On December 10, 2018, the Governor of Puerto Rico signed into Law Act 257 (“Act 257”), which includes numerous amendments to the Puerto Rico Internal Revenue Code of 2011 (“PR Code”). Below is a summary of the major tax provisions included in Act 257 for the benefit of our clients.
Normal Tax– Beginning in tax year 2019, individuals must determine their income tax (regular tax and gradual adjustment) based on the current progressive tax rates, but the tax liability will be 95% of that computation. That is, all individuals will receive a 5% discount on their regular tax.
Alternative Basic Tax (“ABT”)– Act 257 modiﬁes the income threshold for the ABT for tax year 2019 and beyond. Under the new brackets, the ABT rate of individuals will be between 1% and 24% and will apply to individuals with net income subject to ABT in excess of $25,000.
|Net Income Subject to Alternative Basic Tax||Tax Rate|
|In excess of $25,000, but less than $50,000||1%|
|In excess of $50,000, but less than $75,000||3%|
|In excess of $75,000, but less than $150,000||5%|
|In excess of $150,000, but less than $250,000||10%|
|In excess of $250,000||24%|
In calculating ABT net taxable income, Act 257 establishes limits on deduction that may be claimed by individuals who engage in a trade or business. In summary, only those deductions that are directly evidenced to the Puerto Rico Treasury Department (“PRTD”) may be claimed for ABT purposes, including: salaries, professional services informed in 480s informative returns and interest paid, among others.
Nonetheless, if an Agreed Upon Procedure (“AUP”) or Compliance Attestation Report (“CA”), prepared by a CPA who is licensed in Puerto Rico is filed with the tax return, all deductions claimed for the regular tax may be claimed for ABT purposes.
Act 257 marks the return of the ABT Credit for tax year 2019 and beyond. On the other hand, those individuals whose only source of income is from salaries reported in a W-2 Form will no longer be subject to ABT.
The Earned Income Tax Credit (“EITC”) also returns for tax year 2019. The EITC is a refundable credit granted to those Puerto Rico resident taxpayers with earned income under certain gross income thresholds. EITC varies from $300 to $2,000 depending on the taxpayers’ marital status, number of dependents and amount of adjusted gross income.
Normal Tax– For tax year 2019 and beyond, Act 257 reduces the maximum normal tax rate for corporations from 20% to 18.5%. The surtax is still applicable to corporations under the same rules as in previous years, as such, the maximum tax rate applicable to corporations for the year 2019 onwards is 37.5%.
Alternative Minimum Tax (“AMT”)– Act 257 reduces the AMT rate from 30% to 18.5% for taxpayers with a volume of business of less than $3 million. If a taxpayer’s volume of business is $3 million or more, the applicable AMT rate is 23%. The AMT will be the higher of $500 or the tax resulting from imposing the applicable rate (18.5% or 23%) to the AMT taxable income. That means that the minimum tax a regular corporation will pay in Puerto Rico is $500, even when not conducting business during the year or finishing with a net operating loss.
The same restrictions on deductions that apply to individual’s ABT are applicable to the AMT calculation. Likewise, corporations that ﬁle Audited Financial Statements, an AUP or a CA, will be allowed to claim a deduction for all ordinary and necessary expenses in the calculation of the net income subject to AMT.
- Optional Tax
For tax year 2019 onward, self-employed individuals and corporations, whose income originates substantially from rendering services, may opt to use a fixed tax rate schedule to determine their income tax liability as follows:
|Gross Income||Tax Rate|
|Less than $100,000||6%|
|In excess of $100,000, but less than $200,000||10%|
|In excess of $200,000, but less than $300,000||13%|
|In excess of $300,000, but less than $400,000||15%|
|In excess of $400,000, but less than $500,000||17%|
In excess of $500,000
In order to be eligible, all the income of the taxpayer must have been informed through informative returns (480s). Likewise, all tax liability must be covered by withholdings at source or estimated payments.
On a recent publication, the PRTD defined “originates substantially from rendering services” as compensation from services representing at least 80% of the gross income of the taxpayer. In the same publication, the PRTD stated that taxpayer who will elect the Optional Tax and whose gross income is less than $100,000, may submit a sworn statement to their payors that will serve as a partial waiver. With this “partial waiver” the payor will withhold only 6% on each payment, not the required 10%.
- Changes Affecting All Taxpayers
- The 50% disallowance for deductions related to meals and entertainment expenses increases to 75% and is further limited to a maximum of 25% of gross income for the tax year.
- Travel and lodging expenses are now limited to 50% of the amount paid or incurred.
- Taxpayers with volume of business of $3 million or less can use a useful life of 2 years to determine the depreciation expense of certain personal property, including machinery and equipment.
- Taxpayers who ﬁle a Transfer Pricing Study with the Secretary will be released from the 51% disallowance on intercompany expenses paid or incurred.
- A deduction is not allowed for settlement payments made on account of sexual harassment cases.
- The deduction for capital losses, losses of a pass-through entity and net operating losses increases from 80% to 90% of the net capital gain, pass-through income or operating income, respectively.
- The exemption on interest from accounts in cooperatives, savings associations, commercial and mutual banks or in any other organization of a banking nature will be limited to $100 per taxpayer (instead of $2,000 under former law).
- Compensation received in judicial proceedings or extrajudicial settlements for mental anguish will be excluded from gross income.
- The required withholding amount on payments made for services rendered after December 31, 2018 increases from 7% to 10%. In addition, the withholding exemption on payments for services rendered is reduced to $500 (from $1,500).
- Payors will be required to file quarterly returns on payments made to professional services providers.
- The due date to deposit the amounts withheld will be the 15th day of each month.
- Sales and Use Tax (“SUT”)
Service Providers– Effective March 1, 2019, merchants with a volume of business of $200,000 or less will not have to collect the SUT (be it the total 11.5% or the business-to-business rate of 4%).
Prepared Food– A reduced SUT rate of 7% will be applicable to the sale of prepared food sold by restaurants eﬀective on October 1, 2019. The reduced rate will apply to transactions regardless of the payment method used. For this exemption to apply, the restaurant will need to obtain a certification from the PRTD.
Exemptions– Three new exemptions are created: Purchase and rental of e-books feminine hygiene products used for the menstrual cycle, and rent of medical equipment (previously, only the purchase was exempt).
Inclusion– Membership fees paid for shopping establishments (physical or web-based) that allow for the acquisition of goods, services and benefits will now be considered “admission rights” for SUT purposes and subject to the 11.5% SUT. Examples of these include the membership fee for CostCo and Sam’s.