Who is a Puerto Rico Resident for US Tax Purposes

Who is a Bona-Fide Resident of Puerto Rico?

Puerto Rico Resident vs Non-Resident for US Tax & Pub 570: Since Puerto Rico is a Commonwealth of the United States and not technically a state – the IRS tax implications of residing in Puerto Rico are very complicated. Qualifying as a Bona-Fide Resident varies, depending on whether the resident in Puerto Rico is a US Citizen/Lawful permanent Resident or Non-Resident Alien. In general, if a US Citizen or Lawful Permanent Resident meets the Puerto Bona-Fide Resident Rule (not to be confused with the Bona-Fide Resident category under the Substantial Presence Test), then they are considered a resident of Puerto Rico – and Puerto Rico income may be exempt from US Tax. On the other hand, if a Non-Resident Alien resides in the Puerto Rico, then just meeting the Puerto Rico (PR) Bona-Fide Resident rule is not sufficient to be considered a US Person for Tax Purposes (for better or worse) – rather, nonresidents must meet the Substantial Presence version of the rule as detailed in  26 CFR 1.937-1.

Complicating the matter further are the FBAR rules (which are dictated by FinCEN and not the IRS).

Let’s look at the basics of Puerto Rico Residence for Non-Residents vs Citizens and Residents.

Puerto Rico & US Tax Return Filing

The reason why the residence rules are so important for residents of Puerto Rico, is because when certain persons reside in Puerto Rico — even if they are US persons — they can oftentimes avoid any income sourced in Puerto Rico on their US tax return. Therefore, not only can the US person could avoid formally expatriating, but by relocating to Puerto Rico — and sourcing their income in Puerto Rico – they may avoid U.S. tax on the income*.

*US and other foreign income are generally still taxable to US persons residing in Puerto Rico. In addition. More specific rules apply for those granted approval under PR Incentives Code 60.

Puerto Rico Bona-Fide Residence: US Citizens & Green Card

When a US citizen or Lawful Permanent Resident wants to claim Bona-Fide Residence in Puerto Rico, there are multiple requirements:

Generally, you are a bona fide resident of one of these territories (the relevant territory) if, during the tax year, you:

• • • Meet the presence test,

    • Do not have a tax home outside the relevant territory, and

    • Do not have a closer connection to the United States or to a foreign country than to the relevant territory

Presence Test

If you are a U.S. citizen or resident alien, you will satisfy the presence test for the tax year if you meet one of the following conditions.

1. 1. 1. You were present in the relevant territory for at least 183 days during the tax year.

      2. You were present in the relevant territory for at least 549 days during the 3-year period that includes the current tax year and the 2 immediately preceding tax years. During each year of the 3-year period, you must be present in the relevant territory for at least 60 days.

      3. You were present in the United States for no more than 90 days during the tax year.

      4. You had earned income in the United States of no more than a total of $3,000 and were present for more days in the relevant territory than in the United States during the tax year. Earned income is pay for personal services performed, such as wages, salaries, or professional fees. TIP

      5. You had no significant connection to the United States during the tax year. Special rule for nonresident aliens. Conditions (1) through (5) above do not apply to nonresident aliens of the United States. Instead, nonresident aliens must meet the substantial presence test discussed in chapter 1 of Pub. 519. In that discussion, substitute the name of the territory for “United States” and “U.S.” wherever they appear. Disregard the discussion in that chapter about a Closer Connection to a Foreign Country.

What Does This Mean?

The residence rules for US persons who want to claim bona fide residence in Puerto Rico is very complicated. It requires the taxpayer to meet very specific residence rules — and there is very limited leeway, especially if the taxpayer is originally a US resident.

Non-Resident Aliens residing in Puerto Rico

For Nonresident Aliens residing in Puerto Rico, the rules are different as to who is considered a tax resident. The bona fide residence test for US citizens and lawful permanent residents is not the same test that is applied when the taxpayers of nonresident alien.

Let’s go through the basics:

26 U.S. Code § 933 – Income from sources within Puerto Rico

The following items shall not be included in gross income and shall be exempt from taxation under this subtitle:

• • • (1) Resident of Puerto Rico for entire taxable year

    • In the case of an individual who is a bona fide resident of Puerto Rico during the entire taxable year, income derived from sources within Puerto Rico (except amounts received for services performed as an employee of the United States or any agency thereof); but such individual shall not be allowed as a deduction from his gross income any deductions (other than the deduction under section 151, relating to personal exemptions), or any credit, properly allocable to or chargeable against amounts excluded from gross income under this paragraph.

What does this Mean?

If a person qualifies to be treated as a Resident of Puerto Rico for US Tax Purposes, then certain income will exempt from US Tax – specifically, Puerto Rico sourced income.

26 U.S. Code § 937 – Residence and Source Rules Involving Possessions

(a) Bona fide resident

For purposes of this subpart, section 865(g)(3), section 876, section 881(b), paragraphs (2) and (3) of section 901(b), section 957(c), section 3401(a)(8)(C), and section 7654(a), except as provided in regulations, the term “bona fide resident” means a person—

• • • (1) who is present for at least 183 days during the taxable year in Guam, American Samoa, the Northern Mariana Islands, Puerto Rico, or the Virgin Islands, as the case may be, and

    • (2) who does not have a tax home (determined under the principles of section 911(d)(3) without regard to the second sentence thereof) outside such specified possession during the taxable year and does not have a closer connection (determined under the principles of section 7701(b)(3)(B)(ii)) to the United States or a foreign country than to such specified possession.

For purposes of paragraph (1), the determination as to whether a person is present for any day shall be made under the principles of section 7701(b).

