Paying Taxes in Puerto Rico by Michael Richter
As a freely associated state, Puerto Rico has its own tax code (Código de Rentas Internas). Although the code bears marked similarities to the US tax code (Internal Revenue Code), there are significant differences to be aware of.
Income in Puerto Rico may be taxable under its own code, the US tax code, or both. In general, the two codes apply to income generated in their respective states. However, both Puerto Rico and the US tax the global income of their residents. This means that Puerto Rico residents with US source income and US residents with Puerto Rico source income will be double taxed on that income. Fortunately, both allow a tax credit for taxes paid to the source on such income: the US for Puerto Rico source income, and Puerto Rico for US source income. This credit is calculated on Form 1116 for a US tax return, and Schedule C for a Puerto Rico return.
Unfortunately, Puerto Rico has no tax treaty with any individual US state, so one cannot get a credit for state taxed income.
One is generally considered a resident of Puerto Rico after having lived there for more than 182 days out of the year. One's main place of business and family home also need to be in Puerto Rico. However, certain Federal employees must file a Federal return nonetheless (giving them access to some Federal tax credits). See IRS Publication 570 for details.
The source of income is generally where it is generated. The source of salaries and wages is where one is/was employed. For interest and dividends, it is the location of the payer. Pensions get interesting, as the source for the contribution component may be one state while the earnings component may be the other. Anything to do with real estate goes by the location of the property. The source for sales of personal type property is generally where sold; however check exceptions in Publication 570.
The Puerto Rico tax code underwent an overhaul starting for tax year 2011. The specifics mentioned in this article will apply to returns for tax year 2011.
Certain types of income are excluded or exempt from taxation in Puerto Rico, even if generated there. Nevertheless, the Departamento de Hacienda, the taxing authority, requires it to be listed on Schedule IE. It may be good to start one's return here in order to know what not to report in the return proper.
Unlike the US, Puerto Rico does not tax social security pension income or unemployment.
Puerto Rico residents must still pay the US FICA tax on self-employment income. Form 1040-SS is used for this purpose. The form also contains access to a version of the US Additional Child Tax Credit for households with three or more children related to the taxpayer under the age of 17. The credit may be taken to the extent that the taxpayer has paid FICA.
There are three filing statuses in Puerto Rico: married filing together, single, and married filing separately. Unlike the US, all statuses use the same tax table. Married persons filing together avoid higher tax brackets on combined income by making use of the optional (split) computation on Schedule CO.
Reporting Income Salaries and wages on Puerto Rico returns are listed according to the reporting documents, typically Puerto Rican 499R-2 (AKA W-2PR) or US W-2. Federal government salaries and wages are totaled together on a separate line.
Sole proprietor business income is calculated on Schedules K-N. These work much like the US Schedule C, totaling income and subtracting cost of inventory goods (if any) and other expenses. One should be aware that, in general, losses may be deducted only if that category of income is one's main source of income, and never against salary or pension income at that. However, losses may always be carried forward to apply against future income in that category. The exception is that losses from a new principal business may be taken against salary or pension income in the first three years of operation. This exception is granted once in a taxpayer's existence.
The taxable portion of pensions is calculated on Schedule H. The portion paid into the pension (the "cost" of the pension) is recovered first, unlike in the US where it is divided over the expected life of the pension. The intent of Part 1 of the schedule is to show how the taxpayer recovered his/her contributions in the first years of pension distributions. Up to $15,000 of pension income is exempt from taxation for taxpayers that have surpassed the age of 59 in the tax year; up to $11,000 otherwise (line 8). However, three percent of the cost of the pension is always taxable (line 12).
Capital gain on the sale of one's home is calculated on Schedule D1. The reason a new home is mentioned here is that Puerto Rico allows the gain to be carried forward ("postponed") as an adjustment to the basis of a new home, thus allowing homes to better function as investment vehicles. Moreover, there's a once-in-a-lifetime exclusion of up to $150,000 of the gain from income tax for those that have attained age 60.
Taxable gains (if any) from the sale of ones home and any other property is listed on Schedule D. The period considered short-term in Puerto Rico is six months. Lump sum distributions from Puerto Rico pension plans receive tax advantages (Part IV); lump sum distributions from elsewhere are listed in Schedule F, Part VI, to be taxed as ordinary income.
Other income is recorded in the catch-all Schedule F. Up to $2000 of interest per taxpayer from Puerto Rico sources may be excluded from taxation (Part 1, line 2). Moreover, such interest may be taxed at rates (10% and 17%) that may be advantageous. In these cases, the tax is usually withheld by the payer and reported on Schedule B. However, a taxpayer in a lower bracket may opt out of the special rate on line 9, effectively obtaining a refund on the interest withheld for taxes. Similarly, dividends and IRA distributions from Puerto Rico payers may have a portion withheld at a tax advantaged rate (Part 2).
