Taxes for Americans Living in Mexico

Mexico, a neighboring country to the United States, attracts many American expatriates seeking a unique blend of lifestyle advantages. Mexico’s warm climate and diverse landscapes offer an appealing escape from the rigors of American city life. The affordable housing, healthcare, and welcoming expat community make Mexico an attractive destination for retirees and digital nomads. Furthermore, proximity to the US allows for easy visits back home. At the same time, the beautiful beaches and a slower pace of life continue to entice Americans to call Mexico their new home.

Living in Mexico as an American expatriate offers a unique blend of cultural richness, natural beauty, and a lower cost of living. However, it also comes with specific tax implications that require proper attention. At Universal Tax Professionals, we provide specialized 
US expat tax services catering to the needs of Americans living in Mexico.

Tax Residency Status

The first step for any American living in Mexico is to understand their tax residency status. Tax residency is determined by the time an individual spends in Mexico within a calendar year. A person who spends more than 183 days in Mexico during a calendar year is considered a tax resident. This means they are subject to Mexican taxation on their worldwide income.

Tax residency is determined independently from immigration status, so even individuals with temporary or tourist visas may be considered tax residents if they meet the 183-day threshold.

Those who are not considered tax residents in Mexico are only subject to taxation on income earned within the country rather than their worldwide income. It’s advisable for individuals residing in Mexico to keep meticulous records of their time spent in the country to ensure compliance with tax regulations.

Tax Filing Requirements

US Federal Taxes

American expatriates must file a US federal tax return annually, regardless of residence. This means that US citizens or green card holders living in Mexico must submit their US tax returns to the IRS every year when they exceed the IRS filing threshold. The deadline is typically extended to June 15 for expats, with a further extension available until October 15 if requested.

State Taxes

Americans with ties to a US state (such as property ownership, driver’s license, etc.) may have state tax obligations. Some states have specific rules regarding residency, so it’s crucial to understand your state’s requirements.

Mexican Taxes

Mexican residents are taxed on their worldwide income, meaning they must pay taxes on income earned in Mexico and abroad. Mexico imposes various types of taxes, each serving different purposes and collected at different levels of government. Here are some critical aspects of Mexican taxation:

  • Income Tax

    Mexico levies income tax on individuals and businesses based on earnings. Tax rates are progressive for individuals, ranging from 1.92% to 35%. For corporations, the corporate income tax rate is 30%.

  • Value Added Tax (VAT)

    VAT is a consumption tax imposed on the sale of goods and services. The standard VAT rate in Mexico is 16%, though certain goods and services may be subject to a reduced rate of 8% or exempt.

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  • Property Tax (Predial)

    This tax is assessed on real property and is usually collected by municipal governments. Rates and assessment methods can vary between municipalities.

  • Payroll Taxes

    Employers and employees are subject to various payroll-related taxes, including contributions to Social Security and other government social programs.

  • Special Taxes

    Mexico has specific taxes on certain activities or products. For example, there are excise taxes on alcohol, tobacco, and sugary beverages.

  • Import and Export Duties

    Customs duties are levied on goods entering or leaving the country. These can vary depending on the type of goods and their origin.

  • Indirect Taxes

    This category includes taxes on activities like gambling and specific industries like mining and hydrocarbons.

  • Capital Gains Tax

    Profits made from the sale of real estate, stocks, or other assets may be subject to capital gains tax, with rates varying depending on the type of asset and the duration of ownership.

Mexico - US Tax Treaty

The tax treaty between Mexico and the United States is officially known as the “Convention between the Government of the United States of America and the Government of the United Mexican States for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income”. It was signed on September 18, 1992.

The primary purpose of this treaty is to prevent double taxation of income for individuals and businesses that are residents of one or both contracting states. Here are some key provisions and benefits of the Mexico-US tax treaty:

  • Residency Rules

    The treaty provides rules for determining residency in cases where an individual or entity could be considered a resident of Mexico and the US, which helps avoid conflicts and double taxation.

  • Business Profits

    The treaty provides guidelines for taxation of business profits, including provisions for permanent establishments. This helps prevent situations where a business could be taxed in both countries.

  • Dividends, Interest, and Royalties

    The treaty outlines specific withholding tax rates for dividends, interest, and royalties paid between residents of Mexico and the US. These rates are often reduced from the standard rates to promote cross-border investment.

  • Capital Gains

    The treaty defines how capital gains are taxed, especially regarding real property and business assets.

  • Employment Income

    The treaty provides rules for the taxation of employment income for cross-border workers, helping to prevent double taxation.

  • Pensions and Social Security

    Provisions are included to determine the taxation of pensions and social security benefits for individuals eligible for benefits in both countries.

  • Limitation on Benefits

    The treaty includes provisions to prevent abuse or improper use of the treaty’s benefits, particularly by third-country residents.

  • Exchange of Information

    The treaty facilitates the exchange of tax-related information between the two countries, which is crucial for enforcing tax laws and preventing tax evasion.

  • Non-Discrimination

    The treaty includes provisions to ensure that residents of one country are not subject to less favorable tax treatment than residents of the other country in similar circumstances.

