By David W. Klasing, JD, CPA.
Federal enforcement of Puerto Rico residency claims is no longer a niche concern for ultra high‑net‑worth individuals; it is a priority shared by the IRS, the Justice Department, and Congress. Recent cases show that federal prosecutors have subpoenaed client files from a major law firm involved in Puerto Rico residency planning, signaling that investigators are reviewing not only taxpayers’ actions but also the advice and documentation prepared by advisers.
At the same time, a high-profile criminal case illustrates how retroactive moves and aggressive interpretations can lead to jail time and eight-figure restitution.
What’s Changed and Why Practitioners Must Pay Attention
Puerto Rico’s incentive program is now consolidated in Act 60 (formerly Acts 20 and 22), which provides local tax exemptions for eligible decree holders (e.g., 0% Puerto Rico tax on qualifying dividends, interest, and post-move capital gains). Separately, U.S. federal law allows bona fide Puerto Rico residents to exclude Puerto Rico-source income from U.S. federal income tax under IRC §933, with residency determined under IRC §937 and the Treasury regulations.
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Because these benefits hinge on strict residency and sourcing rules, federal tax enforcement has intensified; the IRS has an active compliance campaign, criminal cases have been brought, and grand-jury subpoenas to advisers have been reported. Examiners are scrutinizing residency files and sourcing positions more closely:
- Criminal plea demonstrates the stakes: On June 13, 2025, investor Suresh Gajwani pleaded guilty to filing a false document with the IRS to convert his company to an S corporation retroactively. The court record shows he sought to shelter nearly $30 million in built-in gains under Act 60, despite not becoming a bona fide Puerto Rico resident until January 1, 2020. He submitted a false election stating the company intended to convert as of January 1, 2019; based on that document, the IRS granted the retroactive conversion. Without the scheme, his company would have owed roughly $7 million in U.S. tax, and Gajwani now faces up to three years in prison and must pay about $15.3 million in restitution. The case underscores the government’s willingness to prosecute taxpayers and underscores enforcement risk for construing misrepresentations as fraud.
- Subpoenas to advisers: Federal investigators recently served grand-jury subpoenas on a large law firm seeking books, papers, documents, and data related to Puerto Rican tax-planning structures. Such subpoenas suggest the government is mapping the advisory ecosystem and testing the legal opinions behind residency claims. CPAs should anticipate that their own records, engagement letters, and privilege assertions may be scrutinized.
- Political attention and expanded investigations: The Senate Finance Committee’s ranking member, Ron Wyden, announced an investigation into whether cryptocurrency investor Dan Morehead avoided more than $100 million in taxes by misrepresenting his residency and mis‑sourcing gains. Wyden’s letter notes “ongoing investigations by IRS criminal agents and federal prosecutors” into cases where taxpayers may have misrepresented bona fide residency or income sourcing. With congressional oversight intensifying, Act 60 participants and their advisers should expect a steady flow of audits, information requests, and hearings.
Understanding Bona Fide Residency and Sourcing Rules
The Internal Revenue Code excludes Puerto Rico‑sourced income for bona fide residents (IRC §933), but bona fide residency is determined under §937. A taxpayer must meet three conjunctive tests:
- Presence: At least 183 days in Puerto Rico during the taxable year or meeting an alternative safe harbor. Travel logs, flight records, boarding passes, and passport stamps are critical to substantiate this test.
- Tax home: The principal place of business must be in Puerto Rico, not merely a mailing address or vacation property.
- Closer connection: Personal and economic ties must be stronger to Puerto Rico than to any U.S. state or foreign country. Factors include location of the taxpayer’s home, family, social and community involvement, driver’s license, voter registration, banking relationships, and clubs or organizations.
Meeting these requirements demands more than owning property or visiting periodically. The IRS emphasizes that documentation is crucial and that the residency file should be updated every year.
Source of income matters as much as residency. For services, the income is sourced where the services are performed, not where the clients are located. Under Treas. Reg. § 1.937‑2, capital gains accrued before bona fide residency are U.S.‑source gains and cannot be converted to Puerto Rico‑source simply because the asset is sold after the move. The Gajwani plea illustrates the risk of trying to backdate corporate elections or recharacterize built-in gains. In cases where gains or services straddle the residency date, CPAs should consider allocating income between pre- and post‑residency periods and documenting the rationale.
How CPAs Can Protect Their Clients
- Re-underwrite residency every year: Treat each filing season as a fresh evaluation of the client’s presence, tax home, and closer connection tests. Retain contemporaneous evidence: housing leases, utility bills, school records, local club memberships, doctor and dentist visits, and bank statements. Reconciling these records with cell‑phone location data, credit card transactions, and flight manifests early will reduce surprises during an audit.
- Document sourcing with precision: Develop a standard workpaper for Act 60 clients that ties each income item to its sourcing analysis. For capital gains, note acquisition date, basis, holding period, fair‑market value on the residency commencement date, and sale date. For services income, note where services were performed and by whom. Keep board minutes and corporate resolutions that show where decisions and management functions occur.
- Beware of retroactive “fixes”: Converting a corporation or partnership status after a significant appreciation event, or executing back-dated contracts, is likely to be viewed as fraudulent. Encourage clients to implement entity changes well before moving to Puerto Rico and to obtain multiple professional opinions when rules are complex.
- Mind the forms: If a client begins or ceases bona fide residency, file Form 8898, Statement for Individuals Who Begin or End Bona Fide Residence in a U.S. Territory. Ensure U.S. returns properly exclude Puerto Rico‑source income and include income from other sources. Clients with self-employment income still owe the U.S. self-employment tax and may need to file Form 1040‑SS. Don’t ignore international informational filings (e.g., FBAR, Form 8938), which apply regardless of residency.
- Establish clear engagement boundaries: Engagement letters should describe the scope of services and clearly state whether the firm is providing legal opinions or simply preparing returns based on client-provided facts. Consider formal Kovel arrangements when forensic accounting is needed so that communications with outside accountants remain within the attorney-client privilege. With investigators subpoenaing advisers’ files, ambiguous communications or marketing materials could become exhibits.
- Elevate high-risk cases: Create an internal risk triage: clients with robust facts and documentation; clients who meet tests but need supplemental support; and clients with thin facts, significant U.S. ties, or retroactive actions. For the latter, discuss the potential for voluntary corrective filings or amended returns before government contact occurs.
Looking Ahead
The IRS’s campaign against improper Puerto Rico residency claims is strengthening. Criminal tax agents have already secured a guilty plea and the IRS said in July 2023 it had identified about 100 high-income individuals for potential criminal tax investigation tied to Puerto Rico. Congressional investigators are openly questioning advisers and taxpayers about transactions that may be mis‑sourced. The message to CPAs is clear: residency planning for Puerto Rico is still permissible, but the rules are strict, and the penalty for missteps can be severe.
By approaching Act 60 engagements with the same discipline used for other cross-border planning, including rigorous documentation, annual re-evaluation, precise sourcing analysis, and early involvement of counsel, firms can protect their clients’ benefits and their own reputations in a rapidly evolving enforcement landscape.
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David W. Klasing, is a dual certified tax attorney and CPA who specializes in domestic and international tax, providing businesses and individuals with comprehensive tax representation, planning & compliance services and criminal tax representation. As a former auditor, Mr. Klasing uses his past experience in public accounting to help his clients avoid tax problems before they develop where possible.
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