Bona Fide Resident of Puerto Rico
To qualify as a bona fide resident of Puerto Rico, an individual needs to meet three main criteria: (i) the presence test, (ii) the tax home test, and (iii) the closer connection test.
Let’s consider an example. Sarah, a U.S. citizen living in Massachusetts, works for a private equity firm and is married with two children. After learning about the tax benefits of relocating to Puerto Rico, Sarah decides to establish residency there to access these advantages.
Sarah fulfills the presence test by spending over 183 days in Puerto Rico each year. Additionally, with her principal place of business located in Puerto Rico, she also meets the tax home test.
Closer Connection Test
To satisfy the closer connection test, Sarah must demonstrate a stronger connection to Puerto Rico than to the U.S. or any foreign country. Since Sarah spends only one to two weeks each year traveling outside the U.S. and Puerto Rico, she clearly does not have a closer connection to any foreign country. However, given that Sarah spends several months annually in the U.S. and maintains assets and other ties there, she needs to assess whether she meets the closer connection test.
The closer connection test is based on the “closer connection exception” principles outlined in Code §7701(b)(3)(B)(ii) and Treas. Reg. §301.7701(b)-2(d).
Certain individuals establishing residency in Puerto Rico (or other U.S. territories) are required to file Form 8898, Statement for Individuals Who Begin or End Bona Fide Residence in a U.S. Possession. Part III of this form, titled “Closer Connection to the United States, Foreign Country, or Possession,” includes questions designed to “elicit information relevant to determining whether an individual has closer connections to the United States or a foreign country than to the relevant possession for purposes of the closer connection test under §937(a).”
Treas. Reg. §301.7701(b)-2(d) is titled “Closer connection to a foreign country,” and provides:
- General rule: For purposes of section 7701(b) and the associated regulations, an alien individual will be regarded as having a closer connection to a foreign country than to the United States if either the individual or the Commissioner demonstrates that the individual has stronger ties to the foreign country. In evaluating whether an individual has maintained more significant connections to a foreign country than to the United States, the relevant facts and circumstances to consider include, but are not limited to, the following:
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The location of the individual’s permanent home;
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The location of the individual’s family;
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The location of personal belongings, such as automobiles, furniture, clothing, and jewelry owned by the individual and his or her family;
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The location of social, political, cultural, or religious organizations with which the individual has a current relationship;
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The location where the individual conducts his or her routine personal banking activities;
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The location where the individual conducts business activities (other than those that constitute the individual’s tax home);
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The location of the jurisdiction in which the individual holds a driver’s license;
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The location of the jurisdiction in which the individual votes;
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The country of residence designated by the individual on forms and documents; and
- The types of official forms and documents filed by the individual, such as Form 1078 (Certificate of Alien Claiming Residence in the United States), Form W-8 (Certificate of Foreign Status) or Form W-9 (Payer’s Request for Taxpayer Identification Number).
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- Permanent home: For the purposes of paragraph (d)(1)(i) of this section, it does not matter if the permanent home is a house, apartment, or furnished room, nor does it matter whether the home is owned or rented by the individual. What does matter, however, is that the residence is available at all times, continuously, and not just for brief stays.
As noted in the regulation above, the closer connection test is based on a “facts and circumstances” analysis. The IRS and a court would review the specific facts and circumstances to determine whether Joe has stronger connections to the U.S. than to Puerto Rico.
Permanent Home
The location of an individual’s permanent home is the first factor listed in the regulations and is likely the most significant one.
If Sarah owns a home in Massachusetts and does not sell or rent it out while residing in Puerto Rico, this could represent a substantial connection to the U.S.
As noted earlier, Sarah spends several months each year in the U.S. A key question, then, is where she stays when in the U.S. Does she stay in a hotel on business trips without her family, or does she stay in her former primary residence in Massachusetts with her family?
If the home where Sarah stays in the U.S. is available to her at all times, it may be considered her permanent home there. For instance, if her parents have an in-law suite that Sarah and her family can use whenever they wish, this would count as a permanent U.S. home.
