Ultrarich Fleeing to
Puerto Rico Find the IRS Already Waiting
By Donna Borak
June 3, 2021, 9:46 AM GMT+1
Private wealth clients, hedge fund managers and
cryptocurrency traders fleeing to Puerto Rico for its huge tax breaks—and to
escape President Joe Biden’s proposed capital gains tax increases—are now the
focus of a sweeping Internal Revenue Service review.
The country’s tax collector quietly launched a coordinated
campaign in late January to examine individuals who took advantage, starting in
2012, of tax incentives designed to lure high net-worth individuals and
corporations to Puerto Rico. More than 4,000 mainland U.S. residents and firms
have moved to the territory between 2012 and 2019, revealing potentially
hundreds of millions of dollars in lost tax revenue to the U.S. government,
according to an IRS report delivered to Congress.
Individuals have already started receiving requests for
information, according to tax attorneys that advise clients on federal income
tax issues under Puerto Rican tax incentive laws. More audits are anticipated
now that the U.S. tax filing deadline has passed.
“The IRS doesn’t start a campaign and not follow through,”
said J. Clark Armitage, an international tax lawyer with Caplin & Drysdale.
“There are going to be a lot of audits.”
At issue are taxpayers who may have excluded income subject
to U.S. tax, or failed to file and report income altogether when they moved to
Puerto Rico, according to the IRS notice. The agency is also targeting those
who claim to be bona fide residents of Puerto Rico but may be “erroneously
reporting” U.S. income to evade taxes.
The IRS’s push is taking place as Biden’s proposed tax
increases have triggered moves by America’s wealthiest from high-tax states
like New York and California, while hedge funds like Izzy Englander’s
Millennium Management and ExodusPoint Capital Management have moved to
establish subsidiaries on the island. An ExodusPoint spokesman declined to
comment, while a representative for Millennium did not respond.
It also comes amid a wider crackdown by the Treasury
Department, which recently released estimates showing wealthy taxpayers as a
group are hiding billions of dollars in income. Treasury Secretary Janet Yellen
has previously warned that if left unaddressed the tax gap could grow to $7
trillion over the next decade.
“One of the purposes of a campaign is to stop whatever fraud
is going on while you’re doing the investigations and audits,” said John
Koskinen, former IRS commissioner for presidents Donald Trump and Barack Obama.
“You like to stop people in their tracks.”
Dean Patterson, an IRS spokesman, declined to comment on the
campaign.
Congressional Request
Campaigns by the IRS often take years to organize, as agents
begin to detect factual patterns that indicate a significant loss of revenue
due to non-compliance. In the case of Puerto Rico, much of the focus will be on
establishing whether individuals are truly island residents and whether they
properly sourced income to Puerto Rico.
Unlike previous IRS efforts, the campaign’s origins began in
Congress after lawmakers requested a report from the agency in their 2020
appropriations bill over concerns Puerto Rico’s tax laws may be enabling tax
avoidance and that federal and state governments were being shorted revenue.
“Every revenue authority everywhere is facing the same issue
of needing to find an efficient process when there are fewer resources and
budget constraints,” said Sharon Katz-Pearlman, global head of dispute
resolution and controversy for KPMG.
The IRS’ report to Congress calculated that more than 1,924
applicants—corporations, LLCs, partnerships, and other types—had been granted
tax benefits under the Exports Services
Act (formerly known as Act 20) as of March 2020 based on partial information
provided by Puerto Rico. Act 20 offers entities a 4% corporate rate on
business income and 100% tax exemption on dividends. That provision along
with the Individual Investors Act have now been consolidated into a new
incentive law to attract individuals and investments to the island.
Publicly listed names by the government of Puerto Rico in
many instances could not be verified by Bloomberg Tax. Emails to Collins
Capital LLC, which appears to have a virtual mailbox in San Juan, were returned
twice.
Others, like Atlas Advisors LLC and DSM Partners LLC,
appeared to use similar names of more established U.S.-based companies. A
representative for Northwest Registered Agent LLC confirmed with Bloomberg Tax
that DSM Partners operates in Puerto Rico but could not provide contact
information for the company.
“This is obviously a company set up to look like our
(legitimate) company,” wrote Jono Tunney, a managing partner at Atlas Capital
Advisors LLC, in an email to Bloomberg Tax.
