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Tax guide for Americans in Mexico

Tax guide for Americans in Mexico

Navigating the complexities of tax laws is a critical aspect for US expats living in Mexico.

One of the fundamental distinctions in the Mexican tax system is between residents and non-residents. This distinction has a significant impact on how individuals are taxed and what their obligations are.

Table of contents

  1. Residents vs. non-residents of Mexico
  2. Who can be considered a resident of Mexico
  3. Types of taxes in Mexico
  4. Tax rate in Mexico compared to the US
  5. Filing a tax return in Mexico
  6. Types of income in Mexico
  7. Social security in Mexico
  8. Pension system in Mexico
  9. Tax deductions for expats in Mexico
  10. Tax credits for expats in Mexico
  11. The tax treaty between the USA and Mexico
  12. Most popular tax forms for US expats
  13. Mexico tax forms for US expats

Residents vs. non-residents of Mexico

The Mexican tax system distinguishes between residents and non-residents, each with different tax implications.

  • Individuals classified as residents of Mexico are subject to tax on their worldwide income.
    This means that all income, regardless of where it is earned, is potentially taxable in Mexico.
    Residents also have access to certain tax credits and deductions that may reduce their overall tax liability.
  • Non-residents, on the other hand, are taxed only on their income derived from Mexico.
    This includes income earned in the country, such as wages from employment in Mexico or rental income from Mexican property.
    Non-residents are generally not entitled to the same range of deductions and credits as residents.

Who can be considered a resident of Mexico

The determination of tax residency in Mexico is based on certain criteria:

  1. Physical presence test: The simplest criterion is the amount of time spent in Mexico. If an individual spends more than 183 days in Mexico in a calendar year, he or she is generally considered to be a tax resident.
    These days do not have to be consecutive.
  2. Centre of vital interests: This criterion is more subjective and takes into account where the individual has their primary economic or personal interests.
    If the core of an individual's economic activities or the centre of their personal and family life is in Mexico, they may be considered a resident for tax purposes.
  3. Permanent Home: If an individual has a permanent home in Mexico, this can also be a factor in determining residency.
    However, if they also have a permanent home in another country, the location of their centre of vital interest will usually be the determining factor.
  4. Mexican nationality: Mexican citizens are often considered residents for tax purposes, although this is not an absolute rule and other factors may influence this determination.

Types of taxes in Mexico

Mexico's tax system includes several types of taxes, each with its own set of rules and rates.

Understanding these taxes is essential for anyone living or doing business in Mexico, especially US expats who must navigate both the Mexican and US tax systems.

Personal income tax rates

In Mexico, personal income tax rates for resident individuals are progressive based on taxable income. The following tax rates are effective for the calendar year 2023:

Taxable income (MXN) Tax rate (%)
0.01-8,952.49 1.92
8,952.50-75,984.55 6.40
75,984.56-133,536.07 10.88
133,536.08-155,229.80 16
155,229.81-185,852.57 17.92
185,852.58-374,837.88 21.36
374,837.89-590,795.99 23.52
590,796-1,127,926.84 30
1,127,926.85-1,503,902.46 32
1,503,902.47-4,511,707.37 34
4,511,707.38 and above 35

For non-residents, the tax rates are as follows:

Taxable income (MXN) Tax rate (%)
0-125,900 Exempt
125,900-1,000,000 15
1,000,000 and above 30

Value Added Tax

VAT is a consumption tax levied on the sale of goods and services in Mexico. It is an indirect tax, which means it is collected by businesses on behalf of the government and included in the price of goods and services.

Key aspects of VAT in Mexico include:

  1. Standard rate: The standard VAT rate in Mexico is 16%. This rate applies to most goods and services.
  2. Reduced rate: In some regions, particularly near the border, a reduced VAT rate may apply.
    This is part of Mexico's strategy to remain competitive with neighbouring countries.
  3. Exemptions and zero rates: Certain goods and services are exempt from VAT or taxed at a zero rate.
    Basic foodstuffs, medicines and educational services are examples of items that may fall into these categories.

