What investors need to know

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agenices due to tax incentives that have attracted crypto investors and entrepreneursAFP via Getty Images

The IRS has made no secret of the priority the Service has placed on assessing and collecting crypto taxes since BitcoinBTC first made many mainstream investors aware of the sector. Going back to the early days of consumer crypto, the IRS has taken legal action against US exchanges and US branches of international exchanges, seeking more information about certain traders and customers of companies such as Coinbase and Kraken. Following this, the IRS sent thousands of letters to taxpayers requesting (or demanding) more information and payments related to crypto transactions. More recently, the issue of crypto has moved from other places on the 1040 to a prominent place on the personal income tax return; this, in turn, has made crypto tax planning a priority for accounting professionals in recent years.

Even though the regulatory winds appear to be shifting ever so slightly, with a partial victory for Ripple in the XRPXRP case and positive sentiment around several ETF filings that have recently surfaced, the fiscal outlook remains relatively unchanged. Under current tax laws, guidelines, and interpretations, every crypto transaction, including mining, staking, and trading, is taxed either as ordinary income or as capital gains, depending on the relevant holding period. However, for every tax or financial problem, there is almost always a related tax solution.

Puerto Rico, seeking to attract and retain high net worth individuals and taxpayers, has enacted a series of tax incentives, with more than 5,000 individuals and 3,600 businesses having taken advantage of these measures. The program originally began with the Puerto Rican Export Services Law (Law 20) and the Individual Investor Law (Law 22). In 2022, these two laws were consolidated into Law 60. To be of quality, businesses should generate $3 million in revenue and employ at least one Puerto Rican resident. Individuals must purchase a home on the island and donate at least $10,000 to charities.

At first glance, these seem like simple policies, so why is it becoming controversial? Let’s see what’s going on and how it connects to crypto-assets.

What are the problems

While the headlines focus on crypto traders and asset managers who have moved to Puerto Rico, the real issues are explicitly related to tax guidelines and how existing rules are interpreted. The exemptions provided for investors and entrepreneurs include a 100% exemption on dividends, a 60% exemption on municipal taxes and 0% federal taxes on income from the region. From a business perspective, these entities can avoid paying taxes on dividends from income and profits, with only a 4% tax rate applied to exports.

One of the strictest requirements for obtaining these benefits is that 1) taxpayers must be able to prove that they have been registered on the island for 183 days and that the territory is their tax domicile. According to the IRS, a taxpayer’s tax home is the entire city or general area of ​​the taxpayer’s workplace. For investors and entrepreneurs looking to minimize tax liability while remaining relatively local to US markets, this has unsurprisingly proven to be an attractive offering.

As attractive as these tax incentives are for attracting new residents, problems have arisen alongside investor interest in these tax incentives.

Why crypto is in the crosshairs

It is no secret that the crypto-asset sector, as well as companies and investors operating in the space, have found themselves the target of regulations and government agencies around the world. By its very nature, the blockchain and crypto-asset industry is a global business that is not tied to any particular market. Moreover, Puerto Rico is not the only place that has sought to attract some of this capital, both intellectual and financial, through tax and other incentives. These other locations include, but are not limited to, Malaysia, Portugal, and more traditional financial centers such as the Cayman Islands.

However, when it comes to the problems with Act 22, two things seem to be driving this current crackdown. The first is the fact that Puerto Rico has suffered several natural disasters in recent years and the island is still in the process of rebuilding and strengthening infrastructure and the economy in general. The granting of tax breaks to wealthy international residents has sparked protests and legal challenges. Second, these wealthy individuals and corporations have, by virtue of having higher disposable income and much lower taxes, driven up the cost of living for residents, many of whom do not qualify for these tax incentives.

Lying with doubt and suspicion the crypto industry continues to fight, and the recipe for a crackdown is complete.

What Investors Should Consider

Crypto investors should always monitor the evolving regulatory landscape and outlook for specific crypto-assets (as in the Ripple case) and the attitude towards the industry as a whole. What the recent discussion around the tax incentives provided to Puerto Rico proves is that regulators and tax agencies are actively looking for new sources of revenue. For investors and entrepreneurs, whether located in Puerto Rico or other jurisdictions, the following advice continues to apply. Recommendations include, but are not limited to the following 1) always work with a tax professional familiar with the crypto space and the specific tax situation in question, 2) maintain records and documentation for any major tax exclusions that are being sought, and 3) allocate time on a periodic basis to keep abreast of these (sometimes) rapidly evolving changes.

Crypto taxes are always a hot topic, but well-prepared investors can continue to successfully navigate these sometimes turbulent waters.

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I am a professor at City University of New York Lehman College. I sit on the advisory board of the Wall Street Blockchain Alliance, where I chair the accounting working group. I’m also the chair of the NJCPA Emerging Technologies Interest Group (#NJCPATech). I serve on the advisory board of Gilded, a TechStars 19 company and a participant in the AICPA-CPA.com startup accelerator. I was a visiting scholar at the American Institute for Economic Research in 2019.

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