Puerto Rico occupies a unique status as a Commonwealth of the United States. It has its own constitution and a system of government very similar to that of most states in the Union.
- In 1917, Congress granted American citizenship to Puerto Ricans.
- The Commonwealth of Puerto Rico falls under the jurisdiction of most federal laws of the United States. However, significant taxation differences exist.
- Puerto Rican residents pay taxes to the Hacienda and pay no income tax to the United States on income earned in Puerto Rico.
- Social Security taxes apply to residents of Puerto Rico, who are U.S. citizens. All native Puerto Ricans are U.S. citizens by law.
Retirement plan qualification
Under ERISA Section 1022(i) sponsors of pension, profit-sharing, or stock bonus plans created or organized in Puerto Rico with Puerto Rico trusts, are eligible for two types of favorable tax treatment under the Internal Revenue Code:
- Under ERISA Section 1022(i)(1), if the Puerto Rico plan is exempt under Puerto Rico Code Section 1165 and all of the participants are residents of Puerto Rico, the trust will be treated as exempt under Internal Revenue Code Section 501(a) as if it were part of a qualified plan under Internal Revenue Code Section 401(a). The effect of ERISA Section 1022(i)(1) is to exclude trust income earned in the U.S. from U.S. taxation.
- ERISA Section 1022(i)(2) provides that a sponsor of a Puerto Rican plan can make an irrevocable election for the plan to comply with all of the Internal Revenue Code’s qualification provisions except for the trust situs requirement. An election to maintain an ERISA Section 1022(i)(2) plan enables the plan to cover both U.S. and Puerto Rican employees.
“Dual-qualified” plans have U.S. domestic trusts that cover Puerto Rican employees and qualify under both the Puerto Rico Code and the Internal Revenue Code to provide the Puerto Rican participants with favorable tax benefits.
A retirement plan and any amendments made to the plan, that covers Puerto Rican employees must apply for and receive a letter from the Puerto Rico Hacienda before the plan is qualified under the Puerto Rico Code.
On January 31, 2011, a new Puerto Rico Code was enacted. The new rules generally became effective January 1, 2011, and apply to all qualified retirement plans that cover employees working on the Island, even those plans that are also qualified in the United States. On December 10, 2011, Technical Amendments were made to the Puerto Rico Code to incorporate several changes to the local retirement plan rules.
The Hacienda issued Circular Letter No. 11-10 (as modified by Circular Letter No. 13-02), which describes the statutory changes that must be included in a plan document under the Puerto Rico Code. Plan sponsors of either Puerto Rico-only or dual-qualified plans must adopt these amendments to comply with the Puerto Rico Code by the due date, including any extension, of the employer's Puerto Rico income tax return for the 2013 taxable year.
The Internal Revenue Code and Puerto Rico Code have different requirements for cash or deferred arrangement plans. The major differences are:
- the method for determining excluded employees under coverage testing;
- the definition of Highly Compensated Employee;
- Average Deferral Percentage test, methodology and correction methods;
- there is no Average Contribution Percentage test in Puerto Rico; and
- the dollar amount that can be deferred.
Also, Puerto Rico has a lower catch-up contribution limit for participants 50 years of age or older.
All pension plans covered by ERISA, including dual-qualified plans, are required to file a Form 5500-series return. Plans that are qualified in Puerto Rico and not in the U.S. should include on line 8 the plan characteristic code 3C - Plan not intended to be qualified under Internal Revenue Code Sections 401, 403 or 408. Enter 3J for U.S.-based plans that cover Puerto Rican residents and are qualified under both the Internal Revenue and Puerto Rico Codes.
All plans that have participants in Puerto Rico must file Form 480.70 with the Hacienda.
Since ERISA Section 1022(i)(2) plans and dual-qualified plans are not exempt from excise taxes, Form 5330 must be filed, where applicable.