What Triggers an IRS Act 60 Audit: The 7 Red Flags

The IRS is not auditing Act 60 decree holders at random. It is running a structured, centralized enforcement campaign with dedicated examiners, cross-referenced data sources, and a growing body of case law that gives agents a detailed playbook for challenging decree holders. If you hold an Act 60 decree, understanding what draws IRS attention is not optional — it is the first step in protecting yourself.

This post identifies the seven most common triggers that lead to an IRS examination of Act 60 decree holders, explains what the IRS looks for in each area, and addresses why the type of professional you work with during an audit matters more than most people realize.

Why the IRS Is Targeting Act 60

The IRS did not stumble into Act 60 enforcement. It built a dedicated infrastructure for it.

The Campaign Audit Initiative

In 2021, the IRS Large Business and International Division (LB&I) formally designated Puerto Rico tax incentive compliance as a campaign issue. This is significant. Campaign designation means the IRS has assigned centralized leadership, developed training materials specific to Act 60, and staffed the effort with examiners who specialize in residency and income sourcing issues. These are not generalist auditors working through a checklist. They are trained to find the specific vulnerabilities that Act 60 positions create.

Campaign audits also mean the IRS is selecting returns proactively rather than waiting for anomalies to surface through ordinary processing. The agency uses data analytics, third-party information returns, and inter-agency coordination with the Puerto Rico Department of Treasury to identify audit targets.

The December 2025 GAO Report

In December 2025, the Government Accountability Office published a report evaluating IRS oversight of Puerto Rico tax incentive programs. The GAO concluded that the IRS lacked sufficient data-sharing agreements with Puerto Rico, had limited visibility into decree holder compliance, and recommended enhanced oversight mechanisms. While the report acknowledged resource constraints, its recommendations pointed toward more audits, not fewer.

For decree holders, the GAO report is a warning. Congressional attention to Act 60 compliance creates institutional pressure on the IRS to demonstrate enforcement results. That pressure translates directly into more examinations.

The Gajwani Case and Criminal Enforcement

The Gajwani case demonstrated that the IRS is willing to pursue criminal prosecution against Act 60 participants. The case involved allegations that a decree holder claimed Puerto Rico residency while maintaining significant mainland ties and mischaracterized income sourcing. It sent a clear message to the Act 60 community: the IRS treats these cases as potential fraud matters, not mere compliance disagreements.

With over 100 criminal investigations of Act 20/22/60 participants reported by IRS Criminal Investigation, the stakes extend well beyond back taxes and interest.

The 7 Red Flags That Trigger an Act 60 Audit

1. Income Sourcing Errors

This is the single most common trigger and the issue where the IRS has the most success in adjustments.

Act 60 benefits apply only to Puerto Rico-sourced income. The IRS examines whether income you reported as Puerto Rico-sourced was actually earned through activities performed in Puerto Rico. For service income, the controlling factor is where the services were physically performed. For business income, the analysis depends on where the income-generating activities occur.

What the IRS looks for: The IRS reviews client contracts to determine where work is delivered. It examines email metadata and calendar entries showing meetings with mainland clients. It looks at whether your business has mainland employees or contractors performing work that generates the income you claimed as Puerto Rico-sourced. If you run a consulting business and your largest clients are in New York, the IRS will want to see evidence that you performed those services from Puerto Rico, not during trips to the mainland.

Cryptocurrency and digital asset businesses present particular sourcing challenges, which are addressed separately below.

2. Insufficient Presence Days

The physical presence test under IRC Section 937 requires that you be present in Puerto Rico for at least 183 days during the tax year. The IRS counts days with precision, and it has access to data sources that most decree holders underestimate.

What the IRS looks for: The IRS obtains flight records through summonses to airlines and travel booking platforms. It cross-references credit card and debit card transaction data to determine where you were making purchases on specific dates. Cell phone location data, obtained through legal process, can place you geographically on any given day. Passport stamps, Global Entry records, and TSA PreCheck data all feed into the analysis.

The IRS also looks at negative indicators — evidence that you were somewhere other than Puerto Rico. School enrollment records for your children on the mainland, medical appointments on the mainland, and attendance at mainland events all count against your presence claim.

If your travel logs show 185 days in Puerto Rico but your credit card shows regular charges in Miami during days you claimed to be on the island, you have a problem that no amount of documentation will resolve.

3. Maintaining Mainland Ties

Even if you pass the 183-day presence threshold, the IRS examines the closer connection test separately. This test evaluates where your deeper personal and economic ties are located. Maintaining significant connections to the mainland can defeat your residency claim even with adequate presence days.

What the IRS looks for: The IRS examines whether you retained a mainland home (owned or rented), maintained mainland bank accounts as your primary accounts, kept your mainland driver's license, remained registered to vote on the mainland, maintained club or organization memberships on the mainland, kept your children enrolled in mainland schools, or stored your most valuable personal property (art, vehicles, jewelry) on the mainland.

No single factor is dispositive, but the cumulative picture matters. A decree holder who spends 200 days in Puerto Rico but keeps a Manhattan apartment, votes in New York, belongs to a Manhattan social club, and stores a car collection in New Jersey is going to face a difficult closer connection argument regardless of the day count.

4. Inconsistent Tax Positions

The IRS compares your federal return with your Puerto Rico return and with information returns filed by third parties. Inconsistencies between these documents are among the easiest triggers for the IRS to identify because they surface through automated matching programs.

