In an effort to increase revenues and to set up the basis for an upcoming restructuring of our tax system, the Puerto Rico Governor signed into law Act 77 of July 1, 2014 (Act 77). Act 77 amends various tax legislation, including the Puerto Rico Internal Revenue Code of 2011 (the New PR Code).
Act 77 amends the New PR Code to provide, among other things, a reduced tax to individuals, estates and trusts on the gain derived from the sale of capital assets or pre-pay the tax on the total or partial increase in value of certain assets. Act 77 provides for a reduced tax of 8% for "long term capital assets," and of 15% for "included assets," the income of which is taxable as ordinary income under the New PR Code. Retirement plans, whether qualified or not, are classified as included assets and, therefore, generally are subject to the 15% reduced tax rate.
As a result of Act 77, participants in retirement plans (whether qualified or not) may pre-pay – during a window period that starts on July 1, 2014 and ends on October 31, 2014 – at a reduced tax rate of 15% part or the total amount accumulated under the plan which is not currently distributable. The participant's tax basis will be increased by the amount of the pre-payment and only the taxable portion of such distribution which has not been pre-paid will be subject to tax at the time of distribution. Act 77 further provides that qualified retirement plans allowed for in-service distributions to satisfy this pre-payment will not be disqualified under Section 1081.01(a) of the New PR Code.
Notwithstanding the above, Act 77 is silent on whether allowing for in-service distributions in order to satisfy this pre-payment is mandatory to all qualified retirement plans. If it is mandatory, it is still uncertain whether plan sponsors are required to amend the plans accordingly. Note that retirement plans qualified both under the provisions of the New PR Code and the United States Internal Revenue Code (the U.S. Code) of 1986, as amended, generally cannot be amended for this purpose because in-service distributions to pre-pay Puerto Rico income taxes are not a permissive distribution under the U.S. Code.
Act 77 is...