At a glance
- A Chapter 3 decree fixes Puerto Rico’s income tax on net export services income at 4%, and distributions of that income to the owners are 100% exempt from Puerto Rico income tax.
- A new small or medium business, averaging $3 million or less of gross income over the three preceding years, pays 2% for the first five years and 4% after that.
- The decree is an instrument of Puerto Rico law and does nothing about federal tax. A Puerto Rico LLC is taxed as a corporation by default on both sides, and electing out of that default costs $30,912 of self-employment tax on $300,000 of profit.
- The term is 15 years, extendable by another 15. The services have to carry no connection to Puerto Rico, and that is the condition that fails.
Chapter 3 of Act 60 is the part of the statute that moves a business rather than a portfolio. A consultancy, a software shop, a design studio, an advisory practice, a shared service center: any of them can hold a decree that fixes Puerto Rico’s income tax on the net income from services billed off the island at 4%, and then exempts what the owners take out of it. Fifteen years, extendable to thirty.
What the decree does not do is the part that costs people money, and it is not a small part. A decree is an instrument of Puerto Rico law. It has no effect whatever on the Internal Revenue Code, and one federal tax — the one nobody budgets for — can reach this income however solid the residency is. Whether it does turns on an election that is usually made without anybody being asked about it, rather than on anything the Department of Economic Development and Commerce writes into the decree.
What the 4% applies to, and the rate underneath it
Section 2032.01(a) of Act 60 imposes a fixed preferential income tax rate of four percent on net income from export services and promoter services, in place of any other income tax imposed by Puerto Rico. Section 2032.01(e)(1) then takes the money out again on the way to the owners: shareholders, partners and members are not subject to Puerto Rico income tax on dividends or profit distributions made out of that income, and the distribution is kept out of the alternative minimum tax computation as well.
There is a lower rate underneath that one — most summaries of the statute leave it out — and it changes the arithmetic for a smaller firm. A new small or medium business, defined in the incentives regulation as one averaging $3 million or less of gross income over the three preceding years with no more than 500 employees, pays 2% for the first five years of the decree and 4% for the remainder. Everything turns on the word new. A practice that has been billing mainland clients from San Juan for a decade does not become a new business by applying for a decree.
| Benefit under the decree | Volume over $3 million | New business, $3 million or less |
|---|---|---|
| Income tax on net export services income | 4% | 2% for five years, then 4% |
| Distributions of that income to owners | 100% exempt | 100% exempt |
| Personal and real property tax | 75% exempt | 100% for five years, then 75% |
| Municipal license tax | 50% exempt | 100% for five years, then 50% |
| Employees required in Puerto Rico | One, full time | None |
| Decree term | 15 years, plus 15 | 15 years, plus 15 |
The one full-time employee may be the owner, and the condition attaches to a projected or actual annual volume of business above $3 million.
What this looks like on an actual return
If you read nothing else here, read this. Left alone the structure costs $12,000. An election made for administrative convenience costs $42,912.
A Puerto Rico limited liability company is taxed as a corporation by default, on both sides. For Puerto Rico income tax it is a corporation under the Puerto Rico Code unless it files Form SC 6045 with a timely return. For federal purposes it is a foreign eligible entity all of whose members have limited liability, which under Reg. 301.7701-3(b)(2)(i)(B) makes it an association taxable as a corporation unless a Form 8832 says otherwise. Left alone, it is a corporation twice over.
