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.