People who live in the five US territories — Puerto Rico, the US Virgin Islands, Guam, American Samoa, and the Commonwealth of the Northern Mariana Islands — do pay federal taxes, but not all of them. If you qualify as a bona fide resident of a territory for the full tax year, the IRS does not tax the income you earn within that territory. You still owe federal payroll taxes, self-employment tax, and (in most cases) federal estate and gift taxes, and any income you earn from mainland sources remains fully taxable by the IRS.
What the Federal Income Tax Exemption Covers
The exemption is tied to residency, not citizenship or ethnicity. A bona fide resident of Puerto Rico excludes Puerto Rico-source income from federal gross income under Section 933 of the Internal Revenue Code.1Office of the Law Revision Counsel. 26 U.S. Code 933 – Income From Sources Within Puerto Rico Instead of paying federal income tax on that money, the resident pays income tax to the territorial government. Bona fide residents of the Virgin Islands file with the Virgin Islands Bureau of Internal Revenue rather than the IRS.2Office of the Law Revision Counsel. 26 USC 932 – Coordination of United States and Virgin Islands Income Taxes Guam, the CNMI, and American Samoa follow similar patterns for their residents.3Internal Revenue Service. Tax Guide for U.S. Citizens and Resident Aliens Abroad
One carve-out catches people off guard. If you work for the US government or one of its agencies in Puerto Rico or American Samoa, your wages are not excluded from federal income tax even if you are a bona fide resident.1Office of the Law Revision Counsel. 26 U.S. Code 933 – Income From Sources Within Puerto Rico Taking a federal job in San Juan does not come with the territorial tax break.
And if you don’t qualify as a bona fide resident, you are treated like any other US taxpayer. You report your worldwide income to the IRS, territory earnings included.
Who Counts as a Bona Fide Resident
Section 937 of the Internal Revenue Code and its regulations lay out three tests you must pass for the entire tax year. Failing even one disqualifies you.4Office of the Law Revision Counsel. 26 USC 937 – Residence and Source Rules Involving Possessions
The presence test requires at least 183 days of physical presence in the territory during the tax year. Regulations disregard certain days spent on the mainland — for qualifying medical care, transit under 24 hours, evacuation around a FEMA-declared disaster, service as an elected or appointed territorial official, temporary student status, or competing as a professional athlete in a charitable event.5Internal Revenue Service. U.S. Territories – Determining Bona Fide Residency Status
The tax home test requires your tax home — generally the place where you work or run your primary business — to be in the territory for the full year. Keeping a permanent office in one of the 50 states makes this test almost impossible to pass.
The closer connection test asks whether your life is more rooted in the territory than in the mainland or any foreign country. The IRS looks at driver’s license, voter registration, bank accounts, vehicle registration, family ties, and memberships. The test exists to catch people who park a mailing address in a territory but live their real lives elsewhere.
Federal Taxes You Still Owe
The income tax exemption is the headline benefit, and it’s the one people build their expectations around. Several other federal taxes are unaffected.
Social Security and Medicare
Wages paid to US citizens and resident aliens working in any US territory are subject to Social Security and Medicare taxes under the same rules that apply in the 50 states.6Internal Revenue Service. Persons Employed in a U.S. Possession/Territory – FICA Your employer withholds 6.2% for Social Security and 1.45% for Medicare and pays a matching amount. For 2026, the Social Security wage base is $184,500, so earnings above that level are only subject to the Medicare portion.7Social Security Administration. Contribution and Benefit Base
Self-Employment Tax
Self-employed residents face the same obligation. If net self-employment earnings are $400 or more, you owe self-employment tax to the IRS regardless of whether the underlying income is otherwise exempt from federal income tax. Bona fide residents who are not otherwise required to file a federal return use Form 1040-SS to report and pay it.8Internal Revenue Service. Publication 570 (2025), Tax Guide for Individuals With Income From U.S. Territories The rate is 15.3% on earnings up to the Social Security wage base, combining both the employer and employee shares of Social Security and Medicare.
