Despite Puerto Rico having its own tax system, certain types of income, such as U.S.-sourced interest and dividends, remain subject to federal taxation—even if the recipient is a bona fide resident of the island.
This is because these earnings originate directly from entities within the U.S. and are therefore considered subject to federal tax jurisdiction.
However, there are legal strategies that can help structure the receipt of these earnings more efficiently, so they are taxed in Puerto Rico rather than in the U.S. With proper planning, it is possible to optimize the tax burden and take advantage of Puerto Rico’s benefits, such as lower tax rates or even exemptions under specific local programs.
This post explores some of these strategies and how they can be applied in different situations—all within the bounds of the law—to help Puerto Rico residents manage their investments and wealth more effectively.
Strategies to Reduce or Eliminate U.S. Taxation on Dividends and Interest While Residing in Puerto Rico
The key is to shift the source of income to Puerto Rico as much as possible. Here’s how:
1. Invest in Puerto Rico-Based Companies and Funds
Why it works:
Dividends from companies established in Puerto Rico are considered Puerto Rico-sourced income and are not subject to U.S. federal tax for bona fide Puerto Rico residents.
How to do it:
- Buy shares in Puerto Rican corporations.
- Invest in Puerto Rico-based mutual funds or ETFs (some Puerto Rico funds are structured for tax benefits).
- Create or invest in a Puerto Rico-incorporated business that pays dividends.
Example:
An investor owns shares in Banco Popular (a Puerto Rican bank).
- Banco Popular pays $5,000 in dividends.
- These dividends are exempt from U.S. federal tax because they are Puerto Rico-sourced income.
2. Use Puerto Rican Banks for Interest Income
Why it works:
Interest earned from bank accounts in Puerto Rico and Puerto Rico municipal bonds is considered Puerto Rico-sourced income, meaning it is not taxable by the U.S.
How to do it:
- Open savings accounts and certificates of deposit (CDs) in Puerto Rican banks.
- Invest in Puerto Rican government or municipal bonds (which may be tax-exempt in both Puerto Rico and the U.S.).
Example:
An investor deposits $200,000 in a CD at a Puerto Rican bank with a 5% interest rate.
- They earn $10,000 in interest.
- This interest is tax-free in both Puerto Rico and the U.S.
3. Move Investments to Puerto Rico-Based Private or Hedge Funds
Why it works:
Some investment funds based in Puerto Rico allow residents to receive dividends and interest without paying U.S. federal tax.
How to do it:
- Invest in hedge funds registered in Puerto Rico or funds under Act 60.
- Consider setting up a Puerto Rico-domiciled investment fund.
Example:
An investor moves $500,000 into a Puerto Rico hedge fund.
- The fund pays $30,000 in annual dividends.
- Since the fund is based in Puerto Rico, the dividends may be Puerto Rico-sourced and tax-exempt.
4. Use a Puerto Rico Corporation to Manage Investments
Why it works:
If structured correctly, an Export Services Company under Act 60 (with a 4% corporate tax rate) or a Puerto Rico investment company can receive investment income and distribute dividends with tax advantages.
How to do it:
- Set up a Puerto Rico-based investment company.
- Have the company receive interest and dividends first, then distribute them to you as Puerto Rico-sourced dividends.
Example:
An investor forms a Puerto Rican LLC to manage investments.
- Instead of receiving dividends directly from the U.S., the PR-based company receives them first.
- The company then pays Puerto Rico-sourced dividends, which may be tax-exempt.
5. Use Tax Credits and Deductions
Why it works:
If an investor still receives some U.S.-sourced dividends or interest, they can reduce their U.S. tax liability through foreign tax credits or deductions.
How to do it:
- Use the Foreign Tax Credit (FTC) to offset U.S. taxes if Puerto Rico also taxes those earnings.
- Deduct investment-related expenses (financial advisor fees, management fees, etc.).
What You Should Do Next:
For Puerto Rico residents, U.S. taxes on U.S.-sourced dividends and interest cannot always be avoided, but investments can be structured so that income becomes Puerto Rico-sourced and therefore not subject to U.S. federal taxation.
If you want to explore a tailored strategy for your portfolio, schedule a consultation to discuss how to optimize your tax structure.
