Letter to the Hon. Steven Mnuchin, Secretary of the U.S. Department of the Treasury - Serrano, Velázquez, Grijalva, Ocasio-Cortez Call for Greater Transparency and Oversight of Puerto Rico's Tax Breaks for Wealthy Individuals and Businesses (Acts 20 and 22)

Letter

Dear Secretary Mnuchin:

We write to request that the Department of the Treasury conduct greater oversight over a variety of tax breaks provided to individuals and businesses in Puerto Rico and their impact on Federal tax revenues. In particular, Acts 20 and 22 of Puerto Rico have led to significant tax avoidance by wealthy individuals "residing' in the island. While some have tried to promote these tax breaks as economic development tools, we believe that these giveaways have not resulted in any benefit for Puerto Rico.

As you know, the Federal tax history of Puerto Rico is extremely complicated for both businesses and individuals. Since 1954, Federal income taxes have not been extended to income earned in Puerto Rico, as specified in IRC § 933. Rather, the tax goal has been to allow the territorial government to tax the revenue sources directly at levels necessary to overcome the lack of equal treatment in Federal funding programs.

However, as Puerto Rico's fiscal status has declined, their recent tax policies appear to undermine the federal goals of IRC § 933. In 2012, the territorial government enacted two laws, Acts 20 and 22--potentially in violation of the uniformity clause of the Constitution of Puerto Rico[1]--with the goal of luring wealthy individuals and businesses providing services in the States to Puerto Rico. These laws exempt these individuals from almost all local taxation if they "reside' on the island for a majority of the year. Under the laws, numerous tax exemptions and rate reductions are granted until 2035, with little economic justification. The beneficiaries are not required to make significant specific economic contributions to the territory, or even any contributions that justify any tax savings at all.

The result is that combination of the Federal and territorial laws has enabled high-income individuals and profitable service businesses to avoid any Federal or territorial taxation on some income and to owe extremely low rates of tax on other income. By "residing' on the island for 183 days per year, these individuals now avoid both Federal and local taxes. This results in tax benefits that individuals and businesses could not obtain anywhere else in the world. In other words, Puerto Rico has become a tax haven from the Federal government.

For example, under Act 20, individuals do not have to pay any tax to any government on gains from buying and selling stocks and bonds in the States. Under Act 22, individuals and their firms that provide services in the States from the territory pay an income tax rate of four percent.

The territorial tax exemptions granted to those wishing to avoid Federal taxes stands in stark, unfavorable contrast with the treatment of long-time Puerto Ricans and most other individual and corporate residents of the territory. Most individuals and locally-owned corporations pay high rates of local tax.

There are many other concerns associated with Acts 20 and 22. The better treatment of Act 20 and 22 beneficiaries is not limited to taxes: They have also been exempted from territorial inheritance laws, which may have implications for Federal estate taxation. There reportedly are more than 1,600 individuals and firms who have relocated from the States to Puerto Rico in order to avoid Federal, State, and local taxes.[2] A few years ago, a territorial official said that the smaller number of individuals then included two billionaires and that the average net worth of Act 20 and 22 beneficiaries was $7 million. We understand that the IRS is aware of cases in which businesses in the States route their services through "front' firms in Puerto Rico that do no real work. We have also heard of a case in which an individual avoids $60 million a year in Federal taxes through these territorial policies. There are also questions as to whether Act 22 beneficiaries are really present in Puerto Rico 183 days a year as required by IRC § 937.

The combination of the Federal and territorial tax exemptions is not only depriving the territorial government of revenue intended by IRC § 933, but it also appears to do so without any showing of economic benefits. Additionally, Acts 20 and 22 deprive the Federal, State, and local governments of needed revenue.

In order to better understand the impact of these policies, we respectfully request that the Department:

1. Evaluate whether the Sec. 933 benefit should apply to individuals and firms that relocate from the States and obtain Acts 20 and 22 benefits;
2. Examine the enforcement of Sec. 937 by the IRS and territorial officials;
3. Determine whether Sec. 933 is accomplishing its purpose, specifically in the case of these avoiders of taxes in the States, or whether it should be amended;
4. Calculate the revenue costs to the territorial government, as well as to the Federal, State, and local governments;
5. Investigate how the Sec. 937 183 days a year presence in the territory requirement is being enforced by the IRS and the territorial government and the effectiveness of their monitoring;
6. Analyze whether Sec. 937 should be amended to enhance its effectiveness; whether the territorial inheritance law exemption for Act 22 beneficiaries is adversely affecting Federal estate and generation-skipping taxation and whether U.S. law should be amended; and
7. Consider whether the territory's tax exemptions comply with the requirement in its constitution that taxes be uniform.

Thank you for your cooperation and we look forward to working with you on this important matter.