Federal Estate and Gift Taxes
How federal estate and gift taxes hit depends on how you became a US citizen. If you were born in one of the 50 states and later moved to a territory, you remain fully subject to the federal estate tax on your worldwide assets and to the federal gift tax during your lifetime. For 2026, the lifetime estate and gift tax exemption is $15,000,000 per individual, and the annual gift tax exclusion is $19,000 per recipient.9Internal Revenue Service. What’s New – Estate and Gift Tax
A different rule applies if you acquired US citizenship solely by being born in or residing in a US territory. Under Section 2209 of the Internal Revenue Code, such individuals are treated as “nonresident non-citizens” for estate tax purposes at death.10Office of the Law Revision Counsel. 26 USC 2209 – Certain Residents of Possessions Considered Nonresidents Not Citizens of the United States The exemption for that group is only $60,000, but only US-situs property is taxed rather than worldwide assets. Whether this treatment helps or hurts depends on the size and location of the estate.
Income From Outside the Territory
The exemption only covers income earned within the territory. A bona fide resident of Puerto Rico who also collects rent from an apartment building in Florida owes federal income tax on that rental income.3Internal Revenue Service. Tax Guide for U.S. Citizens and Resident Aliens Abroad The same goes for dividends from US corporations, interest from mainland bank accounts, and pay for services physically performed in the states.
The practical result is a two-return year. You file a federal Form 1040 reporting only your US-source income; your territory-source income stays off the federal return. You also file a separate return with your territory reporting your worldwide income. To prevent the same money from being taxed twice, territories generally allow a credit for taxes paid to the IRS on US-source income.
Sourcing rules decide which bucket each dollar falls into. Compensation for services is sourced to where the work is physically performed. Interest is generally sourced based on the payer’s residence. Capital gains on most personal property are sourced to the seller’s residence, though gains on real estate are sourced to where the property sits. Getting sourcing wrong can trigger unexpected federal liability.
Local Taxes in the Territory
Being exempt from federal income tax does not mean living tax-free. Every territory runs its own tax system, and the structures split into two groups.
Guam, the US Virgin Islands, and the Commonwealth of the Northern Mariana Islands use a “mirror code” system. They take the US Internal Revenue Code and substitute their territory’s name wherever it says “United States.”11Internal Revenue Service. TEB Phase III – Lesson 4 TEB International U.S. Territories/Possessions You calculate tax the same way you would on a federal return, but you file with and pay the territorial treasury. Rates, brackets, deductions, and credits mirror federal law unless the territory has specifically modified them.
Puerto Rico and American Samoa run independent tax codes. Both were originally modeled on the IRC but have diverged over time, with their own rate structures, deduction rules, credits, and forms.3Internal Revenue Service. Tax Guide for U.S. Citizens and Resident Aliens Abroad Residents also pay local property taxes, excise taxes, and sales taxes imposed by the territorial government.
Extra Federal Filings Tied to Territory Status
Territorial residency creates a few filing obligations beyond the annual return.
In the tax year you become or cease to be a bona fide resident, you must file Form 8898 with the IRS if your worldwide gross income for that year exceeds $75,000. Both conditions have to be met. The form tracks your transition so the IRS can verify how income sourcing shifts between your federal and territorial returns. Missing a required Form 8898, or filing one with incomplete or incorrect information, carries a $1,000 penalty unless you can show reasonable cause.12Internal Revenue Service. Instructions for Form 8898
Bona fide residents of US territories are generally exempt from FATCA reporting on Form 8938 for specified foreign financial assets.13Internal Revenue Service. Summary of FATCA Reporting for U.S. Taxpayers The exemption is specific to Form 8938 and does not necessarily cover every foreign account reporting obligation, so anyone with accounts outside the US and its territories should verify separately.
Self-employed bona fide residents with $400 or more in net earnings who have no other reason to file a federal return still owe self-employment tax and must file Form 1040-SS.8Internal Revenue Service. Publication 570 (2025), Tax Guide for Individuals With Income From U.S. Territories Skipping the form does not eliminate the tax; it adds penalties and interest.