Puerto Rico does not offer any tax credits or exclusions for investments in qualified small businesses. However, the tax incentive, Act 60, acts as I.R.C. Section 1202 for investors. Act 60 has several benefits, one of them allowing Puerto Rico residents to pay 0% on capital gains taxes, dividends, and interest.
Federal QSBS Exclusions and State Tax Implications
Allowing capital gains tax exclusions for Qualified Small Business Stocks (QSBS) encourages investment in US small business. QSBS laws help provide capital for these businesses while offering a savvy tax strategy for investors who want to minimize capital gains taxes.
Investors who hold qualified small business stock for at least 5 years can exclude up to $10,000,000 or more of their recognized capital gains from their taxable income if certain criteria are met.
Learn more about the criteria for Qualified Small Business Stock.
Each state has its own treatment of QSBS gains at the state income tax level. There are three ways in which states typically address the exclusion.
- Some states fully conform to the Federal QSBS guidelines, and therefore allow a full exemption if the stock meets the Section 1202 QSBS criteria. States conform to the federal tax code on either a static or rolling basis. “Static” conformity means the state starts conforming to the Internal Revenue Code as of a specific date. “Rolling” conformity means that the state adopts IRC changes as they occur. Alternatively, certain states do not have state income taxes and therefore there is no QSBS implication at the state level.
- Some states partially conform to the Federal QSBS guidelines, whereby the capital gains from QSBS are exempt if additional criteria beyond the Federal guidelines are met, such as only allowing exemptions if the QSBS gains were from a company doing business in that state.
- Lastly, certain states do not allow any capital gains exclusions for QSBS.
Find out how QSBS is recognized by each state here.
Puerto Rico QSBS Exemptions
Puerto Rico does not offer any tax credits or exclusions for investments in qualified small businesses. However, the tax incentive, Act 60, acts as I.R.C. Section 1202 for investors. Act 60 has several benefits, one of them allowing Puerto Rico residents to pay 0% on capital gains taxes, dividends, and interest.
Puerto Rico Capital Gains Tax Rates
Puerto Rico taxes short-term capital gains at the same rate as regular income and long-term capital gains at a flat rate of 15%. Puerto Rican non-resident foreign nationals play a flat rate of 25% on capital gains and non-resident US citizens pay 15%.
In comparison, federal capital gains tax rates have 3 brackets for single taxpayers which are:
- 0% for $0 to $39,375
- 15% for $39,376 to $434,550
- 20% for $434,551 or more
Entrepreneurship in Puerto Rico
Nerma Albertorio, Puerto Rico-born entrepreneur, founded Centro para Emprendedores in 2012. The nonprofit is an educational program for entrepreneurs in Puerto Rico who want to build businesses but cannot do it alone, just like Albertorio. She discovered through multiple failed businesses that building a team is a foundational necessity for entrepreneurs and she sought to teach others that skill in order to foster the entrepreneurial ecosystem of her home.
“Through entrepreneurship, you can really empower people to change and move out of cycles of poverty,” she says.
“I really love when you can see in people’s eyes that they get it, and they understand that they can be owners of their own lives. That’s the best part of this.”
Among other industries, the following industries in particular thrive in the state:
- Agriculture
- Manufacturing
- Service
- Finance and Real Estate
- Trade
- Tourism
Act 60 Benefits for Entrepreneurs, Similar to QSBS
In 2019, the Export Services Act (Act 20) and the Individual Investors Act (Act 22) were merged to become Act 60. Originally, these two acts were meant to attract entrepreneurs and provide incentives for businesses established in Puerto Rico and are now, together, offer lucrative tax rates for entrepreneurs.
A 4% corporate tax for Puerto Rican companies is one of the benefits. This is reserved for companies that export services and is ideal for ecommerce businesses and web-based service providers. To fully benefit, entrepreneurs must become residents of Puerto Rico. Another requirement is that businesses with more than $3 million in revenue must employ at least one local resident.
Eligible trades include exported services including R&D, advertising, consulting, architecture, call centers, software development, educational services, marketing, and more.
On top of this low corporate tax rate, qualified Puerto Rican residents can pay 0% in capital gains taxes, dividends, and interest.
Puerto Rico Opportunity Zones
Puerto Rico is home to approximately 863 Opportunity Zones with 98% of the territory holding the Opportunity Zone designation.
Opportunity Zones (OZ) were created to help economically distressed areas by giving investors preferential tax treatment with new investments in these “specified” areas. Similar to QSBS, if the investment meets eligibility criteria and is held for at least 5 years, the investor can defer or be exempted from capital gains taxes (i.e. if held for at least 5 years, the taxpayer can exclude 10% of the gain and the percentage increases (or “steps up”) to 15% after 7 years).
Opportunity Zone investments can be in the stock of an OZ Qualified Business, an OZ partnership interest or an OZ business property.
To be a Qualified Opportunity Zone Business, the business must meet requirements such as at least 50% of the business’s total gross income being derived from within the Opportunity Zone. To learn more about Opportunity Zone qualifications, please refer to the Opportunity Zones and QSBS article.
Under the Tax Cuts and Jobs Act of 2017, 26 USC 1400Z-2, Puerto Rico made Opportunity Zones, is also home to the associated tax relief incentives that accompany these zones which are effective for tax years beginning on or after December 31, 2017. Refer to this mapfor the Opportunity Zones in the state and here for all Opportunity Zones in the United States.
Some Examples of Opportunity Zones Funds in Puerto Rico include:
- Community Outcome Fund (Business, Real Estate, Commercial, Infrastructure, Mixed-Use, Residential)
- Puerto Rico Opportunity Fund (Affordable Housing, Commercial, Energy Development, Hotel, Infrastructure, Mixed-Use, Residential, Student Housing)
Find more information at The Department of Economic Development and Commerce of Puerto Rico.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.