Russell Katz, general counsel for DSM Capital Partners,
dispelled any association with the island’s programs. “DSM Capital Partners LLC
does not have any connection with Puerto Rico’s tax incentive programs. We have
no involvement in this.”
Among other recipients: brokerage firm Fairbridge Capital
Market Inc. disbanded its Puerto Rico office in 2016, while Mosaic Investment
Partners Inc.— which is still active, according to the government’s corporate
registry—could not be reached at its listed number.
Private investment advisory and wealth management firms like
Blue Capital Management Inc., which declined comment, and investment firm
X-Square Capital LLC, which did not respond to requests for comment, had both
set up offices on the island.
More than 2,300 individuals were also granted tax
exemptions on passive income, such as dividends and capital gains, under the
Individual Investors Act (formerly known as Act 22) between 2012 and 2019,
according to the IRS report. Of those individuals, the IRS could identify only
25%—or 647 individuals—who had previously resided in California, Florida, New
Jersey, New York, and Texas. They paid nearly $558 million in combined
federal income taxes in the five years prior to their relocation to Puerto
Rico, representing a fraction of potential loss revenue to the U.S. Treasury’s
coffers.
Get Me to Puerto Rico
That trend has continued since the start of the pandemic,
with the number of Manhattan residents relocating to Puerto Rico growing by at
least fourfold compared to the previous year, according to change of address
data from the United States Postal Service.
Between March 2020 and February 2021, at least 82 requests
were filed for permanent moves to Puerto Rico by New York City residents
compared with only 22 the previous year. Additionally, at least another 11
Manhattan addresses temporarily forwarded their mail during the pandemic to the
island. None had done so the year prior.
Lawyers specializing in Puerto Rican tax incentives say they
get five to 15 queries a day from prospective clients interested in determining
if they qualify for the tax incentives.
Many are day traders without traditional jobs that
spend their wealth making trades on stocks, securities, commodities, and
cryptocurrencies, earning capital gains that are 100% tax-exempt. Others
include investment bankers and hedge fund managers, who either manage funds or
provide financial advice to clients, allowing them to earn tax-exempt
carried interest.
“We’re seeing quite a class of investment bankers and
financial advisors setting up shop here,” said Isis Carballo-Irigoyen, chair of
McConnell Valdes LLC’s tax practice group.
‘A Lot of Baggage’
Individuals identified by the IRS will have to prove their
Puerto Rican residency, a key factor in claiming the tax benefits. Taxpayers
must live on the island for a minimum of a 183 days annually every year to be
considered a bona fide resident.
Mark Leeds, an attorney who advises U.S. taxpayers on the
territories’ tax incentives, says “there’s a lot of baggage” tied to the term
bona fide resident in the federal code and can be “a very difficult determination”
for individuals. .
Maintaining a residency in the eyes of the IRS goes beyond
simply leasing an apartment in popular Dorado Beach. It includes bringing your
main possessions, joining local clubs, updating your voter registration status,
moving with your spouse, and enrolling your children in the island’s schools.
“You should also try to minimize contact with mainland
U.S.,” said Carballo-Irigoyen. “If the IRS were to audit and they look at your
life, they have to be convinced this is where you live.”
Moving, even if someone has qualified for tax incentives
from Puerto Rico, doesn’t necessarily make someone exempt from filing a U.S.
tax return, Leeds said. Also, “it’s only
Puerto Rico source income that is eligible for exemption. It’s not
foreign source. It’s not U.S. source. Only Puerto Rico source.”
In its audits, for example, the New York Department of
Taxation tries to determine an individual’s “true intentions,” according to a
spokesman for the agency. That means a taxpayer providing clear evidence
they’ve really moved to another state, including the sale of their home in New
York, closing any businesses, and relocating their belongings. Problems arise
when people claim to have moved but can’t supply any supporting evidence.
“If you’ve done things right, you have nothing to worry
about it,” said Carballo-Irigoyen. “But if you’re playing games, then you need
to worry.”
—With assistance from Aaron Kessler.
To contact the reporter on this story: Donna Borak in New
York at dborak@bloombergindustry.com
To contact the editors responsible for this story: Bernie
Kohn at bkohn@bloomberglaw.com; Jeff Harrington at
jharrington@bloombergindustry.com
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