AN OVERVIEW OF THE SPECIAL TAX RULES …

1 AN OVERVIEW OF THE SPECIAL TAX RULES RELATED TO PUERTO RICO AND AN ANALYSIS OF THE TAX AND ECONOMIC POLICY IMPLICATIONS OF RECENT LEGISLATIVE OPTIONS _____ Prepared by the Staff of the JOINT COMMITTEE ON TAXATION June 23, 2006 JCX-24-06 i Contents Page INTRODUCTION .. 1 I. EXECUTIVE SUMMARY .. 2 A. B. OVERVIEW of the Tax and Non-Tax RULES Related to 2 C. SPECIAL Tax RULES Related to Puerto Rico .. 3 D. Statehood, Commonwealth, and Independence Status .. 5 E. Economic Analysis.

2 5 F. Legislative Options .. 6 II. PRESENT LAW TAX PROVISIONS RELATED TO PUERTO RICO AND OTHER POSSESSIONS .. 13 A. OVERVIEW of Tax Provisions Relating to Puerto 13 1. In general .. 13 2. Taxation of individuals .. 13 3. Taxation of corporations .. 17 4. Employment 18 5. Excise 19 6. Taxation of Puerto Rico obligations .. 20 7. Low-income housing credit .. 20 8. Tax 21 B. OVERVIEW of Puerto Rico Tax Law, Compiled by the Library of Congress .. 22 1. 22 2.

3 Domestic or resident corporations .. 23 3. Nonresident foreign companies .. 27 4. Taxation of individuals .. 27 5. Revenues from income 29 6. SPECIAL rates of tax, deductions and credits .. 29 7. Puerto Rico excise and other taxes .. 32 C. OVERVIEW of Tax Provisions Relating to Other Possessions .. 37 1. territories and commonwealths .. 37 2. Virgin 39 3. 41 4. Commonwealth of the Northern Mariana 42 5. American Samoa .. 43 III. MECHANICS OF THE POSSESSION TAX CREDIT.

4 45 A. The Possession Tax Credit in General .. 45 B. Qualification for the Credit .. 47 C. Computation of the Credit .. 48 IV. LEGISLATIVE HISTORY OF THE POSSESSION TAX CREDIT AND GOVERNMENT REPORTS .. 50 Page i V. OVERVIEW OF FEDERAL TAX POLICY ISSUES RELATING TO ECONOMIC DEVELOPMENT IN PUERTO RICO .. 58 A. OVERVIEW of Economic Well Being in Puerto Rico in Comparison to the 50 States.

5 58 B. Federal Tax Policy and Economic Development in Puerto Rico .. 60 VI. SUMMARY OF STATEHOOD, COMMONWEALTH, AND INDEPENDENCE STATUS .. 65 A. Description of Statehood Agenda .. 65 B. Description of Commonwealth 69 C. Description of Independence Agenda .. 70 VII. RECENT PROPOSALS REGARDING THE TAX TREATMENT OF PUERTO RICO .. 72 A. Proposals Related to 72 1. Extend earned income tax credit to residents of Puerto Rico .. 72 2. Extend refundable child credit to residents of Puerto Rico with fewer than three 78 B.

6 Proposals Related to 83 1. Extension of section 30A .. 83 2. Section 199 88 3. Section 956 93 4. Section 245 102 C. Proposal Related to Revenue Transfers .. 111 1. Repeal limitation on cover over of rum excise tax to Puerto Rico .. 111 117 1 INTRODUCTION This pamphlet1, prepared by the staff of the Joint Committee on Taxation, provides an OVERVIEW of the SPECIAL tax RULES related to Puerto Rico and an analysis of the tax and economic policy implications of recent legislative options.

7 This pamphlet was prepared at the request of Senate Finance Chairman Charles Grassley and Ranking Member Max Baucus. A copy of their request can be found in the Appendix of this pamphlet. Part I of the document provides an executive summary of the pamphlet. Part II discusses the present law tax provisions related to Puerto Rico and other possessions. Part III covers the mechanics of the possession tax credit. Part IV traces the legislative history of the possession tax credit and summarizes the findings included in several government reports released over the last 20 years.

8 Part V contains an economic analysis of Federal tax policy issues relating to economic development in Puerto Rico. Part VI is a description of the Puerto Rico statehood, commonwealth and independent party agendas. Part VII is an analysis of the tax and economic policy implications of recent proposals regarding the tax treatment of Puerto Rico. 1 This pamphlet may be cited as follows: Joint Committee on Taxation, An OVERVIEW of the SPECIAL Tax RULES Related to Puerto Rico and an Analysis of the Tax and Economic Policy Implications of Recent Legislative Options, (JCX-24-06), June 23, 2006.

9 2 I. EXECUTIVE SUMMARY A. Introduction In October 2003, Senate Finance Chairman Grassley and Ranking Member Baucus, requested that the staff of the Joint Committee on Taxation (the Joint Committee staff ) prepare a report on legislative options concerning Puerto Rico. The request asked the Joint Committee staff to provide an analysis of the tax and economic policy implications of the legislative options, the revenue costs of such options, and a comparison of the options to present law relative to the States, the District of Columbia, and the other At the same time, the Chairman and Ranking Member requested that the Government Accountability Office ( GAO )

10 Report to the Finance Committee with respect to the Puerto Rico economy, the impact of Federal tax policy on Puerto Rico, and proposed tax legislation regarding Puerto Rico. The Chairman and Ranking Member requested that the Joint Committee staff complete its report following the completion of the GAO report. The GAO completed its report in May of 2006. While this pamphlet is an independent work-product of the Joint Committee staff, the legislative options included in this pamphlet represent specific proposals that have been advocated by various interested parties, including some members of Congress, with respect to stimulating economic growth in Puerto Rico.