Legislative and Regulatory

Update on Employees in Puerto Rico Plans (Aug 2011)

Update on Treatment of Employees in Puerto Rico Plans (Aug. 30, 2011)

If you employ individuals in Puerto Rico (P.R.), this communication is to inform you of some developments that may impact your treatment of those employees for retirement plan purposes. First, some general background information may be helpful.

Companies have generally used one of three approaches for their Puerto Rican employee population with respect to retirement benefits:

  1. Cover the employees under a separate P.R. retirement plan and trust
  2. Cover the employees under a U.S. plan and trust
  3. Not cover the employees under any retirement plan

The specific approach used by a company depends on many factors. A full discussion of these factors is beyond the scope of this communication, but here are some general considerations:

  • Retirement plan qualification requirements with respect to Puerto Rican employees differ from the rules for U.S. employees. Earlier this year, P.R. enacted a new tax code which minimizes many of these differences, but some still exist. Rather than covering U.S. and P.R. employees in the same plan (see next bullet point), having a separate P.R. plan and trust seems to be a cleaner approach. It allows plan design and communications to be tailored specifically to the P.R. population. However, depending on the size of the population, this approach may not be financially feasible for all organizations.
  • It has been fairly common practice for companies to cover P.R. employees under a U.S.-based retirement plan. This has been especially true if the P.R. population is small. Because P.R. tax laws differ, this approach requires that the plan be qualified both in the U.S. and in P.R. (This creates a dual-qualified plan.)

    In practice, not all companies who have covered its P.R. employees in its U.S. plan have submitted the plan to the P.R. authorities for qualification. This practice will need to change under the new P.R. tax code, which requires all plans that cover P.R. employees to be submitted to the Puerto Rican Treasury Department for a determination letter. (Plan sponsors should consider submitting their plan for qualification by the end of this year.) If a determination letter is not obtained, Puerto Rican employees are generally considered to be participating in a non-qualified plan from a P.R. tax perspective.

    This approach is also the most complex from a participant income tax perspective. Where services are being performed in Puerto Rico, but contributions for these individuals are being made to a plan using a U.S. trust, participants have both P.R. sourced and U.S. sourced income. This complicates tax reporting, withholding and tax management for the participant. This also makes distribution processing and the rollover rules more complex.
  • If neither of the first two approaches is attractive to a plan sponsor, a decision may be made to exclude all Puerto Rican employees from any qualified retirement plan. Unlike in the U.S., P.R. does not have employer-sponsored IRA programs that can be utilized. For this reason, some companies consider increasing employees’ pay in order to allow them to self-contribute to an IRA to build retirement income.

Due to the issues with dual-qualified plans, some plan sponsors have considered spinning the P.R. employees and their retirement plan balances out of the U.S. plan to a standalone P.R. plan and trust. From a U.S. tax perspective, the Internal Revenue Service has taken the position that such a transfer would be made to a foreign trust, which is taxable in the U.S. to the P.R. employees and may jeopardize the qualification of the U.S. plan. However, because this position is contrary to earlier private letter rulings it had issued, the IRS has created a window through the end of 2011 to allow such a transfer to a P.R. trust without U.S. tax or plan qualification consequences.

If you employ individuals in P.R., you should be reviewing your options. A detailed discussion of the issues and options related to Puerto Rican employees can be quite complex, and every company’s circumstances and needs are different. Plan sponsors are encouraged to consult with legal counsel to sort through the issues and options.

A technical corrections bill to the 2011 P.R. Code is being considered in the Puerto Rico Legislative Assembly, which if enacted could make additional changes to the requirements for Puerto Rico qualified retirement plans.

This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon for investment, accounting, legal or tax advice.

IRS Circular 230 Disclosure: This communication was written in connection with the potential promotion or marketing, to the extent permitted by applicable law, of the transaction(s) or matter(s) addressed herein by persons unaffiliated with JPMorgan Chase & Co. However, JPMorgan Chase & Co. and its affiliates do not provide tax advice. Accordingly, to the extent this communication contains any discussion of tax matters, such communication is not intended or written to be used, and cannot be used, for the purpose of avoiding tax-related penalties. Any recipient of this communication should seek advice from an independent tax advisor based on the recipient's particular circumstances.


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