Obtaining an Act 60 decree is the beginning of an ongoing compliance obligation, not the end of a process. Decree holders face reporting requirements at both the federal and Puerto Rico levels. Failure to meet these requirements can result in penalties, loss of decree benefits, or—in the case of a failed residency determination—full federal taxation on previously excluded income.
This article outlines the principal compliance obligations and identifies the patterns that most frequently trigger IRS scrutiny.
Federal Reporting Requirements
Form 8898: Statement for Individuals Who Begin or End Bona Fide Residence in a U.S. Possession
U.S. citizens who establish bona fide residence in Puerto Rico and have worldwide gross income of $75,000 or more must file Form 8898 with the IRS for the year of the move. This form requires disclosure of your date of residency change, your address in the possession, and information relevant to the closer connection factors—including the location of your automobiles, personal documents, investments, and the jurisdiction where you derived the majority of your income.
Failure to file Form 8898 by the due date (including extensions) may result in a penalty of $1,000 per failure. More importantly, timely filing supports your residency position. Failure to file undermines it.
U.S. Federal Income Tax Return (Form 1040)
U.S. citizens who are bona fide residents of Puerto Rico must continue to file a federal income tax return reporting worldwide income. Puerto Rico-source income is excluded under IRC §933, but must still be reported. U.S.-source income—including income from services performed on the mainland, U.S.-source interest, and dividends from mainland corporations—remains fully taxable.
A common misconception is that Act 60 decree holders need not file a federal return. That is incorrect. The filing obligation continues. What changes is the tax treatment of qualifying Puerto Rico-source income.
Puerto Rico Income Tax Return
Bona fide residents must also file a Puerto Rico income tax return reporting Puerto Rico-source income and claiming applicable Act 60 benefits. Coordination between the federal and Puerto Rico returns is essential to avoid double-reporting or inconsistent positions.
Puerto Rico (DDEC) Compliance Requirements
Annual Report
Act 60 decree holders must submit an annual compliance report to the Puerto Rico Department of Economic Development and Commerce (DDEC). This report documents compliance with decree conditions, including residency status, charitable contributions, and—for Chapter 2 (Individual Investor) decree holders—the property purchase requirement.
Charitable Donation Requirement
Chapter 2 decree holders must make an annual charitable donation of $10,000, with at least $5,000 directed to a qualifying Puerto Rico nonprofit organization. This requirement applies each year the decree is in effect. Documentation of the donation—receipts, proof of payment, and confirmation of the recipient organization’s qualifying status—should be maintained.
Property Purchase Requirement
Chapter 2 decree holders must purchase residential property in Puerto Rico within two years of the decree’s effective date and use it as their primary residence. Failure to meet this deadline can jeopardize decree benefits.
Common Audit Triggers and Compliance Risks
The IRS has increased enforcement of possession-residency rules in recent years. The following patterns most frequently attract scrutiny:
Inadequate Physical Presence
The single most common audit issue is failure to satisfy the presence test. The IRS counts days carefully. If your day-count margin is thin—particularly in the year of the move—expect that it will be examined. Contemporaneous day-count logs, supported by travel records, credit card statements, and calendar entries, are essential.
Retained Mainland Home
Maintaining a home in the mainland United States that could be treated as a “permanent home” under the closer connection test is a significant audit risk. A dwelling that is continuously available for your use—whether owned or rented, whether used frequently or not—can constitute a permanent home. Selling, renting out, or otherwise relinquishing the mainland property eliminates this risk factor.
Family Remaining on the Mainland
If your spouse or minor children continue to reside primarily on the mainland, this creates a significant connection to the United States under the presence test’s fifth alternative and weighs heavily against you in the closer connection analysis. While courts have held that a spouse can establish separate residency, the family factor is frequently cited in unfavorable residency determinations.
Mainland Business Operations
Continuing to maintain a U.S. office, performing substantial work on the mainland, or having your principal business operations centered outside Puerto Rico can defeat both the tax home test and the closer connection test. It also raises income sourcing issues, because services income is sourced where performed.
Inconsistent Administrative Ties
Retaining a mainland driver’s license, remaining registered to vote in a U.S. state, keeping primary banking relationships on the mainland, and using mainland professional service providers (doctors, dentists, accountants) all weigh against a bona fide residency finding. The IRS looks at these administrative details closely.
Improper Income Sourcing
Claiming Puerto Rico-source treatment for income that is properly sourced to the United States is a recurring audit issue. The IRS pays particular attention to arrangements where the decree holder’s work patterns suggest substantial mainland activity. The working-days allocation method applies strictly, and poor recordkeeping makes it difficult to defend favorable sourcing positions.
The Importance of Contemporaneous Documentation
Across all of these areas, the common thread is documentation. The IRS will request records of physical presence, business activities, residential arrangements, and community ties. These records must be contemporaneous—created at or near the time of the events they document. Reconstructed records carry less weight and invite skepticism.
At a minimum, Act 60 decree holders should maintain:
- A day-count log tracking presence in Puerto Rico, the United States, and any foreign countries
- Travel records (boarding passes, hotel receipts, passport stamps)
- Business activity records documenting where work is performed on each working day
- Records of community involvement, civic participation, and local memberships in Puerto Rico
- Copies of all filings: Form 8898, federal and Puerto Rico tax returns, and DDEC annual reports
- Documentation of charitable donations, including receipts and confirmation of the recipient’s qualifying status
This article is for educational purposes only and does not constitute legal or tax advice. Individual circumstances vary. Consult a qualified tax attorney before making decisions based on this information.
Riefkohl Law advises Act 60 decree holders on compliance planning, audit preparation, and IRS examination defense. Schedule a consultation to discuss your specific situation.