Businesses can claim credit for the VAT paid on their inputs, which helps to prevent the cascading effect of taxation.

Wealth tax

There is currently no specific wealth tax levied on individuals in Mexico.

Inheritance tax

Mexico is notable for having no inheritance tax. When an individual inherits property or assets in Mexico, they do not have to pay tax on the value of the inherited assets.

This is a significant difference from many other countries where inheriting assets can often result in a significant tax burden.

Estate tax

Similar to inheritance tax, there is no estate tax in Mexico upon the death of an individual.

Gift tax

Gifts in Mexico are generally considered part of the recipient's taxable income. This means that if you receive a gift, its value may be subject to income tax, depending on certain conditions and exemptions.

There are exemptions based on the relationship between the giver and the recipient.

For example, gifts between close family members may not be taxable.

Property tax

Known as 'Impuesto Predial', it is paid annually and is based on the assessed value of the property.

The rate of property tax varies according to location and municipality. It is generally a small percentage of the assessed value of the property.

Payroll tax

In Mexico, payroll taxes are mainly levied by the states on salaries, although they do not apply to income in general.

Most Mexican states levy a relatively low tax rate on salaries. Mexico City, for example, levies a 3% payroll tax.

This tax is usually paid by the employer, not the employee.
For employers, the payroll tax is a tax-deductible expense that can be included in their overall business tax calculations.

Tax rate in Mexico compared to the US

When comparing tax rates in Mexico with those in the United States, there are several key differences:

Category Mexico USA
Corporate tax rate 30% 21%
Top individual income tax rate 35% 37%
VAT 16% Varies by state (average around 7.25%)
Capital gains tax rate 10% to 35% 0% to 20%
Dividend tax rate 10% 0% to 20%

Filing a tax return in Mexico

When to file a tax return in Mexico

The process and timeline for filing income tax returns in Mexico differs from the US system:

  • Taxpayers in Mexico are required to file income tax returns annually.
  • The standard deadline for filing individual income tax returns in Mexico is 30 April of the year following the tax year.
  • The fiscal year in Mexico, as in the US, is the calendar year, running from 1 January to 31 December.
  • Unlike the US, Mexico generally does not offer the option of filing an extension for individual tax returns.
  • The Mexican Tax Agency (SAT) offers an online filing system, which is the most common method used by taxpayers.

How to file a tax return in Mexico

Filing a tax return in Mexico involves a number of steps that are important for both residents and non-residents earning income in Mexico. Here's a general guide to the process:

  1. Before filing a tax return in Mexico, you must obtain a Registro Federal de Contribuyentes (RFC) number, which is the Mexican tax identification number. This can be obtained from the Mexican tax authority, the Servicio de Administración Tributaria (SAT).
  2. Gather all relevant financial documents, including proof of income, receipts for deductible expenses, and any other relevant financial records.
  3. The SAT provides an online platform for individuals to file their tax returns. This system is designed to simplify the filing process.
  4. Fill in the electronic tax return form on the SAT website. The form requires detailed financial information, so it's important to have all your documents at hand.
  5. The online system will calculate your tax liability based on the information you provide. Check this carefully to ensure accuracy.
  6. Once you have completed and checked the form, submit it through the SAT portal.
  7. If you owe tax, you can pay online through the SAT portal. Several payment options are available, including direct debit and bank transfer.
  8. After filing, keep a copy of your tax return and any payment receipts. These records are important for future reference and in the event of queries from the tax authorities.

Penalties for late or incorrect filing

Failure to file a tax return on time or providing incorrect information can result in penalties in Mexico:

  • If you miss the 30 April deadline, you may be subject to late filing penalties. These penalties are usually calculated as a percentage of the tax due and increase over time.
  • In addition to late penalties, interest may be charged on the outstanding tax amount. The interest rate is set by the Mexican tax authorities.
  • Filing a tax return with errors or incomplete information can also result in penalties. It's important to ensure that all information is accurate and complete to avoid these penalties.
  • In cases of tax evasion, which involves deliberately misrepresenting or concealing information, the consequences can be more severe, including legal action.

