Puerto Rico has a complex tax situation. Here are some examples of the tax quandary that is Puerto Rico:
- People who live in Puerto Rico for at least six months and a day each year do not pay income taxes on income earned in Puerto Rico. However, they do pay income tax on wages earned on the mainland. So, for example, a student who studies at a college in Virginia and comes home to Puerto Rico for holidays would be responsible for income taxes on the money she earns at an after-school job in Virginia. An actor who spends 27 weeks making and promoting a movie in Puerto Rico and is paid by a production company there will not pay Federal income taxes on those earnings even though he spent the rest of the year in his luxury penthouse in New York. Both pay social security taxes.
- A Federal judge in Puerto Rico has to pay Federal taxes on his or her income, but a local judge for the Puerto Rican judiciary does not.
- Wealthy individuals can avoid paying capital gains taxes on stocks and bonds after establishing residence in Puerto Rico.
- U.S. companies have kept a whopping 60% of their income, some $1.7 trillion, overseas to avoid taxes, according to a 2012 Senate subcommittee report. Puerto Rico is a U.S. territory, but for the purposes of this tax dodge, the island counts as “overseas.” So, for example, Microsoft Operations Puerto Rico (MOPR) is the company in charge of all retail operations in North America. MOPR belongs to a Bermuda-based company which belongs to a company with operations in Ireland which in turn belongs to Microsoft. In past years, 47% of the income from MOPR’s sales in the U.S. went to Puerto Rico, where it was taxed at just over 1% rather than the 35% Microsoft would pay if they sold software directly from their U.S. corporation. A couple of years ago, the IRS sent Microsoft a bill for the nearly $29 billion in taxes they evaded. Microsoft is not the only company taking advantage of these tax dodges, though the IRS is cracking down on this behavior.
- While corporate taxation is tiny in Puerto Rico (because the local government exempts state-based companies investing in the territory from most of the official tax), sales taxes are the highest in the United States at 11%. Five U.S. states have 7% tax rates and California has a 7.5% state sales tax; five states have no sales tax, and other rates range from 2.9 % to the aforementioned 7.5%. In other words, Puerto Rico, which has a much lower per capita income than any state in the Union, has the highest sales tax rates.
- Tax credits such as the Earned Income Tax Credit (EITC)and the Child Credit (CTC) apply differently in Puerto Rico. Under the American Rescue Plan, the Child Tax Credit was extended to Puerto Rico. Prior to that, it was available only to the few families with three or more children — even though a household in the states earning $400,000 with just one child qualified for the full refundable credit. The Earned Income Tax Credit was recently extended to Puerto Rico, but, like the CTC, it is remains limited and would be higher if Puerto Rico were a state.
Each state has its own tax laws and they are often quirky, but Puerto Rico may have the most convoluted tax situation of all.
Puerto Rico and Federal Income Tax
So how much does Puerto Rico contribute to the federal government?
CUNY Centro, The Center for Puerto Rican Studies, recently published a report showing that Puerto Rico paid $5,000,000,000 in federal taxes in 2023. These payments included a variety of types of taxes:
- business income taxes
- individual income tax withheld
- individual income tax payments
- unemployment insurance tax
- payroll tax
- estate and trust income tax
- excise taxes
Puerto Rico’s contribution to the federal coffers has sometimes been higher than those of six different states.
Puerto Rico does receive more in federal funds than it pays in. However, Puerto Rico is not alone in this. Only thirteen states receive less than they pay to the federal government. These profit center states include California, Massachusetts, and New York. But the majority of states get more than they pay. New Mexico nets $14,781 per resident, Maryland gets $12,265, and Virginia makes $11,577 per resident. According to the CENTRO report, Puerto Rico received just $8, 750 per capita, putting it squarely in the middle of the states.
Why does this matter?
Section 933 of the tax code, enacted in 1954, made residents of Puerto Rico exempt from federal income tax on wages earned in Puerto Rico. The idea was to allow Puerto Rico to collect local taxes, when residents of Puerto Rico would not have been able to afford to pay both national and territorial income tax. All but five states collect state tax in addition to the federal income tax their citizens pay, and all state residents must file income tax returns.
However, more than 40% of all the people living in the states don’t pay any income tax at all.
The average household income in Puerto Rico is just over $25,000, so the majority of residents of the Island would not pay any income tax even if Puerto Rico became a state.
And yet the fact that Puerto Ricans are not required to file federal income tax returns is used as an explanation for the inequity in federal benefits in Puerto Rico. Puerto Rico is shortchanged on nutrition assistance, medical funds, and social security, among other kinds of federal funds. In the Vaello-Madero case, the Supreme Court specifically said that since Puerto Rico didn’t pay all federal taxes, it was okay that they should not receive all federal benefits.
A more accurate understanding of the federal taxes Puerto Ricans pay might improve the problems of federal inequity facing Puerto Rico.
The Federal Income Taxes Puerto Ricans Pay
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