Regular readers of the Sovereign Investor Daily may note that I’m quite “liberal” in my references to thinkers of the past. Many otherwise wrong or misguided people with whom I disagree on most things have had some good ideas or said some things worth quoting.

One of my go-to sources of quotations is John Maynard Keynes, the father of modern macroeconomics and bête noire of fiscal conservatives. He had an infamous wit and a pithy delivery.

My second-favorite Keynes quote (although there is some doubt as to whether he said it) was in response to a parliamentarian who wanted to know why he changed his mind about economic matters from time to time. With an icy stare: “When the facts change, I change my mind … what do you do, sir?” (My favorite Keynesian quote is: “In the long run we are all dead.”)

Right on, John. If you’re afraid to change your views when you get new information, you’re not living freely … you’re trapped in an ideology.

And so it is for me. After two years of skepticism, I’ve changed my mind about America’s own tax haven, Puerto Rico … the only place on Earth where you can escape the IRS.

Yessiree, Step Right Up and Pay No Federal Income Tax

There is exactly one place on Earth where a U.S. taxpayer can escape paying all federal income taxes. It is 3,515 square miles — plenty of room for you, if you choose.

The U.S. is one of the few countries that operates a “worldwide” tax system. We are taxed on our income from all sources, domestic or foreign. Other countries use a “territorial” system, where you’re taxed only on income from within that country.

That’s why the IRS is so demanding about reporting your foreign assets and income.

The Foreign Account Tax Compliance Act and the Report of Foreign Bank and Financial Accounts are just two of the many things Americans with offshore assets must deal with that everyone else doesn’t. Woe betide you if you fail to tell Uncle Sam where your offshore money is.

So whether you live inside the U.S. or abroad, you pay federal tax, period … with one exception.

America’s Caribbean Colony

Puerto Rico is a U.S. colony. It’s officially considered an “unincorporated territory,” but a colony is what it is. Its relationship to the U.S. is no different than Australia’s or Canada’s to Britain before they became independent countries.

But Puerto Ricans are U.S. citizens, with most of the rights and privileges that go with it, including a U.S. passport. (The only thing they can’t do is vote for president, and the territory does not have voting representation in Congress.) Puerto Ricans can come and go as they please. Millions of Puerto Ricans live on the mainland, where they are residents of whatever state they live in. When they do, they stop being “Puerto Ricans” and become full voting citizens. No paperwork required.

The process also works in reverse. If you spend 183 days or more on the island in a calendar year, you become a Puerto Rican. You’re still a U.S. citizen, but you are legally regarded as a resident of the territory.

That means you lose your right to vote for president and to have voting congressional representation … but something else also changes: your tax status.

In exchange for their lack of voting representation in the federal government, Puerto Ricans pay no U.S. federal income tax on Puerto Rican sourced income. Any money you earn from working or investing in Puerto Rico itself is tax-free. Income from U.S. sources, however, remains taxable.

For example, let’s say I move to the island, register a limited liability company and write for Banyan Hill as a contractor. I perform my work in Puerto Rico, so I’d pay no U.S. income tax. On the other hand, income from my U.S. and offshore investment portfolio would be taxed by the IRS, as would my IRA and 401(k) distributions when I retire. (If I buy into a Puerto Rico-based investment fund, however, those earnings would be tax-free.)

Too Good to Be True?

Here’s the clincher: Although Puerto Rico levies income tax, you can avoid most of it if you apply for one of two special “tax decrees” under a local law passed in 2012. You pay only 4%.

In other words, if you organize your affairs the right way and don’t mind living on a sunny tropical island for six months of the year, you’ll pay 4% income tax. That’s it.

Now, I haven’t mentioned the elephant in the room: Puerto Rico’s government is bankrupt. I’m not going to go into the whys and wherefores here. The important thing to know is that Congress has appointed a commission to oversee the island’s fiscal restructuring. The progress they’re making — plus the tax decrees I mentioned above — is rapidly transforming the island into one of the hottest real estate markets around.

For two years, I’ve thought that taking advantage of these decrees might backfire, since the congressional debt commission might balk at such great tax breaks. I was afraid you might move there and find out you’ve lost that status.

But I’m now convinced that’s not going to happen.

I pursued my concerns to the very highest political authority on the island — the governor himself, in fact, who met me at his palatial office — and I’m satisfied that if you want to pay 4% income tax as a Puerto Rican resident, you can do so without fear now and into the future.

The April issue of The Bauman Letter will explain this in detail and give subscribers an inside track to contacts who can make this happen safely and inexpensively.

Isn’t it time you consider becoming a four-percenter?

Kind regards,

Ted Bauman
Editor, The Bauman Letter