John Paulson and other plutocrats should think twice before moving to Puerto Rico in search of a tax break. While the Caribbean Island's recent push to lure wealthy individuals from the U.S. mainland seems like a great deal, there is no guarantee that the Puerto Rican government will be able to make good on their long-term promises.
The U.S. territory has a bevy of social and economic problems that appear to be getting worse by the day, making it an inhospitable place for a wealthy individual seeking safety and stability. Crime broke through record highs in the last few years and has started to spill into the wealthy neighborhoods of San Juan, the capital. The violence and economic malaise show little sign of abating. It's a long way from the financial paradise the Puerto Rican government is trying so hard to portray it as.
The financial crisis has forced governments around the world to think of new and creative ways to generate and retain income. In the U.S., fiscal stimulus and money printing was the name of the game for the first few years. Now the government is slashing spending and raising taxes, much to the chagrin of just about everybody, but especially to the top 2% of U.S. taxpayers who arebearing the brunt of the tax hikes.
Indeed, the tax rate on long-term capital gains and dividends for the top 2% of earners jumped this year from 15%, where it had been for over a decade, to just under 24%. The wealthy also saw a boost in federal income taxes from 35% to 39.6%. This has made a lot of America's top earners very upset, especially for big-time investors, like John Paulson. The hedge fund manager who made an estimated $15 billion betting against the housing bubble, along with a number of rich investors, is reportedly looking to move to Puerto Rico to avoid getting stuck with a high tax bill.
Why Puerto Rico? Well, the island recently passed a law allowing new residents to pay zero tax on capital gains and zero tax on income derived from local businesses. This rate applies only to income and gains derived from investments made after the person has become a resident of the island and will last through the end of 2035. Income and gains that accrued before residency was established, but have yet to be taxed, such as paper gains made in a stock that has yet to be sold, will be subject to Puerto Rico's normal 10% capital gains rate. For investments sold after 10 years, but before the end of 2035, the rate drops to 5%.
Being able to move investment earnings made in the past is probably what grabbed Paulson's attention. He has apparently reinvested much of his winnings back into his fund, so he has not paid taxes on the bulk of his wealth. His investment performance hasn't been so hot since the housing crisis, but he still has billions of dollars left floating in his fund that he can't take out without receiving a big tax bill from Uncle Sam.
So to save a few billion dollars, Paulson could make the move down south to Puerto Rico. Becoming a resident of Puerto Rico and receiving this tax benefit involves filling out a simple form and living on the island for at least 183 days per calendar year. But unlike other tax avoidance schemes, Paulson and his family don't have to renounce their U.S. citizenship to get the special tax break given Puerto Rico's unique tax arrangement with the U.S.