So the table below is not a choice between two structures. It is the difference between leaving the default alone and electing out of it, which is done often enough — usually so that a single owner files one return instead of two. Same facts on both sides: a bona fide resident of Puerto Rico, $300,000 of net profit from services billed to clients on the mainland, the work performed on the island, all of it inside a Chapter 3 decree.
| On the return | Taxed as a corporation | Elected pass-through |
|---|---|---|
| Net export services income | $300,000 | $300,000 |
| Puerto Rico income tax at 4% | $12,000 | $12,000 |
| US federal income tax, after section 933 | $0 | $0 |
| Self-employment tax | — | $30,912 |
| Total tax on $300,000 | $12,000 | $42,912 |
Electing out costs $30,912 a year on identical facts, or 10.3 cents of every dollar of profit, which is more than twice what Puerto Rico charges for the decree itself. The arithmetic is ordinary: net earnings from self-employment are 92.35% of $300,000, or $277,050; Social Security takes 12.4% of the first $184,500, which is $22,878; Medicare takes 2.9% of the whole $277,050, which is $8,034. Section 1402(a)(6) is what brings the income within reach, and the decree has nothing to say about it.
The one-line version. Section 933 takes this income out of the federal income tax. It does not take it out of Social Security and Medicare. Figures are illustrative and rounded.
The left-hand column is not free either. A corporation keeps its own books and files its own Puerto Rico return, and a salary paid out of it is ordinary Puerto Rico income at regular individual rates rather than 4% income, with Social Security and Medicare withheld on it exactly as they would be in Ohio. That is a compliance cost and a wage cost; it is not a tax on the profit, and it is what the election is usually made to avoid. The election replaces it with something considerably more expensive. This is the mirror image of the choice between an LLC and an S corporation on the mainland, where the election is the thing that saves employment tax. Here the election is the thing that creates it.
The services cannot have a connection to Puerto Rico
This is the eligibility condition, and it is the one people misread. Section 2031.01 lists nineteen categories of eligible service: research and development, advertising and public relations, economic and environmental and technological consulting, creative industries, engineering and architecture, legal and accounting and tax services, centralized management, electronic data processing and software development, telecommunications and call centers, shared service centers, education and training, medical and laboratory services, investment banking. The list is generous. The restriction attached to it is not.
Services qualify only where they have no nexus with Puerto Rico, and the statute says what a nexus is. A service is outside the decree where it relates to a business activity carried on in Puerto Rico, where it advises on Puerto Rico law or regulation, where it involves lobbying the Puerto Rico government, or where it concerns the sale of property for use on the island. Read plainly: the clients are somewhere else and their business is somewhere else. A consultant who moves to Dorado and keeps a local client list has an eligible business for part of the work and an ineligible one for the rest — the statute contemplates exactly that, and requires separate accounting so that the exempt income, with its costs and expenses, can be identified on its own.
Two structural conditions sit alongside it. The business needs a bona fide office or establishment in Puerto Rico, which is a real place and not a registered agent’s address. Above $3 million of annual volume of business it needs one full-time employee resident on the island, and that employee may be the owner.
What the decree does not reach
Four things, in the order they cause trouble.
- Federal income tax, unless you are a bona fide resident. Section 933 excludes income from sources within Puerto Rico from federal gross income, and only for a bona fide resident of Puerto Rico as section 937(a) defines one. Services performed on the island are Puerto Rico source, and a distribution of that income is Puerto Rico source under Reg. 1.937-2(b), so for a bona fide resident the exclusion carries the whole structure. For someone who has not cleared the presence, tax home and closer connection tests, none of it applies, which is why the three residency tests matter more than the decree does.
- Self-employment tax, wherever the income is not inside a corporation. Section 1402(a)(6) leaves no room: a resident of Puerto Rico computes net earnings from self-employment “in the same manner as a citizen of the United States but without regard to section 933.” Publication 570 puts it in plainer words, that a self-employed bona fide resident of a territory owes the tax on net earnings of $400 or more whether or not those earnings are excludable from gross income. A corporation has no net earnings from self-employment, which is why the default structure never meets this. A decree held by an individual, by a partnership, or by an entity that elected out of the default does.
- The controlled foreign corporation rules, for an owner who stays on the mainland. A corporation organized in Puerto Rico is a foreign corporation for federal purposes, because section 7701(a)(9) defines the United States geographically as the States and the District of Columbia and section 7701(a)(4) defines a domestic corporation by reference to it. Reg. 301.7701-2(b)(8)(i) then lists “Puerto Rico, Corporation” among the entities treated as corporations per se, so there is no election that changes it. A US person who owns one without being a bona fide resident of Puerto Rico owns a controlled foreign corporation — with everything that follows from that. The 4% is real; the federal bill is unchanged.