What the IRS looks for: If a mainland brokerage reports income on a 1099 that does not appear on your federal return, the IRS will investigate whether you improperly excluded it as Puerto Rico-sourced. If your Puerto Rico return claims income that does not align with what third parties reported, the discrepancy generates a flag. If you claimed a deduction on your federal return that contradicts a position you took on your Puerto Rico return — for example, claiming a home office deduction for a mainland property while simultaneously claiming your tax home is Puerto Rico — the inconsistency invites examination.

The IRS also compares year-over-year returns. A sudden, dramatic shift in income sourcing in the year you obtained your decree — particularly if the underlying business did not change — is a reliable audit trigger.

5. Cryptocurrency and Digital Asset Gains

The IRS has identified cryptocurrency as a particular area of concern for Act 60 decree holders. Some decree holders have taken the position that gains from cryptocurrency trading are Puerto Rico-sourced because the trades were executed while physically in Puerto Rico.

What the IRS looks for: The sourcing of cryptocurrency gains is a developing area of law, and the IRS has taken aggressive positions. The agency examines when cryptocurrency was acquired (before or after establishing Puerto Rico residency), whether the gains represent appreciation that accrued while the taxpayer was a mainland resident, and whether the trading activity constitutes a business with mainland connections.

Gains on cryptocurrency acquired before establishing bona fide Puerto Rico residency are particularly vulnerable. The IRS position is that appreciation accruing before the residency move is not Puerto Rico-sourced, even if the asset is sold after the move. This issue has generated significant litigation and is an area where the IRS is actively building case law.

6. Large Capital Gains in the Year of the Move

Decree holders who realize substantial capital gains in the same year they relocate to Puerto Rico attract heightened scrutiny. The timing raises an obvious question: did the taxpayer move to capture a specific tax benefit on a planned transaction?

What the IRS looks for: The IRS examines the timeline between obtaining the decree, establishing residency, and realizing the gain. It looks at whether the asset was held long-term or acquired shortly before the move. It investigates whether negotiations for the sale began before the move. If you sold a mainland business for $20 million six months after obtaining your Act 60 decree, the IRS will conduct a thorough examination of your residency establishment and the sourcing of that gain.

The IRS also examines whether the gain is properly sourced. Selling a mainland business does not automatically generate Puerto Rico-sourced income simply because the seller now resides in Puerto Rico. The sourcing rules for business dispositions are complex and depend on the nature of the assets being sold.

7. Failure to File Form 8898

Form 8898 (Statement for Individuals Who Begin or End Bona Fide Residence in a U.S. Possession) is required when you establish bona fide residency in Puerto Rico. Many decree holders either fail to file this form entirely or file it late.

What the IRS looks for: The absence of Form 8898 is a simple, binary flag. Either you filed it or you did not. Failure to file does not automatically trigger an audit, but it is one of the data points the IRS uses in its selection algorithms. It also creates an adverse inference — if you did not notify the IRS of your residency change as required, the IRS may question whether you actually established residency at all.

Filing Form 8898 late, while better than not filing at all, still generates a record that the IRS can use. Combined with other indicators, a missing or late 8898 contributes to the overall risk profile that triggers examination.

Why Attorney-Client Privilege Matters During an Audit

Most Act 60 decree holders work with CPAs for their tax preparation and compliance. CPAs are competent professionals who serve an essential role. But when an audit begins, the type of professional you work with has a legal consequence that many people overlook.

The Privilege Gap

Communications between a client and an attorney are protected by attorney-client privilege. This is a robust, well-established legal protection. If you tell your attorney that you spent 160 days in Puerto Rico rather than the 183 you claimed, that communication is privileged. The IRS cannot compel your attorney to disclose it.

Communications with a CPA receive a much narrower protection under IRC Section 7525. That protection applies only to tax advice in noncriminal proceedings before the IRS or in federal court. It does not extend to criminal matters. It does not apply to tax return preparation. And it does not apply in many state proceedings.

Given that the IRS has opened over 100 criminal investigations of Act 60 participants, the distinction between full attorney-client privilege and the limited CPA privilege is not academic. If your audit escalates to a criminal referral, conversations you had with your CPA may be discoverable. Conversations with your attorney are not.

The Practical Implication

This does not mean you should replace your CPA with an attorney for all tax matters. It means that when an audit begins — or better yet, before one begins — you should have legal counsel involved in your response strategy. Your attorney and CPA can work together, with the attorney directing the engagement to preserve privilege protections over the audit strategy and sensitive communications.

For a deeper discussion of how legal counsel and CPAs collaborate during Act 60 compliance matters, see our guide on Act 60 tax incentive planning.

What to Do If You Recognize These Triggers

If any of the seven triggers described above apply to your situation, you are not necessarily facing an audit. But you are in a higher-risk category, and proactive steps now can significantly improve your position if an examination does occur.

The most important step is to ensure your documentation supports your residency and income sourcing positions before the IRS asks for it. Building a comprehensive presence test file, maintaining clean income sourcing records, and having an attorney review your overall compliance posture are practical measures that pay dividends under examination.

For decree holders who have not yet addressed their estate planning in conjunction with their Act 60 compliance, doing so ensures that the tax benefits you are working to protect are preserved across generations.

Protect Your Act 60 Benefits

The IRS enforcement campaign targeting Act 60 decree holders is not slowing down. Understanding what triggers an audit is the first step. The next step is making sure your documentation and compliance posture can withstand examination.

Schedule a free strategy call with Riefkohl Law to assess your audit risk profile and develop a defense strategy tailored to your specific situation.

Hans E. Riefkohl Riefkohl Law | San Juan, Puerto Rico Phone: (787) 236-1657 Email: hans@riefkohllaw.com

Attorney-client privilege applies to all consultations. Your information is protected from the first conversation.