A Quick Guide to US Territories and How Their Tax Rules Differ

A Quick Guide to US Territories and How Their Tax Rules Differ

Moving to a tropical island often sounds like a daydream reserved for retirement or a lottery win. But for United States citizens, relocating to a US territory offers a unique middle ground. You get to enjoy island life and a lower cost of living while keeping your US passport and currency.

However, once the initial excitement of palm trees and ocean breezes settles, a complicated question usually arises: How do taxes work here?

Many Americans assume that because territories like Puerto Rico or the US Virgin Islands are part of the United States, the tax rules are identical to living in Florida or California. That is not the case. The tax codes in US territories are distinct, offering potential benefits that are unavailable on the mainland, provided you follow the rules strictly.

If you are a digital nomad, an investor, or someone looking for a change of pace, understanding these differences is vital. Here is a straightforward guide to how US territories handle taxes and what you need to know before you book your flight.

Understanding the Landscape: It Is Not Just "The States"

First, we need to clarify which territories we are talking about. When the IRS references "US possessions" for tax purposes, they generally mean:

• Puerto Rico
• The US Virgin Islands (USVI)
• Guam
• The Commonwealth of the Northern Mariana Islands (CNMI)
• American Samoa

While these are all under US jurisdiction, they generally operate their own tax systems. The United States is one of the few countries that taxes based on citizenship rather than residency. Usually, this means you pay US taxes no matter where in the world you live.

US territories are the exception to this rule. If you become a "bona fide resident" of a territory, you may be exempt from paying US federal income tax on the money you earn within that territory. Instead, you pay taxes to the territory’s local government.

The Golden Rule: Becoming a Bona Fide Resident

You cannot simply rent a mailbox in St. Thomas or San Juan and claim tax benefits. The IRS has strict criteria for who counts as a bona fide resident. Generally, you must pass three specific tests.

1. The Presence Test This is usually the hardest part for frequent travelers. You must be physically present in the territory for a specific amount of time, typically at least 183 days during the tax year. There are no shortcuts here. If you miss the mark by even one day, you could remain liable for full US federal taxes.

Keeping a precise log of your location is essential. This is where Days Monitor becomes your best friend. Our app helps you track your travel days automatically, ensuring you have the data to prove you met the residency requirement if the IRS ever asks.

2. The Tax Home Test Your main place of business, employment, or post of duty must be in the territory. If you do not have a regular job, your "tax home" is the place where you regularly live.

3. The Closer Connection Test You must have stronger ties to the territory than to the US mainland or any other country. The IRS looks at where your family lives, where your belongings are kept, where you vote, and even where you bank.

Puerto Rico: The Most Popular Destination

Puerto Rico is the most discussed territory regarding tax incentives, largely due to Act 60 (formerly Act 20 and Act 22).

Puerto Rico operates a tax system that is independent of the US federal system. If you are a bona fide resident of Puerto Rico, you generally do not pay US federal income tax on income strictly sourced from Puerto Rico.

The local incentives are what draw people in. Under Act 60, eligible residents may pay 0% tax on capital gains and interest specifically accrued after becoming a resident. For business owners who export services from Puerto Rico to the mainland or elsewhere, the corporate tax rate can be as low as 4%.

However, there is a catch. Income earned from outside Puerto Rico is not exempt. If you live in San Juan but work remotely for a company in New York, that income is likely still subject to US federal tax. This makes sourcing your income correctly a critical step in your planning.

The US Virgin Islands: The Mirror System

The US Virgin Islands (St. Thomas, St. Croix, and St. John) uses what is known as a "mirror system." essentially, the USVI tax code mirrors the US Internal Revenue Code.

When you file your taxes as a bona fide resident of the USVI, you fill out a form that looks nearly identical to the standard IRS Form 1040. The difference is that you pay your taxes to the Virgin Islands Bureau of Internal Revenue (BIR) rather than the IRS.

The USVI offers aggressive economic development programs for approved businesses. Beneficiaries of these programs can receive a reduction of up to 90% on personal and corporate income taxes and exemptions on property and gross receipts taxes.

Because of the mirror system, the paperwork can feel familiar to Americans, but the filing destination is different. You must ensure you are filing with the correct agency to avoid penalties from the IRS.

Guam, CNMI, and American Samoa

While less common for digital nomads than the Caribbean territories, the Pacific territories also offer unique tax situations.

Guam and CNMI Like the USVI, Guam and the Commonwealth of the Northern Mariana Islands generally operate under a mirror code system. If you are a bona fide resident, you file your return with the local government. These territories can also offer rebates to offset the tax liability, effectively lowering the tax rate for residents compared to what they would pay on the mainland.

American Samoa American Samoa is unique because it manages its own tax laws and does not use the mirror system. If you are a bona fide resident here, you report your worldwide income to the American Samoa Tax Office. However, you may still need to file a US return if you have income from US sources.

Why Tracking Your Days Matters More Here

The appeal of these territories is obvious. You get the safety and infrastructure of the US legal system combined with tax rates that rival offshore havens. But the IRS is well aware of this appeal.

Audits for those claiming bona fide residency in US territories can be thorough. The burden of proof is always on you. You must prove you were physically on the island for the required number of days. Relying on flight receipts or credit card statements alone can be messy and imprecise.

If you are splitting time between Miami and San Juan, or traveling internationally while based in the USVI, you need a reliable way to monitor your substantial presence.

You can use our free Substantial Presence Test Calculator to get an idea of how the IRS views your time in the US versus its territories. However, for ongoing residency management, having a dedicated tracker on your phone is the smartest move.

Conclusion

Moving to a US territory can be one of the smartest financial and lifestyle decisions you make. It offers a rare opportunity to legally reduce your tax burden while living in paradise.

However, these benefits come with a high requirement for compliance. The rules regarding "sourced income" and "physical presence" are rigid. You cannot approach this casually. You need to sever your closer connections to the mainland, establish a genuine life in the territory, and, most importantly, count your days.

Before you pack your bags, consult with a tax professional who specializes in US territory taxation. And to make sure you never accidentally violate the presence test, keep Days Monitor in your pocket.

Ready to track your residency with confidence? Download the Days Monitor app today. It is the discreet, accurate way to log your location and ensure you stay compliant with residency rules, no matter where your travels take you.