- Work performed off the island. Source follows where the services are performed. Three weeks billed from a client’s office in Chicago are not Puerto Rico source, and they do not become Puerto Rico source because the entity holding the contract has a decree.
The limitation that catches a business already operating there
Section 2032.01(d) is four lines long, easy to skim past, and it decides whether a decree is worth applying for at all. A business already rendering export services from Puerto Rico before its decree was granted gets the 4% rate only on the increase in net income above a base period measured on the three preceding years. The established portion of the income stays where it was, on ordinary rates.
The provision does exactly what it was written to do. The incentive exists to bring activity to the island, not to re-paper the activity already sitting there. For an established firm the question is therefore not how much of the profit gets 4% treatment but how much of the profit is growth — two very different numbers on the same return.
What it costs to keep the decree
| Obligation | When | What it costs |
|---|---|---|
| Annual decree compliance report to the DDEC | Every year | $500 filing fee |
| Exempt business return, Form 480.30(II) | Every year, to Hacienda | Preparer time |
| Municipal license tax on the exempt volume | Every year | Half the ordinary patente |
| Personal and real property tax | Every year | A quarter of the ordinary bill |
| One full-time employee, above $3 million | Continuing | Payroll |
The $5,000 filing fee and the $10,000 annual donation that come up in every Act 60 conversation belong to the Chapter 2 individual resident investor decree, not to this one. Fee schedules sit in regulation and are revised periodically, so treat the figures as current rather than permanent.
The annual report is the obligation that ends decrees, and it ends them quietly. Nothing arrives in the mail; the decree simply stops being in good standing, and the discovery usually comes years later when somebody asks for a certificate of compliance. The filing dates, fees and penalty ladder are worth reading once, in advance, rather than at the point somebody needs the certificate. Anyone still weighing an application should also note the December 2026 deadline sitting over the current terms.
What to do about it
- Leave the default alone unless somebody has priced the alternative. A Puerto Rico LLC is a corporation on both sides until an election says otherwise. Those elections are Form 8832 federally and Form SC 6045 in Puerto Rico, the second due with a timely return, and neither is a formality.
- Run the client list against the nexus rule. Not the whole list at once. Client by client, asking where the client’s business is carried on, and flagging anything that touches Puerto Rico property, Puerto Rico law or a Puerto Rico government body.
- Decide whether you are a new business or an existing one before modeling anything, because section 2032.01(d) changes the base the 4% applies to.
- Price the compliance honestly. Two sets of books, two returns, a payroll if the volume requires one, and a Puerto Rico preparer alongside the federal one.
- Model both sides in one place. A Puerto Rico projection that ignores self-employment tax, and a federal projection that ignores the decree, will each look fine on their own and will disagree with the return.
Frequently asked questions
Does the 4% rate replace my US federal tax?
No. The decree is a Puerto Rico instrument and reaches Puerto Rico tax only. What removes the federal income tax is section 933, which excludes Puerto Rico source income from gross income for a bona fide resident of Puerto Rico. Services performed on the island are Puerto Rico source and the distribution of that income is Puerto Rico source under Reg. 1.937-2(b), so for a bona fide resident the two work together. For anyone who is not a bona fide resident, the 4% is not a saving at all — it is an additional tax.
Should my Puerto Rico LLC elect to be taxed as a partnership or a disregarded entity?
Usually not, and it is worth asking out loud rather than leaving to whoever forms the company. A Puerto Rico LLC is taxed as a corporation by default on both sides: for Puerto Rico income tax under the Puerto Rico Code unless Form SC 6045 is filed with a timely return, and federally under Reg. 301.7701-3(b)(2)(i)(B), because all of its members have limited liability. The election is normally made so that a single owner files one return instead of two. On $300,000 of profit, filing one return instead of two costs $30,912 of self-employment tax.
