Miami's GenTrust eyes big profits with Puerto Rico tax play

Pixabay

Not just azure waters and pristine beaches make Puerto Rico an attractive destination. With its generous financial incentives, the territory is also a haven for wealthy Americans seeking to legally avoid taxes.

Now, in a twist, a big financial advisory firm in Florida is aiming to capture that opportunity for itself.

GenTrust Wealth Management, a $2.6 billion independent practice in Miami that caters to ultra affluent investors from New York to California, opened an outpost in the capital city of San Juan right before the COVID-19 pandemic hit in early 2020. Its first objective: to become the go-to wealth manager for thousands of hedge fund traders, rich U.S. mainlanders and cryptocurrency investors who have flocked to the Caribbean island in recent years to legally erase U.S. taxes on their profits. Another goal: to capture a lucrative tax break for serving its American mainland clients.

GenTrust, which charges fees, not the conflict-prone commissions of brokers, is the largest independent advisor so far to tap into Puerto Rico’s program of outsize tax incentives. It’s stepping into a potential gold mine.

Independent financial advisory firms are the fastest-growing and most profitable segment of the wealth management industry, according to consulting firm McKinsey. With profit margins between 27.5% and 33.3%, according to Schwab, a firm that layers in legal tax breaks could multiply those returns. While several New York and Connecticut hedge funds, including Millennium Management and ExodusPoint Capital Management, have set up island subsidiaries, independent advisory firms have been far slower to make the leap.

“With wealth management and investment advice, you’re seeing more firms starting to investigate Puerto Rico, but they are a little later to the game,” said Gwayne Lai, a tax director at accounting firm Anchin in New York.

Two big tax breaks
Puerto Rico is a U.S. commonwealth that answers to the IRS, but it has quirky tax rules. Most residents pay no federal income tax; per capita income in 2020 was less than $33,000, according to World Bank data. But since 2012, the territory has been luring high-income investors and companies through two mammoth tax incentives.

One benefit gives individuals who spend at least 183 days a year on the island a pass on owing capital gains taxes on investment profits they accumulate once there. After 10 years, the benefit also lets those individuals pay just 5% on profits they massed before they moved to the island. The perk also applies to dividend and interest income. With the long-term capital gains rate a top 23.8%, it’s a big windfall.

Say an investor who moves to Puerto Rico buys $50,000 of shares in Twitter. She sells them later for $100,000. She owes no tax to Puerto Rico or to the U.S. Treasury. If she had stayed stateside, she’d owe $11,900 in capital gains tax.

A second benefit gives a similar tax break to companies. A U.S.-based firm that “exports” services through its Puerto Rican outpost, with Puerto Rican employees, to clients in the mainland U.S. and other countries can qualify for a 4% income tax rate. As of January 2020, nearly 8,400 individuals and companies had won approval to receive the two tax benefits and other ones for manufacturing, international banking and finance, film production, green energy and doctors, according to the most recent Puerto Rican government data. Since then, COVID-19 and the rise of remote work have sent more mainland Americans to the island. The incentives also allow legal avoidance of state taxes, like California’s top 13.3% rate.

Say a U.S. business with three owners sets up a Puerto Rican pass-through entity to provide investment management services. It has business profits from the entity of $700,000. With the 4% fixed rate, the entity would owe $28,000 in taxes to Puerto Rico and nothing to the IRS. By contrast, if the business generated that income outside Puerto Rico, it would flow through to its owners, who would pay U.S. taxes at ordinary rates. Each owner would owe the IRS more than $86,000, for a collective $258,000.

Tax

How Vanguard’s tax-bomb target-date funds slammed wealthy investors

Affluent investors who have maxed out their retirement plan contributions hold target date funds in taxable brokerage accounts.

By Lynnley Browning

March 17

The two incentives, which expire in 2036 and are part of a law known as Act 60, are separate from controversial arrangements that some multinational corporations, including Microsoft, have with the Puerto Rican government to shift their U.S. profits to island subsidiaries and avoid U.S. taxes on billions of dollars of profits.