It’s important to note that tax treaties can be complex, and their interpretation may vary depending on individual circumstances. Individuals and businesses seeking to take advantage of the benefits of the Mexico-US tax treaty should seek advice from qualified tax professionals with expertise in international taxation.

Foreign Earned Income Exclusion

The Foreign Earned Income Exclusion (FEIE) is a valuable tax provision for American expatriates, including those living in Mexico. It allows qualifying individuals to exclude a certain amount of their foreign-earned income from their US taxable income. Here are some key points to understand about the FEIE for American expats in Mexico:

  • Qualifying for the FEIE: To qualify for the FEIE, you must meet either the Physical Presence Test or the Bona Fide Residence Test. The Physical Presence Test requires you to be present in a foreign country (in this case, Mexico) for at least 330 full days during any 12-month period. The Bona Fide Residence Test involves establishing a true and continuous residence in a foreign country.
  • Exclusion Amount: For the 2022 tax year, a qualifying individual can exclude a maximum amount of $112,000 through the FEIE. 
  • Types of Income Covered: The FEIE applies to various types of earned income, including wages, salaries, professional fees, and self-employment income. It does not apply to passive income like dividends, interest, or rental income.
  • Reporting Requirements: To claim the FEIE, you must file a US federal tax return (Form 1040) and include Form 2555 (Foreign Earned Income) and any other required forms or schedules.
  • Documentation and Records: It’s crucial to keep accurate and detailed records of your presence in Mexico, including travel dates and supporting documents that substantiate your eligibility for the FEIE.
  • Limitations and Special Cases: Some individuals, such as certain US government employees or its agencies, may have additional considerations or limitations on their ability to claim the FEIE.
Taxes for Americans Living in Mexico - Beautiful Beach in Mexico

Foreign Tax Credit

The Foreign Tax Credit (FTC) is another essential provision for Americans living in Mexico. It allows individuals to offset their US tax liability by claiming a credit for income taxes paid to a foreign country. Here are key points to understand about the FTC for American expats in Mexico:

  • Qualifying for the FTC: To qualify for the FTC, you must have paid or accrued foreign income taxes to a foreign country, such as Mexico. This can include taxes on wages, self-employment income, and investment income.
  • Credit vs. Deduction: Unlike the Foreign Earned Income Exclusion (FEIE), which excludes a portion of the foreign-earned income from US taxation, the FTC is a dollar-for-dollar reduction of your US tax liability. 
  • Form and Calculation: You must file Form 1116 with your US federal tax return to claim the FTC. The calculation is based on the foreign taxes paid or accrued. The credit is limited to the lesser foreign taxes paid or a proportionate amount of the US tax on foreign income.
  • Carryovers and Carrybacks: Excess foreign tax credits can be carried forward for up to 10 years or carried back for one year to offset US tax in those years.
  • Types of Income Covered: The FTC applies to various types of foreign income, including wages, salaries, self-employment income, and certain passive income like dividends and interest.
  • Specific and General Categories: The FTC is divided into specific and general categories, each with its own rules and limitations. Specific categories include passive category income (such as dividends and interest) and general category income (including all other income types).
  • Limitations and Considerations: Certain limitations and complex rules apply to the FTC, including restrictions on claiming both the FTC and the FEIE for the same income.

Foreign Financial Accounts

  • Foreign Bank Account Report (FBAR)  

American citizens and residents must file an FBAR if they have a financial interest in or signatory authority over foreign financial accounts and if the aggregate value of those accounts exceeds $10,000 at any time during the calendar year. 

  • Foreign Account Tax Compliance Act (FATCA) 

FATCA was enacted to increase transparency and compliance with US tax laws by requiring foreign financial institutions (FFIs) to report information about financial accounts held by US taxpayers to the IRS. US persons, including American expatriates living in Mexico, must report their foreign financial accounts to the IRS by filing Form 8938 (Statement of Specified Foreign Financial Assets) and tax returns if they exceed specific thresholds.

Social Security and Medicare

Americans living in Mexico face specific considerations regarding Social Security and Medicare. While living abroad, individuals are generally still subject to US self-employment taxes if they’re self-employed, though the US – Mexico Totalization Agreement can help prevent double taxation. Moreover, it is important to note that Medicare benefits are typically not accessible abroad, necessitating alternative health coverage. Additionally, maintaining Medicare enrollment might be advisable for future coverage or to avoid potential penalties. 

Consulting a tax professional with expertise in international taxation and Social Security agreements is highly recommended to navigate these intricate matters and ensure compliance with US and Mexican regulations.

Seeking Professional Advice

Given the complexity of cross-border taxation, seeking advice from a qualified tax professional with expertise in international taxation is highly recommended. They can provide tailored guidance based on your situation and ensure US and Mexican tax laws compliance.

In conclusion, living in Mexico as an American expat offers many opportunities but requires careful attention to tax obligations. Understanding your residency status and filing requirements and leveraging provisions like the FEIE and FTC can lead to substantial tax savings. Therefore, consulting with a tax professional well-versed in US and Mexican tax codes is crucial for a smooth and compliant expatriate experience.