May30
Category: Tax Law

Q&A: Disregarded Entities for Puerto Rico Income Tax Purposes

The concept of a disregarded entity was unknown for Puerto Rico income tax purposes until last year when it was introduced to the Puerto Rico Internal Revenue Code of 2011, as amended (the “PR Code”) by Act No. 52 of June 30, 2022.  By contrast, for United States income tax purposes, the disregarded entity tax treatment has been available since the late 1990s. 

The questions and answers below discuss the main topics related to disregarded entities for Puerto Rico income tax purposes:     

What is a disregarded entity?

A disregarded entity is an entity that is “ignored” as a separate entity from its owner for Puerto Rico income tax purposes.

Is a disregarded entity required to file a Puerto Rico income tax return?

No, a disregarded entity is not required to file a Puerto Rico income tax return.  Instead, the owner reports the entity’s income, expenses, gains, and losses on its own Puerto Rico income tax return.

Are all entities eligible to be treated as a disregarded entity for Puerto Rico income tax purposes?

No, only those Puerto Rico organized and non-Puerto Rico organized limited liability companies (LLCs) that have one member (i.e., owner) may elect to be classified as a disregarded entity for Puerto Rico income tax purposes; provided that for these purposes, a married couple under the community property regime is considered one owner. 

Which Puerto Rico organized LLCs are eligible to be classified as disregarded entities for Puerto Rico income tax purposes?

For Puerto Rico organized LLCs, the sole member must be a Puerto Rico resident individual or a married couple in which both are Puerto Rico residents.

What happens if a Puerto Rico organized LLC fails to timely elect to be classified as a disregarded entity for Puerto Rico income tax purposes?

It will be treated as a corporation for Puerto Rico income tax purposes, which is the default classification in the case of a Puerto Rico organized LLC, unless it timely elects to be classified as a pass-through entity (i.e., “Entidad Conducto”). 

Which non-Puerto Rico organized LLCs are eligible to be classified as a disregarded entity for Puerto Rico income tax purposes?

Those non-Puerto Rico organized LLCs that have a single member and are treated -by election or by operation of law- as a disregarded entity for income tax purposes in the United States, or their respective foreign country.  In these cases, the member does not have to be an individual, nor does it have to be a resident of Puerto Rico.  For these purposes, a married couple under the community property regime is considered one owner.

What happens if a non-Puerto Rico organized LLC that is classified -by election or by operation of law- as a disregarded entity in the United States, or in its respective foreign country, fails to timely elect to be classified as a disregarded entity for Puerto Rico income tax purposes?

Such entity will be classified as a pass-through entity (i.e., “Entidad Conducto”) for Puerto Rico income tax purposes, and it cannot elect to be treated as a corporation for Puerto Rico income tax purposes.

The classification as a disregarded entity for Puerto Rico income tax purposes is available for which taxable years?

In the case of a Puerto Rico organized LLC, the election is available for the taxable year 2022 and years thereafter.  For non-Puerto Rico organized LLCs, the disregarded entity classification is available for taxable year 2023 and years thereafter.

Is the classification as a disregarded entity for Puerto Rico income tax purposes mandatory for all eligible LLCs?

No, it is optional. The LLCs can elect to be classified as a pass-through entity (i.e., “Entidad Conducto”), which are generally subject to the Puerto Rico partnership income taxation rules, or as a corporation, as applicable. 

How does an eligible entity choose to be classified as a disregarded entity for Puerto Rico income tax purposes?

The election is made by filing Form AS 6045 entitled Partnership, Limited Liability Company or Corporation Classification Election with the Puerto Rico Treasury Department, along with the Puerto Rico income tax return.

When is the election to be taxed as a disregarded entity due?

The election is due on or before the due date for the owner to file its Puerto Rico income tax return for the taxable year in which the election will be effective, including extensions.

Can an eligible entity change its classification once an election to be classified as a disregarded entity for Puerto Rico income tax purposes is made?

Generally, yes, but the entity and its owners must consider the income tax implications and the conversion costs that may apply by reason of the change in classification as well as any limits or conditions that may apply.

Is a disregarded entity required to comply with the filing and payment responsibilities related to other taxes (i.e., not income taxes)?

Yes, a disregarded entity is solely disregarded for Puerto Rico income tax purposes.  The entity is required to comply with the filing and payment responsibilities related to other taxes (i.e., not income taxes), including but not limited to employment taxes, sales and use taxes, property taxes, municipal license taxes, among others.

What are the advantages of disregarded entity status?

  • No separate income tax return must be filed for the LLC; and tax compliance costs may be lower.
  • Lower income tax rates (avoid the effect of double taxation vis-à-vis being taxed as a corporation).

If disregarded entity classification is elected in Puerto Rico, does the entity have to make a similar election for United States income tax purposes?

No. The applicable requirements and rules for United States income tax purposes are different and separate from the Puerto Rico election.  Furthermore, electing disregarding entity for United States income tax purposes can have serious negative United States tax implications, particularly United States estate taxes and FICA/FUTA taxes, thus careful consideration should be given to such an election as there are very few instances where such a United States income tax election would be advisable.

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