Not having a permanent home in the U.S. is not a strict requirement for passing the closer connection test; Sarah may maintain permanent homes both in the U.S. and in Puerto Rico. However, having a permanent home in the U.S. would be a significant factor against her in determining whether she meets the closer connection test.
Time Spent in the U.S.
Even if Sarah meets the presence test by spending more than 183 days in Puerto Rico, and although the regulations do not specifically list time spent in the U.S. as a factor, the amount of time Sarah spends in the U.S. would still be a crucial consideration in evaluating her connections there. If Sarah spends 185 days in Puerto Rico and 180 days in the U.S. within a year, she may be close to failing the closer connection test.
Location of Family
The location of an individual’s family is the second factor listed in the regulations and likely the second most important one.
In our society, a person’s closest family members are typically their spouse and children. Therefore, it would be essential to analyze where Sarah’s spouse and children are throughout the year. If Sarah spends several months a year in the U.S., where are her spouse and children during this time? Do they spend almost the entire year in Puerto Rico, or are they visiting the U.S. as frequently as (or even more than) Sarah? Where are Sarah’s children enrolled in school? Where do they attend camp? Are they regularly connecting with people in the U.S., or is Puerto Rico more like their primary home?
The more time that Sarah’s spouse and children spend in the U.S., the more likely it is that Sarah’s ties to the U.S. will be considered significant.
Each person’s circumstances are unique. For instance, if Sarah were unmarried, without children, and her widowed father lived with her in Puerto Rico, then the time her father spends in the U.S. would be an important consideration.
Location of Personal Belongings
The location of personal belongings is the third factor listed in the regulations. If Sarah and her spouse chose not to move any furniture from their Massachusetts home to Puerto Rico but instead purchased new furniture for their home in Puerto Rico, this could indicate ongoing connections to the U.S. These connections may be viewed as especially strong if the furniture in Massachusetts includes heirlooms or items with sentimental value.
Other Factors Listed
The regulations listed above include several other factors that are important and should be taken into account when attempting to meet the closer connection test. For instance, Sarah should obtain a Puerto Rican driver’s license, designate Puerto Rico as her residence on official forms, and register to vote in Puerto Rico. However, it’s important to note that the IRS and a judge may not place significant weight on factors that are easily manipulated.
Years Spent in Puerto Rico
Although not explicitly listed as a factor, if Sarah moves to Puerto Rico for only a few years and then returns to the U.S., it may indicate that her ties to Puerto Rico were not as significant. The IRS typically has up to three years to audit individuals after they file their tax returns. This “after-the-fact” review can provide the IRS with insights (often with the benefit of hindsight) that may not have been clear initially.
Additionally, if Sarah moves back to the U.S. after just a few years, an IRS auditor might suspect that she was “taking advantage” of Puerto Rico’s tax breaks. While these tax incentives are fully legitimate for bona fide residents, the auditor could be motivated to scrutinize Sarah’s connections to the U.S. in an attempt to challenge her claim of meeting the closer connection test. If her situation is already close to the threshold, a determined IRS auditor could be a concern.
If, after leaving Puerto Rico, Sarah and her spouse sell or donate all of their Puerto Rican furniture, this might suggest they did not have a strong connection to those belongings, especially in contrast to the furniture they may still own in Massachusetts.
Planning to Meet the Closer Connection Test
It is strongly recommended to maintain only one permanent residence, preferably located in Puerto Rico. Additionally, it is crucial for close family members to reside in Puerto Rico for the majority of the year.
For individuals moving to Puerto Rico with the intention of claiming bona fide residency, yet continuing to maintain significant ties to the U.S., it is prudent to carefully evaluate their daily activities in Puerto Rico. Documenting regular, meaningful interactions with individuals and entities in Puerto Rico could be pivotal in convincing a judge, particularly one who may be uncertain, of the individual’s substantial connections to Puerto Rico.