Taxes in Puerto Rico versus the US work on two separate tracks: bona fide residents of Puerto Rico generally owe no federal income tax on income earned on the island under Internal Revenue Code Section 933, and instead pay income tax directly to Puerto Rico’s Departamento de Hacienda at local rates that top out at 33%. Federal payroll taxes still apply. So do federal estate tax rules, but in a form most people don’t expect. And the island’s 11.5% sales tax reaches into daily spending in a way most mainland states don’t. The full comparison is less lopsided than the “no federal tax” headline suggests.
Federal Income Tax on Island Earnings
Section 933 of the Internal Revenue Code lets a bona fide resident of Puerto Rico for the entire tax year exclude Puerto Rico-source income from federal gross income.1Office of the Law Revision Counsel. 26 USC 933 – Income From Sources Within Puerto Rico Wages from a local employer, interest from a Puerto Rican bank, and dividends from Puerto Rican corporations are not reported on a federal return and owe no federal income tax. Federal employees are the notable exception: compensation for services performed as a federal government employee remains taxable by the IRS even if you live and work on the island.2eCFR. 26 CFR 1.933-1 – Exclusion of Certain Income From Sources Within Puerto Rico
The exclusion does not extend to income sourced from the mainland or abroad. Dividends from a mainland corporation, rent from a Florida property, or freelance payments for work performed in the states all remain federally taxable. For the 2025 tax year, you generally need to file a federal return if your gross income from non-island sources reaches $15,750 as a single filer or $31,500 if married filing jointly.3Internal Revenue Service. Check if You Need to File a Tax Return
Mixing island and mainland income in a single year forces you to allocate deductions between the two sources so that only the mainland portion gets taxed federally. The IRS expects clear records showing where each dollar came from, and this allocation is where audit problems most often start.
Who Qualifies as a Bona Fide Resident
None of Section 933 applies unless you meet the IRS’s three-part residency test for the entire tax year. You need to satisfy all three, not just one.
The presence test is usually met by being physically in Puerto Rico for at least 183 days during the year. Alternatives include a three-year lookback of at least 549 days with a minimum of 60 days each year, spending no more than 90 days in the mainland during the year, or earning no more than $3,000 of mainland-source income while spending more days in Puerto Rico than in the states.4Internal Revenue Service. Publication 570 – Tax Guide for Individuals With Income From U.S. Territories
The tax home test requires that your principal place of business, or your regular residence if you have no fixed workplace, sit in Puerto Rico for the full year. Keeping an office in a mainland state or working there heavily can shift your tax home back to the U.S.
The closer connection test looks at the pattern of your personal life: where your family lives, where you’re registered to vote, where you hold a driver’s license, where you bank, where you keep belongings, and where your civic and social ties are. No single factor decides it; the picture as a whole has to lean toward Puerto Rico.4Internal Revenue Service. Publication 570 – Tax Guide for Individuals With Income From U.S. Territories
The year you establish or end residency, you must file IRS Form 8898 if your worldwide gross income is $75,000 or more. The penalty for skipping it or filing it incompletely is $1,000 absent reasonable cause.5Internal Revenue Service. Residents of U.S. Territories / Possessions – Form 8898 Bona Fide Residence
Puerto Rico’s Local Income Tax
What the IRS doesn’t collect, Hacienda does. Puerto Rico runs its own graduated income tax with brackets that have been in place since 2018:
- Up to $9,000: 0%
- $9,001 to $25,000: 7% on the amount over $9,000
- $25,001 to $41,500: $1,120 plus 14% on the amount over $25,000
- $41,501 to $61,500: $3,430 plus 25% on the amount over $41,500
- Over $61,500: $8,430 plus 33% on the amount over $61,500
Someone with $80,000 of net taxable income owes $8,430 on the first $61,500 plus 33% of the remaining $18,500, or about $14,535 in local tax. The 33% top rate exceeds the highest income tax rate in most mainland states, and the 25% bracket starts at just $41,500. That’s the tradeoff for the federal exemption: middle and upper earners pay Puerto Rico steeply on income that would be split between the IRS and a state on the mainland.
Individual returns are due to Hacienda by April 15, with an automatic six-month extension available on request. Years with mixed island and mainland income can require two separate returns.
Act 60 Lowers the Local Rate for Some
Puerto Rico’s Incentives Code (Act 60) offers reduced local rates for a narrow set of taxpayers. A Chapter 3 export services decree can drop a qualifying business’s income tax rate to a flat 4% on services provided to clients outside Puerto Rico. Chapter 2 gives new residents a full exemption on dividends, interest, and capital gains that accrue after they become bona fide residents.6Oficina de Gerencia y Presupuesto. Puerto Rico Incentives Code – Act 60-2019
The Chapter 2 exemption comes with real costs: at least $10,000 in annual donations to Puerto Rico nonprofits (with at least $5,000 to certified child-poverty organizations), a required purchase of a Puerto Rico primary residence within two years of the decree, and a $5,000 annual filing fee. Missing the annual compliance report can trigger a $10,000 fine. Gains on assets you owned before moving remain federally taxable when you sell, since only post-residency accrual is exempt.
