The tax benefits of Puerto Rican residency gained some attention and notoriety when hedge fund billionaire John Paulson went to Puerto Rico to “kick the tires.”
He did not become a Puerto Rican resident (not yet, at least), but ended up buying a resort there instead. My theory is that John Paulson can’t move anywhere without attracting adverse media attention. The media would declare that Paulson’s purchase of a Big Gulp at Seven Eleven as tax motivated.
Puerto Rico has long used corporate tax incentives to attract many large American multinational companies. Both Apple and Microsoft can attribute a great deal of their tax benefits and success to Puerto Rico. Many pharmaceutical companies have Puerto Rican operations.
The Puerto Rican government—not lacking in creativity—passed a series of tax bills in 2012 to create economic incentives for Americans to move and start businesses in Puerto Rico. Namely, they eliminated taxation on dividends, interest, and capital gains as well as reduced corporate taxes to just 4%.
Frankly, my hat is off to the Puerto Rican government for its ingenuity. Our own federal government could learn a lesson or two from this legislation.
Less known are the substantial benefits for research and development in Puerto Rico. The combination of the R&D, business, and personal tax benefits make Puerto Rico a far better option than Silicon Valley.
While the reader may argue that any intent to unseat Silicon Valley as the King of the technology hill is foolish and farfetched, I will make the argument in this article that Puerto Rico is a much better location for operations, or at least a subsidiary.
To all my friends in the “city by the Bay,” no offense, but the Fillmore has been closed for a long time, Janis Joplin has been dead for more than 40 years, and Journey stopped touring a long time ago. Yes, the proximity of Sonoma and world-class wine and beauty is compelling, but the costs of living in the Bay area are not.
Silicon Valley Versus Puerto Rico—David Versus Goliath
A few key distinctions come to mind right away when you consider the possibility of Puerto Rico versus Silicon Valley as an alternative location for research and development.
Immediately, I think of the dramatic differences in the cost of living between Puerto Rico and San Francisco and Silicon Valley. Housing is a major factor in the cost of living and typically the largest expense for employees when considering whether to relocate to a high-cost urban area. Outside of San Juan, the differential becomes dramatically more pronounced.
The difference in the cost of housing between San Francisco and San Juan is massive. Rents are a third of what they are in Silicon Valley.
I heard a story during the early days of the tech bubble that has always stayed in my mind. A single mother with a child rented a room in a person’s house without kitchen privileges for $2,000 per month in 2000. The same mother would have had a three-bedroom house in a nice neighborhood, a live-in maid, and could have sent her child to the best private school in San Juan or any other Puerto Rican city for the same money.
Of course, there is the incredible difference in taxes as well.
Startups tend to attract young entrepreneurs with young families. Cash compensation tends to be low, in favor of “success-based” compensation after a sale or IPO.
Recently, Puerto Rico adopted tax incentives that would allow workers to exercise the sale of stock in their company following a sale or an IPO without any personal tax due.
The proceeds would not be subject to federal taxation or Puerto Rican taxation.
The taxes in California by contrast would be confiscatory.
Assuming a significant sale, the California resident would be subject to long-term capital gains taxation of 20% along with the 3.8% Medicare tax on investment income. At the state level, the capital gains wouldn’t receive preferential treatment and would be taxed at ordinary tax rates, which could reach as high as 13.1%.
A Puerto Rican resident would pay no federal or Puerto Rico taxes on the sale of company shares, while the California resident pays 37%. That’s an incredible difference.
Let’s not understate the fact that San Francisco is a very cosmopolitan city, but when you’re barely paying your bills, the quality of the local museum and opera company aren’t your biggest concerns.
A few recent stories have covered tech companies providing housing for workers not only to reduce the high cost of living but also to encourage a family (more likely, frat house) environment, where employees can exchange ideas 24-7. Clearly, a beach house in the Puerto Rico could provide a similar work and living environment at a fraction of the cost.
What about the weather?
The Bay area is prone to earthquakes and foggy weather. Puerto Rico has Caribbean weather and world-class resorts. The Bay has wine country; Puerto Rico has world-class rum. Puerto Rico is very accessible from the mainland. I once counted over 50 flights per day from the mainland US originating from major Eastern cities and Chicago. Most of the discount airlines have multiple flights per day to Puerto Rico.
What about the rule of law?
Remember that Puerto Rico is part of the US with federal courts. Law firms in Puerto Rico are sophisticated and cost about 75% less than firms in San Francisco and New York City. You’ll need and want to keep your US lawyer, but it’s likely that your attorney in Puerto Rico also went to Harvard or Georgetown.
Ultimately, it’s about the money.
Shareholders and employers will be able to dramatically reduce operating costs through a combination of significant tax incentives and R&D incentives in Puerto Rico. The local universities provide a rich talent pool and US-based employees who move to Puerto Rico and become residents will be able to personally benefit financially in a manner that’s impossible in Silicon Valley or the entire continental US. If it’s about the money, then it’s equally about how much of the money that you get to keep.
I am certain that many of the readers of this article will say “foolish” and “very naïve” at the idea that Silicon Valley should move to Puerto Rico.
All it takes is for someone to be first.
I recently met two entrepreneurs who were moving through another round of venture-capital financing. Both were in a position to sell some of their shares following the financing. Both shareholders would reap a few million dollars each. One of the shareholders was a resident of NYC, while the other was a California resident. The company had 20 employees living and working in Silicon Valley.
If their company had been in Puerto Rico instead of Silicon Valley, neither of the entrepreneurs would have paid any federal and state income taxes. Neither of the two would have paid any Puerto Rican taxes. The employees would have qualified for the compensation exemptions under R&D provisions and had no taxation on the sale of company shares.
The employees’ families would have enjoyed living in housing that is a fraction of the cost of the Bay area. Their children would become bilingual. Their families would come to visit them every winter, and the employees would return to see their families a few times per year. And there would be no need to renounce your US citizenship like Eduardo Saverin.
In the final analysis, perhaps the proposal is a bit naïve, but if money really talks, the venture capitalists and entrepreneurs should be listening.
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