‘Right down our alley’
Most independent advisory firms are set up as partnerships or other “pass-through” entities that don’t pay taxes but instead funnel profits to the owner, who then pays tax on them at ordinary rates. The top individual rate is 37%, so Puerto Rico slashes that to a tiny fraction. GenTrust, which also has offices in New York, is owned by its executives and managers. So the Puerto Rican incentive could make them some of the most profitable planners in the industry.

George Perez, a founding principal of GenTrust and a former senior wealth advisor at Merrill Lynch, said that the recent influx of investors and traders who have relocated to the island is “right down our alley.” He added that his firm aims to more than double the on-island assets it now manages, to $1 billion within five years. GenTrust won’t reap tax benefits from serving its well-heeled Puerto Rican clients, whose money it has managed over two decades through its Miami office. Opening the San Juan office in December 2019 “really wasn’t about the tax break — it was about having a presence there after the debacle of UBS and closed-end funds,” Perez said.

But a new entity GenTrust established is primed to seek approval from the Puerto Rican government for a 4% tax rate on the advisory services it provides to its mainland U.S. clients from its San Juan outpost.

“Currently, we are providing investment advisory services within Puerto Rico to Puerto Ricans, so we are unable to receive tax benefits for that,” Perez said. But “if we were to export services— say, exporting investment advisory services from PR to the U.S., then that would fall under our [new] entity.”

Perez, a former Merrill Lynch advisor, said that GenTrust is seeking to hire advisors from Merrill Lynch and UBS. “We are talking to several teams and will put those operations in place, then take advantage of outsourcing services” to mainland U.S. clients to capture the tax break.

PIxabay

The brokerage industry’s self-regulator, the Financial Industry Regulatory Authority, or FINRA, lists 123 brokerages and investment advisory firms in Puerto Rico, but most of them are local-only practices that don’t qualify for the tax breaks. A handful of outposts are branches of big broker-dealers, including Merrill Lynch, Charles Schwab, Oppenheimer and Barclays. Some are branches of brokerages that offer wealth management services, including Cetera Financial Networks and Mesirow Financial Investment Management. But the majority are offshoots of obscure, small U.S.-based brokers and investment shops.

GenTrust was founded in 2011 and initially catered to professional athletes and entertainers. As hedge fund traders and Bitcoin enthusiasts have flooded into San Juan’s ritzy Condado, El Dorado and Old San Juan neighborhoods in recent years, the firm sees the potential for broader client bases. “If GenTrust puts our whole tech team in PR for servicing or concierge service for clients stateside, yes, we can take advantage” of the tax incentive, Perez said.

The IRS is watching
Under a new campaign aimed at rooting out tax cheats, the IRS began scrutinizing last year individual investors who abuse the 183-day rule. An IRS report to Congress in 2019 found that between 2012 and 2019, 647 individuals paid a collective $558 million in U.S. taxes over five years prior to relocating to Puerto Rico for tax purposes. A total of 2,331 individuals and 1,924 businesses had either relocated or set up branches as of 2019. Ismael Vincenty-Medina, a tax lawyer at O’Neill & Borges in San Juan, said that it’s easy to mess up the subjective element of the residency requirement that a person have a “cultural connection” with Puerto Rico, through their home and families. So-called bona fide residents with children who go to a U.S. boarding school “could be an issue,” he said.

Some $70 billion of Puerto Rican government bonds tanked in 2013 and collapsed further in 2017 when the territory filed for bankruptcy, marooning clients of UBS who had invested in them through closed-end funds managed by the bank’s subsidiaries in Puerto Rico. The mess is still wending its way through courts and FINRA arbitration panels. Vincenty-Medina said that UBS qualified for the 4% tax break on exporting its investment services to U.S. mainland clients.