Payroll and Self-Employment Taxes Still Apply
Federal income tax may drop away, but Social Security and Medicare do not. Puerto Rico employers withhold at the same rates as mainland ones: 6.2% each from employer and employee for Social Security (12.4% total) and 1.45% each for Medicare (2.9% total).7Internal Revenue Service. Topic No. 903, U.S. Employment Tax in Puerto Rico For 2026, Social Security tax applies to earnings up to $184,500.8Social Security Administration. Contribution and Benefit Base
Self-employed island residents owe the full 15.3% combined rate and report it on Form 1040-SS. That filing is required even in years when Section 933 wipes out all federal income tax. Beyond IRS penalties, skipping it can shrink or eliminate your future Social Security retirement benefits and Medicare eligibility, since those programs credit you based on contributions.9Internal Revenue Service. About Form 1040 (PR), Self-Employment Tax Return – Puerto Rico
Sales Tax Runs Higher
Puerto Rico’s sales and use tax, the IVU (Impuesto sobre Ventas y Uso), is 11.5% on most purchases: 10.5% to the central government and 1% to the municipality. Mainland sales taxes generally sit between 4% and 8%, depending on state and locality, so the IVU is a real hit on day-to-day spending.
Unprepared food and food ingredients are generally exempt from the central government’s portion, though municipalities can impose up to 1% on unprepared food through local ordinance.10Department of the Treasury (Puerto Rico). Uniform Sales and Use Tax (SUT) in All Municipalities Prescription medicines and healthcare services are exempt. Prepared food, electronics, clothing, and household goods are fully taxable at 11.5%. Puerto Rico leans hard on consumption tax because there’s no significant federal income tax revenue flowing back to the territory.
Property Taxes Run Much Lower
Property tax is the mirror image of the sales tax comparison. The Centro de Recaudación de Ingresos Municipales (CRIM) assesses real property using a valuation methodology based on 1957 market data, which keeps assessed values far below anything a mainland assessor would produce for a comparable home. Primary residences also qualify for an exemption of up to $15,000 in assessed value, which often zeroes out the bill on modest homes.
Businesses pay a separate municipal license tax (the patente), calculated on prior-year business volume at rates that vary by municipality. Credits may apply for similar taxes paid in other jurisdictions.11Justia Law. Laws of Puerto Rico Title Twenty-One – Computation of License Tax The patente is separate from income tax and applies regardless of any Act 60 decree.
Estate and Gift Tax: The Hidden Trap
This is the piece of the comparison that surprises new arrivals most. Under IRC Section 2209, a U.S. citizen domiciled in Puerto Rico at death is treated as a “nonresident not a citizen” for federal estate tax purposes.12eCFR. 26 CFR 20.2209-1 – Certain Residents of Possessions Considered Nonresident Not a Citizen of the United States The consequence is severe: instead of the $15,000,000 federal estate tax exemption a mainland domiciliary gets in 2026, a Puerto Rico domiciliary receives only $60,000 in exemption against U.S.-situs assets.13Internal Revenue Service. Whats New – Estate and Gift Tax
The estate tax reaches only U.S.-situs assets, meaning stock in U.S. corporations, U.S. real estate, and certain U.S. financial assets. Property located in Puerto Rico, foreign real estate, and life insurance proceeds are generally outside its reach. But someone who keeps a large mainland stock portfolio after moving can face a federal estate tax bill that wouldn’t have existed had they stayed on the mainland.
Lifetime gifts run under a different rule. A Puerto Rico domiciliary can transfer shares of U.S. corporations as gifts during life without triggering federal gift tax, even though the same shares would be taxable at death. That asymmetry makes lifetime gifting a central planning tool. Note that domicile for estate and gift tax purposes (physical presence plus intent to remain indefinitely) is a separate standard from the bona fide residency test used for income tax, so the two statuses don’t always align.
Federal Tax Credits Mostly Don’t Reach Puerto Rico Residents
Because island residents generally don’t file federal income tax returns, most federal credits are unavailable. The federal Earned Income Tax Credit doesn’t apply. The Child Tax Credit is a partial exception: families can claim the refundable Additional Child Tax Credit on Form 1040-SS even without a federal income tax liability, worth up to $1,700 per qualifying child, with eligibility starting at $2,500 in earned income.14Internal Revenue Service. Child Tax Credit
Puerto Rico runs its own local Earned Income Tax Credit through Hacienda, with amounts that vary by filing status and number of dependents. It’s smaller than the federal version available on the mainland but provides some benefit to lower-income working families.
Weighing the Two Systems
Read together, the systems trade off in ways the headline numbers hide. Puerto Rico wins on federal income tax (zero on island earnings) and property tax (very low). The mainland wins on sales tax (typically half the IVU rate or less), on middle-income tax brackets (25% doesn’t start at $41,500 in most states), and on estate tax (a $15,000,000 exemption instead of $60,000 on U.S.-situs assets). Payroll taxes are a wash.
Act 60 decree holders sit in a different position, with a 4% flat rate on export services or an exemption on post-move investment income, but the annual $10,000 donation, $5,000 fee, property purchase requirement, and compliance costs eat into the benefit unless investment or export income is substantial. The residents who come out clearly ahead are those with high investment income, significant export service revenue, or both, and who genuinely relocate rather than treat the move as a paper exercise.