Recent Modifications To Puerto Rico's Tax Code And The Impact It May Have On Your Qualified Retirement Plan
Governor Ricardo Roselló of Puerto Rico enacted certain revisions to the Puerto Rico tax code (the “PR Code”) in February 2017. He did so with the goal of retaining and attracting workers to Puerto Rico by improving the benefits for its professional workforce. The Governor also hoped to alleviate difficulties associated with the establishment and administration of retirement plans. As a result, tax-qualified retirement plans covering Puerto Rico employees are subject to new requirements. Although the PR Code generally tracks the U.S. Internal Revenue Code, the new rules under Act No. 9-2017 (the “Act”) establish differences between the two codes. These differences affect various aspects of qualified retirement plans, including contributions, highly compensated employees, and cash or deferred arrangements. The Act took immediate effect in February, but the Puerto Rico Treasury Department (the “Hacienda”) is still in the process of addressing the application of the various changes and the implementation of the Act. Despite the lack of guidance, employers sponsoring Puerto Rico retirement plans or dual-qualified retirement plans should pay attention to these rules because the requisite amendments will most likely require new determination letters from the Hacienda.
Material Changes to the PR Code
On February 8, 2017, the Governor of Puerto Rico enacted Act. No. 9-2017 modifying retirement plan qualifications under the PR Code. The following changes were made and apply to all retirement plans (regardless of the employer), including Puerto Rico-only plans and dual qualified plans.
- Highly Compensated Employees (“HCEs”): USD $150,000 Threshold and No Automatic Treatment for Corporate Officers.
Prior to the Act, the U.S. and Puerto Rico used the same monetary threshold for defining HCEs. However, under the new rules, the threshold has been increased from USD $120,000 to $150,000. Unlike the U.S. tax code, which subjects its HCE threshold to cost-of-living adjustments, the Act establishes the PR Code’s HCE threshold as a fixed number. Additionally, corporate officers may no longer receive automatic treatment as HCEs under the PR Code. Rather, corporate officers will only be classified as HCEs if their salary surpasses the new USD $150,000 threshold.
- Annual Contribution Limits: Limited to the lesser of 25% of net income or USD $75,000.
The new annual contribution limit on per-participant contributions to defined contribution plans under the Act is the lesser of 25% of “net income” or USD $75,000. This is a departure from the previous statutory limit, the lesser of 100% of compensation or USD $54,000, which is the current rule under the U.S. tax code. The maximum contribution under the Act does not allow cost-of-living adjustments and does not apply to rollover contributions. This new limit also comes with ambiguities, including how the Hacienda will define “net income” and whether the annual, per-participant limit on compensation under a plan will apply under the Act. Currently, both the U.S. and Puerto Rico tax codes contain provisions limiting the amount of compensation that may be used to determine benefits under the qualified retirement plan. If this annual USD $270,000 compensation limit continues to apply in both countries, contributions under the new rule cannot exceed US $67,500.
- Increase in the Aggregate Limit on Tax-Deductible Employer Contributions.
Currently, tax deductible contributions to defined contribution plans cannot exceed 25% of the aggregate compensation of all plan participants. However, under the Act, this aggregate limit is increased to the extent that the tax-deductible contributions do not exceed the aforementioned individual annual contribution limits.
- Plans with a Cash or Deferred Arrangement (“CODA”) Could Qualify for Exemption From the Average Deferral Percentage Test.
For the most part, retirement plans must comply with Puerto Rico’s laws governing coverage and participation requirements, as well as non-discrimination provisions. However, the Act provides an exemption from the Average Deferral Percentage Test for certain CODA plans. The new safe harbor rule applies to: (1) plans containing a CODA that have fewer than 100 participants; (2) whose business generates less than $10 million in annual gross income, and (3) where the employer provides a benefit of no less than 3% of compensation to all eligible employees. The definition of “business” and “gross income” are not specifically defined in the Act and require further guidance by the Hacienda.
Looking Forward: Assessing the Impact on Your Plan
Differences in the Puerto Rico and U.S. tax codes can cause confusion for employers that hire Puerto Rican employees or sponsor dual-qualified retirement plans. For example, an employer with a dual qualified retirement plan will have to comply with the new PR Code definition of HCEs, which conflicts with the HCE definition in the U.S. tax code. Furthermore, there are various ambiguities within the Act which could elicit different interpretations of the new rules. Therefore, although the Act took immediate effect, it may be prudent for employers to wait for further guidance from the Hacienda on how best to implement certain new rules (such as the safe harbor provision for plans containing a CODA). The Act does not make clear when the retirement plans must be in compliance with all of the new rules, and have yet to define many key terms for purposes of implementation.
Importantly, the amendments necessary for compliance with the new law most likely will be classified as qualification amendments, which would necessitate updated determination letters from the Hacienda. It would be wise for employers sponsoring Puerto Rico plans or dual qualified plans to begin updating their plans and policies to the extent possible under the unambiguous provisions of the Act. Furthermore, employers should continue to monitor developments regarding the new Act by looking for newly released guidance on the aforementioned, unresolved ambiguities since mid-year changes might be necessary.