It would be a very long article to try and unwind the Puerto Rico "loophole" as a tax haven for United States citizens. Also, it's not really that interesting unless you actually plan or are thinking of moving to Puerto Rico. I know that if I lived in Idaho, I wouldn't think about Puerto Rico. In fact, I pretty much did not even think about Puerto Rico my entire adult life until I seriously thought about moving there in 2016. But, I'll give it a shot.
First of all, the US Constitution does not fully function in Puerto Rico. Even though I was born in the States, an American Citizen, AND a United States Officer, I have had both my 1st Amendment rights and 2nd Amendment rights violated on multiple occurrences. If this occurred Stateside, I would have a legal case. But, because I am in Puerto Rico, the Insular Cases may apply.
Basically, the "Insular Cases" of the Supreme Court established in the early 1900s that the newly obtained territories from Spain (ie. Philippines, Guam, and Puerto Rico) did not have the same, full rights as on the mainland. If the territories had the same rights, then obviously the territories could not be as easily looted and exploited as Colonization dictates.
Somewhere down the line, it also established that residents of Puerto Rico do not have to pay Federal Income Tax (You don't enjoy the full rights. You also don't have to pay the taxes!). Puerto Rico has its own, tiered tax system like many States do, but tiers that are higher than Federal Income Tax brackets after a certain income level.
The IRS has specific communications about "Source of Income" specifically in regards to Puerto Rico. So, if I physically perform the work in Puerto Rico, which technology has made exceptionally easy, then that income is considered to be sourced from Puerto Rico.
It's also why movie stars who shoot in Hollywood, will have to pay California and Federal income taxes because the "Source" of their income was completed in California. Companies that end up editing the film, like in New Zealand or Ireland, will have their work taxed at their respective tax rates in their country because they physically do the work there. (Side note: California may still try and claim their share through various other laws they have depending on other factors).
Puerto Rico, due to their Federal Income tax exemption, has special tax programs to incentive companies to do their work physically on the island. The tax rate is 4% total. 50 cent realized it could be higher than 60% mainland. So, it's quite the savings.
But if you travel frequently between the mainland and Puerto Rico, and you act as a "consultant," then it becomes very sketchy on terms of "Source of Income." For example, let's say the consultant spends 5 months in the States, and 7 months in Puerto Rico. Maybe they do 50% of the work Stateside, and 50% in Puerto Rico. They should be paying Federal Income tax on the 50% they did Stateside because of "Source of Income" rules. Many "consultant" individuals create corporations in the respective states they practice in and "bill" the parent company with tax exemption to keep the "Source of Income" separate. Smart. Clean.
But, sometimes they don't. Sometimes you outright tell your CPA that you want to commit fraud(?) and charge 100% of the work to Puerto Rico (despite actually doing 50% of the work Stateside). I don't know if that's what happened in this situation. Maybe it was more egregious. I don't have access to the email history.
In December 2018, Hernández formed Company A under Puerto Rico law for an undercover special agent of the IRS-CI posing as a wealthy United States taxpayer from Arizona. In December 2019, Hernández caused to be prepared and filed a fraudulent tax-exemption application with the Office of Industrial Development and fraudulently obtained Act 20 tax exemption status for Company A.
In December 2019, Hernández also determined that Company A would report $500,000 in business earned income in Puerto Rico, which would reduce Company A’s federal taxes. Then in July 2020, Hernández caused a Puerto Rico corporate tax return for Company to be prepared and filed with the Puerto Rico Department of Treasury (Hacienda), falsely claiming that $500,000 was earned in Puerto Rico by Company A.
I have a good friend who was wrongfully, criminally prosecuted by this same office. We all know the DOJ is corrupt as fuck and many of their actions are done for political reasons. Is this another example of Entrapment?
I will be interested to read the emails that the undercover agent sent and their evidence if it ever goes public.
I know many CPAs right now are shaking in their boots for dealing with any Act 20 decree holders until they see to what degree the Fraud was.
Keep in mind, BDO is the same firm that was involved with a partner resigning after an indictment in a corruption scandal. Justice is political these days.
UPDATE: It could be entrapment, but if there is a way out (ie. the CPA could decline the client), then it's not a defense. Also, it is possible it was quite blatant. But we'll see if it goes to trial.