Puerto Rico income tax treatment of a corporation of individuals and its shareholders is similar to an “S” corporation under the U.S. Internal Revenue Code. The Corporation of Individuals is not subject to the corporate income tax, but rather, like an “S” corporation or a partnership, it is merely a pass-through entity. The income, deductions, gains, losses, and credits flow through to its shareholders with the same characteristics as in the hands of the corporation. The shareholders must determine their income tax liability taking into account such items. The use of losses by the shareholders is subject to certain limitations.
To be treated as a corporation of individuals the following requirements must be satisfied:
- Be an eligible domestic corporation;
- Have no more than 35 eligible shareholders: individuals, certain trusts or estates;
- Have only one class of stock;
- An election has to be filed with the Secretary of the Puerto Rico Treasury during the preceding taxable year or, on or before the 15th day of the 4th month of the taxable year for which the election would be effective. This election requires the consent of all shareholders;
- At least 90% of its gross income must be derived from a trade or business in Puerto Rico and, therefore, it must not have passive income in excess of 10%.
All of these requirements must be met when the election is made and at all times thereafter. Failure at any time to qualify as a corporation of individuals terminates the election and the corporation is taxed as a regular corporation.
Among the corporations ineligible for corporation of individuals treatment are: insurance companies, registered investment companies, corporations that enjoy tax exemption pursuant to the provisions of any of the Incentives Acts (except for Tourism Development Acts), tax exempt corporations, and financial institutions.