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Types of income in Mexico

In Mexico, different types of income are subject to taxation, each with its own set of rules and regulations.

Understanding these different types of income is crucial for taxpayers, including expats, to ensure proper reporting and compliance with Mexican tax laws.

Employment income

Employment income is one of the most common types of income and includes all income received from work, whether as an employee or as an independent contractor. Here are the main aspects of earned income in Mexico:

  • Salary and wages: This is the simplest form of employment income and includes regular payments made by an employer to an employee.
  • Bonuses and commissions: Additional income such as bonuses, commissions and other incentive payments are also considered part of employment income and are taxable.
  • Benefits in kind: Non-monetary benefits provided by an employer, such as housing, cars or insurance, may be considered part of taxable employment income.

Equity compensation

Equity compensation refers to non-cash compensation that represents ownership in the company, such as stock options, restricted stock and performance shares. In Mexico, equity compensation is becoming more common, especially in multinational companies and start-ups.

Key issues include:

  • Taxation at vesting or exercise: Equity compensation is generally taxed at the time of vesting (for restricted stock) or exercise (for stock options). The taxable amount is the fair market value of the shares at that time.
  • Capital gains: If there is a subsequent sale of the shares, any gain realized over the value at vesting or exercise is usually treated as a capital gain and subject to capital gains tax.

Business income

Business income in Mexico refers to income earned from commercial, industrial, agricultural, or professional activities. This type of income is particularly relevant for entrepreneurs, business owners and the self-employed.

Capital Gains

Capital gains tax in Mexico applies to the profit made from selling assets such as real estate, stocks, or other investments. Key points to consider are:

  • Taxable event: A capital gain is typically realized when an asset is sold for more than its purchase price.
  • Real estate capital gains: For real estate, the gain is the difference between the selling price and the adjusted basis of the property, which takes into account any improvements and depreciation.
  • Stocks and securities: Gains from the sale of stocks, bonds, and other securities are also subject to capital gains tax.

The tax rate for capital gains can vary based on the type of asset and the duration of ownership. Long-term gains may be taxed differently from short-term gains.

Dividend income

Dividend income in Mexico is taxed differently from regular income and has its own set of rules:

  • Dividends are distributions of a company's profits to its shareholders and can come from Mexican or foreign companies.
  • In Mexico, profits distributed as dividends are already taxed at the corporate level. However, there is an additional tax at the individual level.
  • Dividends paid by Mexican companies are subject to a withholding tax, which is usually deducted by the company before distribution.
  • Foreign dividends are included in the individual's taxable income and taxed at the individual's regular income tax rate. Foreign tax credits may be available to avoid double taxation.

Interest income

Interest income is a common form of income in Mexico, especially for those with savings or investments. It includes income from bank deposits, bonds, and other interest-bearing financial instruments.

Here are some key points:

  • Interest from Mexican or foreign sources is considered taxable income in Mexico. This includes interest from savings accounts, time deposits, bonds, and other similar investments.
  • Banks and financial institutions in Mexico often withhold tax on interest income. The rate may vary depending on the type of investment and the amount of interest earned.
  • For tax residents, foreign interest income is also subject to taxation in Mexico. Foreign tax credits may be available to avoid double taxation.

Rental income

Rental income is another important type of income in Mexico, especially for those who own property and rent it out.

Key aspects include:

  • Income from the rental of property in Mexico is taxable. This applies to both residential and commercial property.
  • Property owners can deduct certain expenses related to the rental property, such as maintenance, repairs, property management fees, and property taxes, from their rental income.
  • In some cases, rental income can be taxed at a flat rate, which simplifies the tax calculation process.
  • Non-residents who receive rental income from Mexican real estate are also subject to Mexican income tax on that income.