Many sections of the Puerto Rico return pertaining to investments that gain value include boxes marked "prepaid". Puerto Rico allows taxpayers to pay taxes in advance for anticipated gains at a favorable rate of 5%. Doing so increases the basis of those investments by the amount on which tax was paid. This basis may be reported for distributions from Puerto Rico IRAs.
Figuring the Tax Taxpayers in Puerto Rico are allowed a number of deductions and exemptions from their taxable income. These are listed on the main forms or on Schedule A, along with certain limits. The standard deduction has been replaced by a special deduction of up to $9350 per taxpayer, with a phase out of fifty cents per dollar income over $20,000, including exempt income. This deduction is available only to those whose principal source of income is from employment, sole proprietor businesses, capital gains, pensions, and alimony. Moreover, other sorts of income cannot exceed $5000.
A taxpayer may claim a $2500 exemption for every dependent whom the taxpayer supports more than 50%, who has less than $2500 income ($7500 for university student), and who meets one of the following:
- has not attained age 21 in the tax year
- is the taxpayer's parent
- is incapable of self-support due to a physical or mental ailment (attach certification)
- has attained age 65 in the tax year
- has not attained age 26 and attends a university
Note that there are no residency or relationship requirements, as in the US.
In case of divorce, the custodial parent has the right to claim the exemption. That parent may cede the exemption to another valid taxpayer with Schedule CH. The exemption may be split equally in cases of joint custody.
To calculate tax, a single tax rate table is used for all taxpayers: 0% on income up to $5000 7% on income from $5001 to $22,000 14% on income from $22,001 to $40,000 25% on income from $40,001 to $60,000 33% on income above $60,000
For example, a taxpayer with taxable income of $35,000 would have a tax of: $5,000 x 0% = $0 $17,000 x 7% = $1190 $13,000 x 14% = $1820
TOTAL = $3010
Note that this means taxpayers with less than $8,500 in gross income ($12,000 if married and filing jointly) can expect to pay no taxes after taking into account their personal exemptions. Such persons are therefore not obligated to file a return. The exceptions are for persons who are married filing separately ($6,000) and for persons that are neither residents of Puerto Rico nor US citizens ($0).
If net taxable income exceeds a certain amount ($100,000 in 2011), an additional 5% tax, designed to phase out personal and dependent exemptions, kicks in. It is calculated on Schedule P.
An alternative minimum tax applies when the sum of adjusted gross income and certain exempt and excluded income exceeds certain thresholds. The rate is a flat 10% over $150,000, 15% over $250,000, and 20% over $500,000. This tax, calculated on Schedule O, is always paid instead when it exceeds tax as ordinarily determined.
The tax code of Puerto Rico provides for a number of credits.
A credit of 3.5% is allowed on taxable earned income less than $22,500. The maximum of $350 phases out 2% for income over $10,000.
Each taxpayer who has reached the age of 65 in the tax year may claim a $400 credit if gross income does not exceed $15,000, including excluded income. Married couples who are both over 64 have a higher limit of $30,000.
Each person who relies solely on a pension of $4800 or less may claim a $300 credit.
Taxpayers paying college expenses may take advantage of the American Opportunity Credit on Schedule B2.
The credits mentioned here may all generate a refund, beyond reducing tax owed to $0. Further, more specialized credits are listed on Schedule B.
These credits along with those for tax withheld from other income sources are subtracted from the calculated tax. Any balance is generally paid with the return on or before the due date of April 15 of the year following the tax year. If there is an overpayment, Hacienda will refund it by mailed check or direct deposit, as the taxpayer indicates.
Resources http://www.hacienda.gobierno.pr/planillas_y_formularios/individuos.html Forms, returns, and instructions for many years, in English and Spanish. The long form contains all schedules most people need.
http://www.hacienda.gobierno.pr/downloads/pdf/planillas/481.1.pdf Form to claim the credits for low-income pensioner and/or for persons age 65 and over. This is used by taxpayers not otherwise obligated to file a return.
http://www.irs.gov/pub/irs-pdf/p570.pdf IRS rules governing US treatment of possession income.
http://www.irs.gov/pub/irs-pdf/f1040ss.pdf http://www.irs.gov/pub/irs-pdf/i1040ss.pdf Form to pay self-employment taxes and apply for the child tax credit for those not obligated to file a regular US return.
http://www.irs.gov/pub/irs-pdf/f1116.pdf http://www.irs.gov/pub/irs-pdf/i1116.pdf Form to apply for a tax credit for Puerto Rico tax on Puerto Rico source income (including Federal employee salary or wages paid in Puerto Rico). Only used by those that need to file a regular US return.
Michael Richter prepares taxes with H&R Block at its office in Sears, Las Catalinas Mall, 400 Calle Betances, Caguas, PR 00726. 787.703.1588