• • • (b) Source rules Except as provided in regulations, for purposes of this title—

      • (1) except as provided in paragraph (2), rules similar to the rules for determining whether income is income from sources within the United States or is effectively connected with the conduct of a trade or business within the United States shall apply for purposes of determining whether income is from sources within a possession specified in subsection (a)(1) or effectively connected with the conduct of a trade or business within any such possession, and

      • (2) any income treated as income from sources within the United States or as effectively connected with the conduct of a trade or business within the United States shall not be treated as income from sources within any such possession or as effectively connected with the conduct of a trade or business within any such possession.

    • (c) Reporting requirement

      • (1) In general If, for any taxable year, an individual takes the position for United States income tax reporting purposes that the individual became, or ceases to be, a bona fide resident of a possession specified in subsection (a)(1), such individual shall file with the Secretary, at such time and in such manner as the Secretary may prescribe, notice of such position.

      • (2) Transition rule If, for any of an individual’s 3 taxable years ending before the individual’s first taxable year ending after the date of the enactment of this subsection, the individual took a position described in paragraph (1), the individual shall file with the Secretary, at such time and in such manner as the Secretary may prescribe, notice of such position.

26 U.S. Code § 911 – Citizens or Residents of the United States Living Abroad

(d)(3) Tax home

• • • The term “tax home” means, with respect to any individual, such individual’s home for purposes of section 162(a)(2) (relating to traveling expenses while away from home). An individual shall not be treated as having a tax home in a foreign country for any period for which his abode is within the United States, unless such individual is serving in an area designated by the President of the United States by Executive order as a combat zone for purposes of section 112 in support of the Armed Forces of the United States.

26 CFR 1.937-1

The regulations under 1-937-1 serve to expand the ability to meet the Presence Test in possessions such as Puerto Rico.

• • • (c) Presence test –

    • (1) In general

    • • • A United States citizen or resident alien individual (as defined in section 7701(b)(1)(A)) satisfies the requirements of this paragraph (c) for a taxable year if that individual:

        • Was present in the relevant possession for at least 183 days during the taxable year; (ii)

        • Was present in the relevant possession for at least 549 days during the three-year period consisting of the taxable year and the two immediately preceding taxable years, provided that the individual was also present in the relevant possession for at least 60 days during each taxable year of the period;

        • (iii) Was present in the United States for no more than 90 days during the taxable year;

        • (iv) During the taxable year had earned income (as defined in § 1.911-3(b)) in the United States, if any, not exceeding in the aggregate the amount specified in section 861(a)(3)(B) and was present for more days in the relevant possession than in the United States; or

        • (v) Had no significant connection to the United States during the taxable year. See paragraph (c)(5) of this section.

    • (2) Special rule for alien individuals

• • • • • A nonresident alien individual (as defined in section 7701(b)(1)(B)) satisfies the requirements of this paragraph (c) for a taxable year if during that taxable year that individual satisfies the substantial presence test of § 301.7701(b)-1(c) of this chapter (except for the substitution of the name of the relevant possession for the term United States where appropriate).

What Does this Mean?

In order to qualify as a bona fide resident of Puerto Rico, the presence test is generally the most important of the three elements. While the five factors above layout the options for U.S. citizens and legal permanent residents, the rules for nonresident aliens is different. For nonresident aliens, they will meet the presence test in order to be a bona fide resident of Puerto Rico if they meet the substantial presence test — and in order to do the analysis, the individual substitutes the term Puerto Rico (or other relevant possession) instead of United States.

FBAR – Who Must File the FBAR

• • • Who is a United States Person?

      • A “United States person” means:

        • A citizen or resident of the United States;

          • An entity created or organized in the United States or under the laws of the United States.

            The term “entity” includes but is not limited to, a corporation, partnership, and limited liability company;

        • A trust formed under the laws of the United States; or

        • An estate formed under the laws of the United States.

Who is a Resident of the US?

While US Citizens and Legal Permanent Resident (absent a Form 8833 treaty position) are always US Persons, so are certain Residents. 

As defined by FinCEN For FBAR purposes:

• • • A United States resident is an alien residing in the United States.

    • To determine if the filer is a resident of the United States, apply the residency tests in 26 U.S.C. § 7701(b).

    • When applying the § 7701(b) residency tests use the following definition of United States:

      • United States includes the States, the District of Columbia, all United States territories and possessions (e.g., American Samoa, the Commonwealth of the Northern Mariana Islands, the Commonwealth of Puerto Rico, Guam, and the United States Virgin Islands), and the Indian lands as defined in the Indian Gaming Regulatory Act.

Therefore if a person is either a US Citizen, Legal Permanent Resident or Resident Alien of the United States (including Puerto Rico) under IRC 7701(b), then they may have an FBAR filing requirement.

Puerto Rico is NOT Considered a Foreign Country for FBAR

A financial account is foreign when it is located outside of the United States, which includes the following places:

• • • United States, including the District of Columbia; 

      • United States territories and possessions, such as:

      • Commonwealth Northern Mariana Islands

      • District of Columbia

      • American Samoa

      • Guam

      • Commonwealth of Puerto Rico

      • United States Virgin Islands Trust Territories of the Pacific Islands

    • Indian lands as defined in the Indian Gaming Regulatory Act

Therefore, since Puerto Rico is part of the United States, then accounts located in Puerto Rico are not required to be reported on the FBAR.

Puerto Rico Residence Rules is Complicated

In conclusion, the US tax rules and implications surrounding residents of Puerto Rico is very complicated material. whether or not a person will qualify as a bona fide resident of Puerto Rico will be determined by whether they are a legal permanent resident become a U.S. citizen or non resident — and if they meet the specific requirements based on their US Person status.

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