Unlike other professional sports, professional golf keeps improving. The PGA Championship last weekend was over-the-top exciting and a great storyline.
If you missed it, Phil Mickelson won the PGA Championship last Sunday. At age fifty and eleven months, his improbable win shattered the record for the oldest golfer to win one of the four major world golf championships - by four years!
Improbable indeed. Entering the tournament, Mickelson’s golf game was in shambles. Once one of the world’s elite golfers, the popular Mickelson was ranked an embarrassing 115th in the world and relegated to an afterthought in golf circles – until Sunday.
Mickelson’s classy performance on one of the world’s hardest golf courses on Kiawah Island, climaxed in wonderful manic fashion. Reminiscent of the final scene in the movie classic Caddyshack, an entourage of excited (inebriated?) golf fans stormed the eighteenth fairway and mobbed Mickelson as he closed out his historic round, chanting “Lefty”. Goose bumps.
It was fascinating to watch Mickelson struggle to control his emotions and manage intense stress over his much younger competition. A truly remarkable accomplishment and an inspiration for us middle-agers that you’re as good once as you ever were.
Golf, better weather and to again be allowed to sit at a bar and eat dinner has been good for the soul. However, trouble is brewing that may snuff out of the fun for financial planners later in 2021 in the form of major federal tax law changes in 2022.
The last time we faced such massive tax change was 2013. I’ve never worked as many hours as I did in late 2012 performing pre-2013 tax planning. Late 2021 may be even worse if President Biden pushes through his proposed income/estate tax law changes.
I may have to summon a Mickelson-esque tax planning performance on behalf of our clients in the second half of 2021.
I’m a longstanding critic of the cynical way politicians from both parties use federal tax policy as political strategy and social engineering. As I remind my liberal friends, business owners take massive risks and create jobs, they are not an enemy and there are real risks to over-taxing them. I also point out that the top 10% of US taxpayers already pay 70% of all federal income taxes – facts are stubborn.
In turn, I scold my conservative friends that gratuitous tax cuts push the political pendulum left and opens the door to “soak the rich” tax increases. The massive 2017 tax cut jammed through by Republicans defines gratuitous and precipitated the hot tax mess that is coming in 2022.
That’s the current state of affairs as Biden is floating some bone-jarring tax law changes. Here’s an incomplete list of his tax wish list:
- Increased tax rates on higher earning taxpayers
- Elimination of the capital gain tax rate
- Serious reduction in the federal estate tax exemption
- Elimination of the step up in cost basis on inherited assets
- Levy a new capital gain on estates at death
It’s too early to focus on the actual provisions of the new tax law and I’m not worried it will be made retroactive to 2021. However, meaningful tax law change is definitely coming and you should prepare to consider tax planning moves later in 2021 once the new law takes shape.
One of the more interesting new tax planning strategies is the physical relocation to Puerto Rico. This is now a legitimate tax planning tactic since major new tax legislation was passed in Puerto Rico in 2020.
I’ve always been intrigued by Puerto Rico, even though I’ve not (yet) visited the tropical island. As a US territory, you can enjoy the Caribbean beach experience without a passport, no currency headaches, no custom hassles and direct flights from the US mainland. I’ve also heard that San Juan is one of the more dynamic and historic cities you can visit.
Now add attractive tax haven status to list of Puerto Rican assets. If you pick up and move to Puerto Rico and pass their residency test, Puerto Rican-sourced income avoids federal income tax and is taxed locally at ridiculously low rates – all without renouncing US citizenship!
Even though Puerto Ricans are considered US citizens, taxable income is considered “foreign source”. If a US citizen relocates to Puerto Rico, lives there more than six months a year, buys a house, votes locally and makes local charitable contributions, they earn residency status. In many respects, it is no different than relocating to Florida for the state tax benefits and proving it is your new state of residence.
The Puerto Rican income tax breaks run for thirty years.
Here’s the key tax benefit: Puerto Rican-sourced income is not taxed by the federal government. For example, let’s say a certain wealth advisory firm, now headquartered in York, were to move their office to an ocean view suite in Puerto Rico and exports professional advisory services to their clients via webinar, the owner would not owe any federal income tax on future business profits. The Puerto Rican tax on business profits would range from 0-4% during the thirty-year special tax period.
Below $3 million of annual business revenue, there’s no job creation requirement either.
Hmmm.
Capital gains and dividends from investments can also avoid federal income tax rate, but that’s a more complicated topic.
There are catches. There are no federal estate benefits by relocating to Puerto Rico. In addition, the IRS is fully aware of this legal tax arbitrage and are likely to audit many emigres to ensure the residency test is being honored. And don’t mention the hurricane risk. Lastly, if Puerto Rico were to become a state, the foreign source income exclusion goes out the window.
A trickle of business owners have already relocated their business and residency to Puerto Rico; it may become a torrent if the new federal tax law is passed for 2022.
Before you peruse San Juan real estate listings, consult with an advisor conversant in sophisticated tax matters.
Until next time, adios….Tim
Puerto Rico tax information source: Kavane Grant Thortan, accounting firm.