Can my business get the 2% rate?
Only if it is a new small or medium business: averaging $3 million or less of gross income over the three preceding years, with no more than 500 employees. It runs for the first five years of the decree, then 4% for the remainder. The same status carries a full property tax and municipal license tax exemption for those five years.
Do I have to hire anyone in Puerto Rico?
Only above $3 million of projected or actual annual volume of business, and then it is one full-time employee resident on the island, who may be the owner. Below that threshold there is no employment requirement. There is still a requirement for a bona fide office or establishment on the island, which is a separate condition and a real one.
Can I keep serving my Puerto Rico clients?
You can serve them; that income is simply outside the decree. Services that relate to a business activity carried on in Puerto Rico, that advise on Puerto Rico law, that involve lobbying the Puerto Rico government or that concern property for use on the island all have a nexus with Puerto Rico and are not export services. The statute contemplates a business doing both and requires separate accounting so the exempt income, with its costs and expenses, can be identified on its own.
I already run my business from Puerto Rico. Is a decree worth applying for?
Sometimes, but not on the arithmetic most people expect. Section 2032.01(d) limits the benefit for a business that was already rendering export services from Puerto Rico to the increase in net income over a base period measured on the three preceding years. If the business is flat, the decree may apply to very little of it. If it is growing quickly, the calculation looks quite different.
How long does the decree last, and can it be lost?
Fifteen years, extendable by a further fifteen. It can be lost, and the common route is administrative rather than dramatic: the annual compliance report is not filed, the decree stops being in good standing, and nobody notices until a certificate of compliance is needed for a sale, a lender or a renewal.
Do I need a Chapter 2 decree as well?
They answer different questions. Chapter 3 covers the business and its distributions; Chapter 2, the individual resident investor decree, covers an individual’s interest, dividends and capital gains from investments. An owner whose money is all in the operating business may need only Chapter 3. An owner with a portfolio alongside it is looking at two decrees, two sets of conditions and two annual reports.
Related reading
- Puerto Rico Act 60: a US tax guide, for how the chapters fit together.
- The Chapter 2 individual resident investor decree, which covers investment income rather than a business.
- The three bona fide residency tests, which decide whether section 933 is available at all.
- The annual decree report: dates, fees and what happens when one is missed.
- Puerto Rico tax against US tax, side by side.
Talk to us before you apply
The decree application is the easy part. The parts that decide whether it was worth doing are the entity, the client list and the base period — all three cheaper to get right before the filing than after it. The firm handles the Puerto Rico and federal sides together, so nothing falls into the gap between two preparers.
Sources. The 4% rate, the limitation for an existing Puerto Rico business and the exemption for distributions are section 2032.01 of Act 60, subsections (a), (d) and (e)(1). Eligibility, the nineteen service categories and the nexus rule are section 2031.01. The 2% rate and the enhanced property and municipal exemptions for a new small or medium business are the PYMES subchapter, and the definition of that status is article 1020.01(a)(61)-1 of the incentives regulation. The 50% municipal license exemption over a fifteen-year period is section 2032.04. On the federal side: section 933, section 1402(a)(6), section 7701(a)(4) and (a)(9), Reg. 1.937-2(b) and Publication 570. Entity classification is Reg. 301.7701-3(b)(2)(i), which makes a foreign eligible entity whose members all have limited liability an association taxable as a corporation; Reg. 301.7701-5(a) for why an entity organized in Puerto Rico is foreign; and Reg. 301.7701-2(b)(8)(i), which lists a Puerto Rico corporation among the corporations per se. The Puerto Rico default and the Form SC 6045 election sit in the Puerto Rico Internal Revenue Code of 2011; disregarded entities were first recognized there by Act 52-2022. The 2026 Social Security wage base of $184,500 is from IRS Publication 15. The exempt business return is Form 480.30(II). Figures in the tables are illustrative and rounded, and a specific decree’s own conditions govern over any general description of the program.
