The Tax Implications of Mexico Residency for US Persons

Americans as Tax Residents in Mexico and US Tax Treatment

Tax Resident of Mexico and Treatment for US Persons

It is very common for US Persons to travel to Mexico for both business and pleasure. Some taxpayers may even relocate to Mexico full-time and become tax residents of Mexico. Conversely, some Mexican citizens may obtain permanent residency from the United States, but still remain in Mexico and therefore considered to be a resident of Mexico for taxes. But, even though they are tax residents of Mexico, from a US tax standpoint they are still considered US Persons who are taxed on their worldwide income — unless they make certain treaty elections. Before becoming a tax resident of Mexico, there are certain things that a US person should consider. Let’s take a look

Worldwide Income

It is important to note, that when a person becomes a tax resident of Mexico, they may be taxed on their worldwide income in Mexico by the Mexican Tax Authorities, but since they are still a US person they are also taxed on their worldwide income from a US tax perspective. In other words, when a person is a US person such as a US Citizen, Lawful Permanent Resident, or foreign national who meets the Substantial Presence Test, they are taxed on their worldwide income whether or not the income is earned or sourced in the United States — although they may be able to eliminate certain taxes by making a treaty election. Alternatively, Taxpayers may also qualify for the Foreign-Earned Income Exclusion and/or the Foreign Tax Credit to reduce or eliminate taxation

Treaty Elections

The United States has entered into nearly sixty double-taxation agreements with countries across the globe, including Mexico. Under the treaty, a US person who would otherwise be taxed on their worldwide income may be able to elect to be treated as a foreign person if they could show that they meet the requirements of being a foreign person for tax purposes. By doing this, the taxpayer may be able to avoid US tax on worldwide income and only be taxed by the US government on their US-sourced income.

*Currently, there is litigation pending on the issue of whether this type of election to be treated as a foreign person would eliminate FBAR reporting requirements during that time period. The IRS’ position has always been merely making a treaty election to be treated as a foreign person does not eliminate FBAR filing requirements.

Worldwide Reporting

Just as US persons are required to report their worldwide income, they are also required to report their global assets to the US government — even if the US Person resides outside of the United States. There are various different international information reporting forms that a Taxpayer may have to file. And, the failure to file these forms may result in significant fines and penalties –– although these penalties can oftentimes be minimized or eliminated through one of the offshore amnesty programs.

Starting or Investing in a Foreign Business

When a person invests in a foreign business in Mexico, there are various tripwires and pitfalls to be aware of. Whether or not the business is considered a controlled foreign corporation or is considered a passive foreign investment company can significantly alter the requirements of reporting income from a foreign business.

CFC vs Non-CFC

When a business is considered a controlled foreign corporation it changes the corporation into something much more complicated from a US tax perspective. When the income is considered Subpart F income, it may be taxed by the IRS even in a year in which the income was not distributed — and in fact, that income may never end up being distributed. In addition, based on the tax cuts and jobs act there’s also the introduction of GILTI (Global Intangible Low-Taxed Income). GILTI effectively expands the reach of the IRS to tax foreign income that has not actually been distributed and/or repatriated to the United States. 

PFIC

PFIC refers to Passive Foreign Investment Companies. PFICs can take on many forms, but some of the more common types are foreign holding companies and pooled fund investments, such as mutual funds and ETFs. Whereas a US mutual fund or ETF is taxed at a reduced tax rate on income such as long-term capital gains and qualified dividends, these rules do not apply to PFICs — wherein the income is actually taxed at the highest tax rate available, in addition to interest for the amount of time the income withheld but not distributed –– which could lead to a tax rate exceeding 50 or 60% based on the length of the investment.

Social Security

You will generally still have to pay US tax on Social Security income that you received from the US government. If you are receiving Social Security from multiple countries, then the rules will get more complicated — and there may be issues involving the windfall provision.

Pensions

Depending on whether pension income is from a public pension or a private pension impacts whether it will be taxed for residents living abroad. In general, when a pension is private, the US government retains the right to still tax that income even when it is being received by a resident in Mexico.

Foreign Tax Credit

Taxpayers who have already paid taxes in Mexico on income sourced outside of the United States may also be able to apply foreign tax credits against any US income tax they would have to pay on that for an income. it is important to note that it is not always a dollar-for-dollar credit, foreign tax credits will generally reduce if not completely eliminate US tax liability on that same income.

Current Year vs Prior Year Non-Compliance

Once a taxpayer has missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist that specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

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