Many Act 60 decree holders focus heavily on satisfying the bona fide residency test—and rightly so. But residency alone does not determine the scope of your tax benefits. The IRC §933 exclusion applies only to income derived from sources within Puerto Rico. Income from sources outside Puerto Rico—including U.S.-source income—remains fully subject to federal income tax, regardless of your residency status.

The sourcing rules that apply to Puerto Rico residents are set forth in IRC §937(b) and Treas. Reg. §1.937-2. These rules apply the general U.S.-source income framework of IRC §§861–865, substituting “Puerto Rico” for “United States.” Understanding how each category of income is sourced is essential to determining the actual tax benefit available to you.

Personal Services Income: Where You Work Is Where It’s Sourced

Compensation for personal services is sourced based on where the services are physically performed. This is the most straightforward rule and, for many Act 60 clients, the most consequential.

If you perform services entirely in Puerto Rico, all resulting compensation is Puerto Rico-source income eligible for the §933 exclusion. If you perform services partly in Puerto Rico and partly in the mainland United States, the income must be allocated between Puerto Rico and non-Puerto Rico sources. The standard allocation method is a time-based approach: the ratio of days worked in Puerto Rico to total days worked.

The practical implication is direct. Every day you spend working on the mainland generates U.S.-source income that is fully taxable under federal law. The §933 exclusion does not apply to that portion. This is true regardless of where your employer or client is located. Being a Puerto Rico resident working remotely for a mainland client generates Puerto Rico-source income only if the work is physically performed in Puerto Rico.

Interest Income

Interest income is generally sourced based on the residence of the obligor—the entity paying the interest. Under Treas. Reg. §1.937-2, interest paid by Puerto Rico obligors is treated as Puerto Rico-source income. Interest from U.S. banks and mainland financial institutions generally remains U.S.-source income.

For Act 60 residents seeking to maximize Puerto Rico-source interest income, using Puerto Rico-based financial institutions for deposits and lending relationships is a relevant structuring consideration.

Dividend Income

Dividend income follows specific rules under the sourcing framework. Dividends from a corporation that derives at least 80% of its gross income from the active conduct of a trade or business within Puerto Rico over a three-year testing period may qualify as Puerto Rico-source income. Dividends from mainland U.S. corporations generally remain U.S.-source.

For Chapter 3 (Export Services) decree holders, distributions from the export service entity to Puerto Rico-resident shareholders are eligible for a 100% tax exemption under Act 60—but only if the underlying business income qualifies and the shareholder satisfies the bona fide residency requirement.

Capital Gains: The Residence-of-Seller Rule

Gains from the sale of personal property are governed by IRC §865. The general rule sources such gains to the seller’s tax residence. For a bona fide Puerto Rico resident, this means gains from the sale of personal property are generally Puerto Rico-source income—a highly favorable result.

However, several important exceptions apply:

Inventory property. Gains from inventory sales are sourced based on where title passes, not the seller’s residence. Inventory attributable to a Puerto Rico office may qualify as Puerto Rico-source under the office rule.

Depreciable property. Gains attributable to depreciation are sourced based on where the depreciation deductions were previously allocated.

Intangible property. Gains from the sale of intangible property that generate contingent payments based on productivity or use are treated as royalties and sourced accordingly—to the location where the intangible is used.

The office attribution rule (IRC §865(e)(2)). This is one of the most significant provisions in the Act 60 context. Gains that are attributable to a fixed place of business (an office) maintained outside the taxpayer’s country of residence are sourced to that office’s location. For Act 60 decree holders, this means that gains attributable to a retained U.S. office may be re-sourced to the United States, removing them from Act 60 benefits entirely. Closing or restructuring any mainland U.S. office is a critical compliance step.

Rental and Royalty Income

Rental income follows the situs of the property. Rents from Puerto Rico real property are Puerto Rico-source income. Rents from mainland U.S. real property are U.S.-source income. Royalties for the use of intangible property (patents, copyrights, trademarks) are sourced to the location where the intangible is used.

Mixed-Source Income

IRC §863 provides allocation rules for income derived partly from sources within and partly from sources outside Puerto Rico. This includes income from services performed in multiple jurisdictions and income from the production and sale of inventory across borders. For these mixed-source items, income is apportioned based on production activities or other prescribed methods.

Summary: Sourcing by Income Type

Why Sourcing Compliance Matters

Claiming Puerto Rico-source treatment for income that is properly sourced to the United States is a common compliance risk. The IRS has demonstrated particular interest in arrangements where Act 60 decree holders continue to perform substantial work on the mainland while treating the resulting income as Puerto Rico-source. The working-days allocation applies strictly. Income attributable to U.S. working days is U.S.-source income—regardless of where the employer or client is located, regardless of where the contract was signed, and regardless of where payment is received.

Act 60 residents should maintain detailed, contemporaneous records of where work is performed, including calendars, travel records, and project logs. These records should be created in real time, not reconstructed after the fact.

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 income sourcing analysis, compliance planning, and IRS examination defense. Schedule a consultation to discuss your specific situation.