For tax year 2018, employers in Puerto Rico will be required to report certain severance payments, as discussed further below, as "exempt wages" on Withholding Statement Form 499R-2/W-2PR (the Puerto Rico equivalent of the US W-2 Form – PR Form W-2),as opposed to Form 480.6D.

Under Section 4.3 of Act 4-2017, known as the Labor Transformation and Flexibility Act, which amends Section 1 of Act No. 80 of May 30, 1976 (Act No. 80), known as the Unjust Dismissal Act, severance payments as well as any equivalent voluntary payment made by the employer to employees on account of their dismissal, are excluded from the definition of gross income and as such are not subject to Puerto Rico income tax, whether such payment is made at the time of their dismissal or later, or whether it is made by reason of a settlement agreement or pursuant to a judgment or administrative order.

The amount of the severance payment excluded from the definition of gross income, and not subject to Puerto Rico income tax, is equal to the severance payment that would be payable pursuant to the provisions of Act No. 80. Severance payments that are made in excess of such amount are subject to Puerto Rico income tax.

We note that although Section 1031.01(b)(15) of the Puerto Rico Internal Revenue Code of 2011, as amended, excludes Act No. 80 severance payments from the definition of gross income (and from the imposition of tax), the employer is still required to report the Act No. 80 severance payments to the employee and the Puerto Rico Treasury Department (PRTD).

In this regard, the PRTD issued Internal Revenue Informative Bulletin 18-18 on October 30, 2018 (IRIB 18-18),2 to provide, among others, that Form 480.6D (Informative Return for Exempt and Excluded Income and Exempt Income Subject to Alternate Basic Tax) can no longer be used to report severance payments to the employee and the PRTD. Instead, IRIB 18-18 provides that for tax year 2018, severance payments will be reported on PR Form W-2 as "exempt wages" in the form´s new box number 16, under exemption code I.

We note that the new requirement to report severance payments as exempt wages on PR Form W-2 for Puerto Rico income tax purposes will likely help employers in reducing reporting errors and omissions, and late filings caused by the former reporting scheme that required employers to report severance payments in Form 480.6D as income other than wages for Puerto Rico income tax purposes and as wages on PR Form W-2 for social security and Medicare tax purposes.

These reports must be filed electronically by January 31, 2019, through the Puerto Rico Treasury Internal Revenue Unified System (known as SURI, for its Spanish acronym). Failure to file the reports by the deadline may result in penalties.

Lastly, the PR Governor enacted HR Bill 1544 as Act 257 of 2018 (Act 257). Act 257 amended numerous provisions of the Puerto Rico Internal Revenue Code of 2011, as amended. In this respect, Act 257 amended the definition of wages to include severance payments made to pursuant to Act 80 as wages subject to Puerto Rico withholding tax. Based on this new definition of wages for severance payments made after December 31, 2018, the aforementioned reporting for severance payments may be subject to additional changes in tax year 2019 onwards. Notwithstanding, we expect the PRTD to issue regulations to continue to treat the Act 80 portion of the severance payments as exempt wages not subject to withholding tax.