The IRS Pursuit For Crypto Taxes Extends To Puerto Rico: What Investors Need To Know

The IRS has made no secret of the priority that the Service has placed on crypto tax assessment and collection since Bitcoin
BTC
first made many mainstream investors aware of the sector. Going back to the early days of mass-market crypto, the IRS filed legal action against U.S. based exchanges and U.S. branches of international exchanges, seeking more information on certain traders and customers from firms including Coinbase and Kraken. Following up on that the IRS has sent thousands of letters to taxpayers requesting (or demanding) more information and payments connected to crypto transactions. More recently, the “crypto question” has moved from other places on the 1040 to a prominent place on the individual tax return; this, in turn, has made crypto tax planning a priority for accounting professionals in recent years.

Even as the regulatory winds seem to be shifting ever so slightly, with a partial win by Ripple in the XRP
XRP
case, and positive sentiment around multiple ETF filings that have recently been put forward, the tax outlooks remains relatively unchanged. Under current tax laws, guidance, and interpretations every crypto transaction – including mining, staking, and trades – are taxed either as ordinary income or capital gains depending on the holding period involved. For every tax or financial problem, however, there is almost always a related tax-based solution.

Puerto Rico, seeking to attract and retain high net worth individuals and taxpayers, passed a slew of tax incentives, with over 5,000 individuals and 3,600 businesses having taken advantage of these measures. The program initially began with the Puerto Rican Export Services Act (Act 20), and the Individuals Investors Act (Act 22). In 2022 these two Acts were consolidated through Act 60. To quality, businesses would need to generate $3 million in revenue and employ at least one Puerto Rican resident. Individuals must purchase a home on the island and donate at least $10,000 to charities.

On the surface these sound like straight-forward policies, so why is this becoming controversial? Let’s take a look at what is going and how it connects to cryptoassets.

What Are The Issues

While the headlines are centering around the crypto traders and asset managers that have relocated to Puerto Rico, the real issues are explicitly connected to tax guidance, and how the existing rules are being interpreted. The exemptions that have been on table for investors and entrepreneurs include a 100% exemption on dividends, a 60% exemption on municipal taxes, and 0% federal taxes on income that is sourced within the region. From a business perspective, these entities can avoid paying taxes on dividends from earnings and profits, with only a 4% tax rate charged on exports.

One of the more stringent qualifications to obtain these benefits is that 1) the taxpayers must be able to prove they list on the island for 183 days, and that the territory is their “tax home.” According to the IRS, the tax home for a taxpayer is the entire city or general area of the workplace of the taxpayer. For investors and entrepreneurs seeking to minimize tax liabilities while remaining relatively local to U.S. markets this has unsurprisingly proven to be an attractive offer.

As appealing as these tax incentives are for attracting new residents, there are issues that have arisen alongside investor interest in thes tax incentives.

Why Crypto Is In The Crosshairs

It is no secret that the cryptoasset sector, as well as the firms and investors operating in the space, have found themselves as the target of regulation and governmental agencies the world over. By its very nature, the blockchain and cryptoasset sector is a global business that is not tethered to any one particular marketplace. Additionally, Puerto Rico is not the only locale that has sought to attract some of this capital – both intellectual and financial – via tax and other incentives. These other locations include, but are not limited to Malaysia, Portugal and more traditional financial hubs such as the Cayman Islands.

Specific to the issues connected to Act 22, however, there are two points that seem to be driving this current crackdown. First is the fact that Puerto Rico has endured several natural disasters in the last several years, and that the island is still very much in the process of rebuilding and reinforcing infrastructure and the broader economy. Granting tax breaks to wealthy international residents has caused protests and legal challenges. Second is that these wealthy individuals and enterprises have, by the nature of having more disposable income and much lower taxes, driven up the cost of living for residents, many of whom are not eligible for these tax incentives.

Layered with the doubt and suspicion that the crypto sector is still combating, and the recipe for a crackdown is complete.

What Investors Should Consider

Crypto investors should always keep a watch on the changing regulatory landscape and outlook for both specific cryptoassets (such as in the Ripple case), and the attitude toward the sector at large. What the recent discussion around the tax incentives provided in Puerto Rico prove is that regulators and tax agencies are actively seeking sources of new revenue. For investors and entrepreneurs, be they located in Puerto Rico or in other jurisdictions the following advice continues to apply. Recommendations include, but are not limited to the following – 1) always work with a tax professional familiar with the crypto space and the specific tax situation in question, 2) retain records and documentation for any major tax exclusions that are sought, and 3) allocate time on a periodic basis to keep abreast of these (sometimes) rapidly changing changes.

Crypto taxes are always a hot topic, but well prepared investors can continue to navigate theses sometimes tumultuous waters successfully.