Sección en Inglés Taxation of federal employees in Puerto Rico By German Ojeda, CPA Like any other resident of Puerto Rico, federal employees are subject to local income taxation on their worldwide income. However, unlike other bona fide residents of Puerto Rico, federal employees must file a US income tax return, even if their wages are from sources within Puerto Rico. Puerto Rico income taxation A federal employee who is a resident of Puerto Rico will be subject to local income taxation on all of his income, including 100% of his wages, regardless of its source. Similarly, a federal employee resident in Puerto Rico will be able to claim all the itemized deductions granted by the 2011 Puerto Rico Internal Revenue Code, as amended (the “PRIRC”). Said resident taxpayer is also entitled to claim the personal exemption according to his/ her filing status and the exemption for qualifying dependents. One particular item of interest to federal employees is the potential local income taxation of the “cost of living allowance” (COLA) benefit. The COLA benefit represents a special item of the federal employee’s overall compensation intended to compensate those employees stationed in certain “high-cost” locations. As a general rule, the COLA benefit is exempted from local income taxation, up to the amount that is exempted from the income tax imposed by the United States Internal Revenue Code of 1986, as amended (the “USIRC”), provided that evidence of the amount received during the taxable year accompanies the Puerto Rico individual income tax return (normally achieved by attaching a copy of the federal W2 form). Further, if the taxpayer has not complied with his/her tax responsibilities during the four (4) years preceding that of the income tax return being filed, the exclusion from gross income of the COLA benefit may be revoked or denied by the Secretary of the Treasury of Puerto Rico. Even though the COLA is generally not subject to regular income taxation as indicated above, this benefit is now subject to the alternate basic tax provisions of the PRIRC. Since the wages paid to federal employees resident in Puerto Rico are normally subjected to local income tax withholding, the income tax withheld throughout the year from the employee’s compensation may be claimed as a credit against the determined Puerto Rico income tax liability.
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EL CPA • FEBRERO 2012
US income taxation Another very important element of a federal employee’s tax responsibilities is that he/she must file a federal income tax return even though all of his/her income is from sources within Puerto Rico and, thus, otherwise excludable from federal income taxation pursuant to the provisions of Section 933 of the USIRC. Provided there is no taxable non-Puerto Rico source income, this US income tax return will normally be an informational tax filing, upon which no tax is due. This is as a result of the foreign tax credit that may be claimed for the taxes paid in Puerto Rico on the wages being reported in both the Puerto Rico and the United States income tax returns. In this US individual income tax return that must be prepared and filed by the federal employee, he/ she must report all non-Puerto Rico source income (as well as all the wages earned as a federal employee) and must exclude all income from sources within Puerto Rico. As a result, when claiming either the standard or itemized deductions, these must be allocated based on the proportion that each type of income (includable vs. excludable) bears to the total income. The personal exemption, as well as the exemption for dependents, is not subject to allocation. Summary In sum, a federal employee who is a bona fide resident of Puerto Rico for the entire taxable year will be subject to local income taxation on his/her worldwide income just like any other bona fide resident of Puerto Rico. The COLA benefit, although generally not subject to the regular income tax provisions, may be subject to income taxation through the alternate basic tax. In addition, federal employees are required to file an individual income tax return with the United States even if they are bona fide residents of Puerto Rico and their compensation is for services rendered within Puerto Rico. Notwithstanding the requirement to file a US individual income tax return, a federal employee resident of Puerto Rico will be able to claim a foreign tax credit against the US tax liability which should generally offset the total US tax and result in no balance of tax due with the US income tax return. Mr. Ojeda is Senior Manager, Ernst & Young Puerto Rico