IRS Launches Last-Minute Audits Aimed at Puerto Rico Tax Abuses

The IRS is committing more resources to audits of wealthy Americans sheltering billions of dollars in Puerto Rico amid greater congressional scrutiny of the agency’s enforcement activities, following a whistleblower letter that accused the agency of allowing “tax evasion of epic proportions.”

The audit plan is designed to provide senior revenue officials with a feasible tax enforcement narrative ahead of planned meetings with investigators from the Senate Finance Committee and inquiries from members of Congress, an IRS official with direct knowledge of the decision told Bloomberg Tax.

The agency, the official said, plans to deploy a team of additional agents and open audits of individuals claiming tax benefits under a Puerto Rico tax perk known as Act 22. The program entices wealthy people to the island with promises of total, or near total, tax exemptions on their income.

The IRS’s effort responds to an anonymous letter from a field agent in Miami blasting the agency for failing to police a brazen pattern of tax evasion under Act 22 that costs the US treasury billions of dollars annually. The IRS’s response to the fraud is “woefully unproductive” and is considered “a clown show” by Americans claiming immunity from US taxes, the letter stated. The allegations were first reported by the New York Times on May 28.

The whistleblower’s letter, media coverage, and pressure from Congress has prompted the IRS to commit resources toward the issue, the IRS official told Bloomberg Tax.

The letter’s recipients included Senate Finance Committee Chair Ron Wyden (D-Ore.) and Ranking Member Mike Crapo (R-Idaho), IRS Commissioner Danny Werfel, a half-dozen senior IRS officials, and the 12 House Democrats who signed a letter to the IRS last year about federal efforts to investigate abuses of the Puerto Rico tax break.

Senate Finance plans to meet with the IRS later this month to discuss tax evasion under Act 22, continuing to build on the public reports and private information the panel has received.

“It appears that a significant number of wealthy tax cheats decided they’d buy some property up in the mountains or on the beach outside of San Juan, visit every once in a while, and abuse Act 22 in a way that rips off taxpayers both in Puerto Rico and on the mainland U.S.,” Wyden said Thursday in an emailed statement. “To this point, they’ve gambled that they could stay ahead of any big enforcement effort, and that approach has paid off for them.”

Wyden said questions around residency need investigating, but he expressed particular concern for whether scofflaws are mischaracterizing income they made in the mainland US as Puerto Rican, to evade what he said were millions or billions of dollars in taxes they legally owe.

“This is about how the rich are avoiding taxes and paying their fair share in the United States, writ large, using Puerto Rico’s colonial status as their loophole in order to do so,” Rep. Alexandria Ocasio-Cortez (D-N.Y.) told reporters on June 5.

Ocasio-Cortez, who signed onto last year’s letter led by Rep. Nydia M. Velázquez (D-N.Y.), said it’s an issue that she has consistently raised with the Biden administration.

“They are behind the ball on this, and it is a failure that must be turned around as soon as possible,” Ocasio-Cortez said.

IRS Cites ‘Ongoing Campaign’

Act 22, enacted in 2012, draws wealthy mainlanders to Puerto Rico with tax exemptions on income, dividends, interest, and capital gains. It was later folded into another program known as Act 60, which offers a corporate tax rate of 4% to businesses located in Puerto Rico that export services performed on the island to clients outside of the territory.

Americans seeking the tax relief, however, must be residents of Puerto Rico and must demonstrate their income is earned on the island. Income and gains sourced from the US are still subject to the federal tax code. More than 5,000 millionaires and billionaires have moved to Puerto Rico, but the island currently has 2,670 active Act 22 agreements, according to the Office of Incentives at the Puerto Rico Department of Economic Development and Commerce.

The IRS has claimed it is closely monitoring abuses of the Act 22 residency, reporting, and sourced income requirements, but the whistleblower letter contends the agency is “lying.”

“There seems to be no appetite to pursue these wealthy, aggressive and arrogant Americans who blatantly use their wealth and privilege as a shield,” the whistleblower wrote.

The IRS prioritized enforcement of tax noncompliance in Puerto Rico three years ago under its Large Business and International Compliance Campaign through examinations, outreach, and soft letters—informal notifications alerting taxpayers to a potential compliance problem. According to the whistleblower letter fewer than 20 inquiries have been made—less than 1% of all known Act 22 beneficiaries—and no soft letters or assessments have been issued.

An IRS spokesperson declined an opportunity to comment beyond a statement released last week, saying the agency has “an ongoing campaign with active audits underway reviewing taxpayers who have potentially claimed benefits through Puerto Rico Act 22 without meeting the U.S. tax code’s residency requirements.”