The time may be ripe for testing the decades old interpretation of the U.S. Internal Revenue Code of 1986, as amended, ( U.S.-IRC ) as imposing U.S. estate tax liability for property located in Puerto Rico if the Puerto Rico resident was born in the United States.
An increasing number of persons who have lived most of their lives in Puerto Rico and who are the descendants of native-born Puerto Ricans face the prospect of significant U.S. estate tax liability due to an accident of circumstance, namely having been born in one of the fifty states of the United States, the District of Columbia or in a foreign country while their parents were studying, traveling or working abroad.
Being born outside of Puerto Rico or another U.S. possession has significant estate tax consequences for Puerto Rico residents that are U.S. citizens. While native-born Puerto Ricans residing in Puerto Rico are not subject to any local or U.S. estate tax on property within Puerto Rico , pursuant to Sections 2208 and 2209 of the U.S.- IRC, residents of Puerto Rico born in the United States are treated as all other citizens of the United States and as a result are subject to the U.S. estate tax of up to 55% on all of their property world-wide, including property located in Puerto Rico. Thus, generally, native- born Puerto Ricans may completely shield their estate from U.S. and Puerto Rico estate taxes to the extent it is invested in property within Puerto Rico, while United States born Puerto Ricans may not. Of course, native born Puerto Ricans are subject to estate taxes for property located in the United States (as any other person owning property located in the United States) or elsewhere. A review of the relevant US- IRC sections and regulations, Congressional legislative history and IRS Private Rulings indicate that this result may not have been intended by Congress and that there may be room for a more liberal interpretation of Sections 2208 and 2209 of the US-IRC. The intent of Congress was to prevent wealthy United States citizens with no connection to its possessions from changing their residence in order to avoid U.S. estate taxes, and not to penalize Puerto Ricans born outside of Puerto Rico.
Prior to the enactment of Sections 2208 and 2209 of the US-IRC, the U.S. estate tax was applicable to residents and citizens of the United States. A series of Tax Court rulings held that, given the special protection afforded Puerto Rico residents from U.S. taxes by Congress, the quoted language was not sufficient to impose any federal estate taxes on Puerto Rico residents, absent a more specific mandate from Congress. As an IRS memorandum noted, The loophole created by these decisions was a serious one. A United States citizen could prevent the application of the estate tax to unlimited wealth in the United States, including real property situated in the United States, by simply establishing his domicile in Puerto Rico, or any other possession, a short time before his death. Consequently, corrective legislation soon followed.
The corrective U.S. legislation established that for purposes of the U.S. estate tax a citizen of the United States who is also a resident of one of its possessions would be subject to U.S. estate tax on his worldwide properties (including Puerto Rico properties), unless he acquired his United States citizenship solely by reason of (1) his being a citizen of such possession of the United States, or (2) his birth or residence within such possession of the United States. The IRS reasoned that a child born in the United States of persons born in Puert Rico acquired his citizenship from his birth in the United States and is therefore subject to U.S. estate tax liability.
Certain private rulings, however, have indicated a willingness by the IRS to consider persons born outside both the United States and its possessions, whose parents were born or naturalized in Puerto Rico, as having acquired their U.S. citizenship solely from their parents Puerto Rico citizenship or Puerto Rico naturalization. These persons have therefore been deemed not subject to U.S. estate tax on their property within Puerto Rico if at the time of death they reside in Puerto Rico. Because the purpose of Sections 2208 and 2209 is to prevent wealthy Americans whose origins are not in a U.S. possession from avoiding U.S. tax. The IRS has already recognized that a taxpayer s citizenship need not be derived solely from being citizen of a U.S. possession or his birth or residence in a U.S. possession. The time may have come for the IRS to consider ruling that persons born in the United States by happenstance of Puerto Rican parents and that have established long-term residence in Puerto Rico have acquired U.S. citizenship from their parents Puerto Rico citizenship or Puerto Rico birth. These persons would be deemed subject to U.S. estate tax on exclusively for property located in the United States or elsewhere, not for property located in Puerto Rico.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.