Since Bitcoin first brought the industry to the attention of many mainstream investors, the IRS has been open about the importance of crypto tax assessment and collection. Since the beginning of the mass-market cryptocurrency, the IRS has taken legal action against domestic exchanges and American subsidiaries of foreign exchanges, requesting additional data on specific traders and consumers from companies like Coinbase and Kraken. In response, the IRS wrote hundreds of letters to taxpayers requesting (or demanding) additional details and payments in relation to cryptocurrency transactions. The “crypto question” has more recently shifted from a less visible location on the 1040 to a prominent location on the individual tax return; as a result, accounting professionals have prioritized crypto tax planning in recent years.
Even while there appears to be a minor shift in the regulatory winds, as seen by Ripple’s partial victory in the XRP case and the favorable reaction to several recent ETF filings, the tax outlooks are mostly unchanged. Every cryptocurrency transaction, including mining, staking, and transactions, are subject to taxation as either ordinary income or capital gains, depending on the length of the holding period, under current tax rules, regulations, and interpretations. However, there is nearly always a tax-based answer for any fiscal or tax issue.
Over 5,000 people and 3,600 businesses have benefited from Puerto Rico’s tax incentives, which the island territory established in an effort to draw and keep high net worth individuals and taxpayers. The Puerto Rican Export Services Act (Act 20) and the Individual Investors Act (Act 22) served as the program’s foundational legislation. These two Acts were combined into one by Act 60 in 2022. Businesses would need to make $3 million in revenue and have at least one resident of Puerto Rico working for them to qualify. People have to buy a house on the island and give organizations at least $10,000.
These seem like simple policies on the surface, so why is this causing controversy? Let’s examine the situation and how it relates to crypto assets.
Although Puerto Rico has become a popular destination for cryptocurrency traders and asset managers, the main problems are directly related to tax advice and how the law is currently being applied. The exemptions that have been put out for business owners and investors include a 0% federal tax rate on local income as well as a 100% exemption on dividends and a 60% exemption on municipal taxes. With only a 4% tax rate applied to exports, these firms can avoid paying taxes on dividends from earnings and profits from a business standpoint.
One of the stricter requirements to qualify for these benefits is that the taxpayers must be able to demonstrate that they have lived on the island for 183 days and that the territory serves as their “tax home.” The entire city or approximate region of the taxpayer’s place of employment is considered to be the taxpayer’s tax home, according to the IRS. It should come as no surprise that this has turned out to be a compelling offer for investors and business owners looking to reduce tax obligations while staying relatively close to U.S. markets.
In spite of how desirable these tax advantages are for luring new inhabitants, problems have emerged alongside investor interest in them.
It goes without saying that governmental organizations and regulatory bodies from all over the world have turned their attention to the crypto asset industry, as well as the companies and investors working in it. The blockchain and crypto asset industry is by definition a global industry unbound by any single market. Puerto Rico is not the only place that has tried to entice some of this capital—both financial and intellectual—through tax and other incentives. The Cayman Islands and other more established economies like Malaysia and Portugal are among these additional destinations.
There are two things, however, that seem to be motivating this present onslaught specifically with regard to Act 22-related problems. First, Puerto Rico has had numerous natural disasters over the past few years, and the island is still actively rebuilding and fortifying its infrastructure and overall economy. Protests and legal challenges have resulted from giving tax benefits to wealthy foreign residents. Second, because they pay lower taxes and have more spare income, these affluent people and businesses have raised living expenses for locals, many of whom are ineligible for these tax breaks.
The recipe for a crackdown is full when combined with the uncertainty and distrust that the cryptocurrency industry is still dealing with.
Investors in cryptocurrencies should continually keep an eye on how the regulatory environment is evolving, including the future for individual crypto assets (as in the case of Ripple) as well as the sector as a whole. Regulators and tax agencies are actively looking for new revenue streams, as evidenced by the recent controversy surrounding the tax incentives offered in Puerto Rico. The following advice is still valid for investors and business owners, whether they are based in Puerto Rico or another country.
Recommendations include, but are not limited to, the following: 1) always work with a tax professional knowledgeable about the cryptocurrency industry and the particular tax situation in question; 2) retain records and documentation for any significant tax exclusions sought; and 3) set aside time on a regular basis to stay up to date on these (sometimes) rapidly changing changes.
Crypto taxation is always a hot topic, but well-informed investors can continue to effectively navigate these occasionally turbulent waters.
