the Puerto Rico Tax Incentives Code (Act 60). This was discussed in a previous Holland & Knight alert on Act 60, along with the rules for establishing bona fide residency in Puerto Rico. As that alert discussed, the IRS's most frequent challenge to Act 60 benefits relates to the residency requirements for Puerto Rico.¹

The IRS's decade-long fight against taxpayers claiming residency in the U.S. Virgin Islands (USVI) offers important reminders to taxpayers who find themselves opposite the IRS in a dispute about Puerto Rican residency. Puerto Rico and the USVI are both U.S. possessions under the Internal Revenue Code, and the bona fide residency rules apply equally. This Holland & Knight alert examines Vento v. Director of Virgin Islands Bureau of Internal Revenue, 715 F.3d 455 (3d Cir. 2013), a case in which taxpayers successfully defended their claim of residency in the USVI.

Residency

Under U.S. law, a taxpayer must demonstrate that he or she is a bona fide Puerto Rican resident to claim tax advantages afforded to Puerto Rican residents.² A taxpayer is a bona fide Puerto Rican resident if, during the taxable year, he or she is present in Puerto Rico for at least 183 days, does not have a tax home outside of Puerto Rico, and does not have a closer connection to the U.S. or another foreign country.³ The determination of whether a taxpayer is a bona fide resident is typically analyzed by the IRS using the following 11 factors:

• intention of the taxpayer
• establishment of a home in the foreign country for an indefinite period
• participation in activities
• physical presence in the foreign country
• nature, extent and reasons for absences from his or her temporary foreign home
• assumption of economic burdens and payment of taxes to the foreign country
• status of resident contrasted to transient or sojourner
• treatment accorded his or her income tax status by an employer
• marital status and residence of his or her family
• nature and duration of employment
• good faith in making the trip abroad

Vento v. Director of Virgin Islands Bureau of Internal Revenue

In Vento, the U.S. Court of Appeals for the Third Circuit grouped those 11 factors into four categories and analyzed whether a husband and wife were bona fide residents of the USVI. The four categories analyzed by the Third Circuit were as follows:

1. the taxpayers' "intent to remain in a place for an indefinite or at least substantial period of time"⁴
2. the taxpayers' physical presence⁵
3. the taxpayers' "social, family and professional relationships"⁶
4. the taxpayers' "own representations," including whether they self-identify as residents, "by paying taxes and observing the other economic burdens, civic obligations and legal formalities of residency"⁷

Upon analyzing these factors, the Third Circuit reversed a prior district court decision that had found that the husband and wife taxpayers were not bona fide residents of the USVI, marking a big win for taxpayers claiming USVI residency generally.

The Evidence

Key to the Third Circuit's determination was the following evidence:

• Taxpayers had purchased an estate in the USVI.
• They had established business interests there.
• Credit card records showed their presence.
• They had formed a professional relationship there, including discussions with a local university about establishing a physics department.
• They had spent time together as a family in the USVI.
• They self-identified as USVI residents.
• They attempted to pay 2001 taxes to the USVI tax authority.
• They had obtained driver's licenses in the USVI.
• They registered to vote in the USVI.

While analyzing the evidence against the four categories described above, the Third Circuit made a few important observations:

• Having a mobile lifestyle does not necessarily mean that a taxpayer is not a bona fide resident.⁸ Notably, the Third Circuit offered the reminder that "[u]nlike domicile, residency does not require 'an intent to make a fixed and permanent home.'"⁹
• Moreover, "there is nothing unlawful or deceitful about choosing to reside in a state or territory because of its low taxes," and such motive does not necessarily "undermine [a] claim of bona fide residency."¹⁰

Conclusion: The Key to Proving Residency Is Documentation

As with all tax disputes, documentation is crucial to supporting a claim of Puerto Rican residency. Taxpayers should maintain a residency file that is updated annually with detailed travel logs, flight records and passport stamps. Furthermore, taxpayers should keep boarding passes, hotel receipts and other travel-related documentation, as well as utility bills, evidence of property ownership (or long-term lease), family ties, and social and community involvement.

If taxpayers find themselves opposite the IRS in a challenge to Puerto Rican residency or simply want to strengthen their residency position, ensure compliance and mitigate the risk of IRS challenges, please contact the authors for professional guidance.

A forthcoming Holland & Knight alert will address potential civil and criminal exposures if the IRS opens an examination.

Notes

¹ See I.R.C. § 937.

² See I.R.C. § 933(1) (providing that Puerto Rican sourced income is excluded from a bona fide Puerto Rican resident's U.S. gross income).

³ See id. § 937(a); Treas. Reg. § 1.937-1(c)(1).

⁴ Vento, 715 F.3d at 467.

⁵ Id. Section 932 merely requires that a taxpayer be a bona fide USVI resident at the end of the taxable year and contains no requirement that a taxpayer's "tax home" be in the USVI or that the taxpayer prove his or her case "to the satisfaction of the Secretary."

⁶ Vento, 715 F.3d at 467.

⁷ Id. at 468.

⁸ Id. at 475.

⁹ Id. at 466 (quoting Sochurek v. Comm'r, 300 F.2d 34, 38 (7th Cir. 1962)).

¹⁰ Id. at 471–72.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.