Tax haven investments

Investments in tax havens can be a complex area in terms of taxation, particularly for Mexican tax residents.

Mexico has specific criteria for defining tax havens, generally focusing on jurisdictions with significantly lower tax rates than Mexico.

Mexican tax residents are required to report their investments in tax havens. Failure to do so may result in severe penalties.

Mexico has CFC rules that may attribute income earned by foreign entities controlled by Mexican residents to those residents for tax purposes.

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Social security in Mexico

This is a comprehensive system designed to provide workers with a range of benefits including health care, retirement, and social services.

This system is particularly relevant to both local workers and expats working in Mexico.

An overview is provided below:

  1. Participation in the Mexican social security system is mandatory for everyone working in Mexico. Both employers and employees pay contributions based on the employee's salary.
  2. The Social Security system provides access to health care, including medical, surgical, pharmaceutical, and hospital services.
  3. The social security system also provides disability benefits, unemployment insurance, and assistance for occupational accidents and diseases.
  4. The social security system provides maternity leave, childcare services, and family benefits.

Pension system in Mexico

The pension system in Mexico is a key component of the social security framework, The pension system is primarily contributory, meaning that the benefits received depend on the amount and duration of contributions paid during an individual's working life.

Here are some key aspects:

  • The pension system is primarily contributory, meaning that the benefits received depend on the amount and duration of contributions paid during an individual's working life.
  • The standard retirement age in Mexico is 65, although early retirement options are available under certain conditions.
  • Employees in Mexico have individual retirement accounts (AFOREs) in which their pension contributions are accumulated.

Tax deductions for expats in Mexico

Expatriates living and working in Mexico may be eligible for various tax deductions that can significantly reduce their taxable income and overall tax liability.

Personal deductions

Personal deductions in Mexico allow individuals to reduce their taxable income by deducting certain personal expenses.

These deductions are subject to limits and specific conditions established by the Mexican tax authorities.

Education Expenses

Education expenses, including school and university tuition fees, may be deductible under certain conditions.

There are limits to the amount that can be deducted, and these generally apply to education expenses within Mexico.

Proper documentation and receipts are required to claim these deductions, and the educational institution must be recognized by the Mexican education authorities.

Standard deductions

In Mexico, standard deductions are a fixed amount that taxpayers can deduct from their gross income to reduce their taxable income. These deductions are designed to simplify the tax filing process for individuals who may not have significant itemized deductions.

The standard deduction is a fixed amount set by the Mexican tax authorities. It applies to all taxpayers who don't itemize their deductions.

Opting for the standard deduction simplifies the tax filing process, as it requires less documentation and detailed record-keeping than itemizing deductions.

All taxpayers are eligible for standard deductions, but it's important to evaluate whether standard or itemized deductions are more beneficial based on your individual financial situation.

Business deductions

For expats running a business or working as independent contractors in Mexico, business deductions play a crucial role in reducing taxable income.

These deductions include:

  • Business expenses: Expenses incurred in running a business, such as rent, utilities, supplies, and salaries, are deductible.
  • Capital expenditure: Investments in business assets that have a useful life beyond the tax year can also be deducted, subject to depreciation rules.
  • Travel and entertainment: Business-related travel and entertainment expenses are deductible, but must be documented and justified as necessary for the conduct of business.
  • Professional services: Fees for professional services such as legal, accounting, or consultancy services are also deductible for business expenses.

Losses

Losses incurred in business or investment activities can be used to offset taxable income in Mexico.

This includes:

  • Business losses can be carried forward to offset future profits, subject to certain limitations and conditions.
  • Losses from the sale of capital assets, such as real estate or stocks, can be used to offset capital gains.

Proper documentation of losses is essential for them to be recognized by the tax authorities.

There may also be limits on the amount of losses that can be carried forward and for how long.

Tax credits for expats in Mexico

Tax credits are an important aspect of the tax system for expatriates living in Mexico, as they can directly reduce the amount of tax owed. Unlike deductions, which reduce taxable income, tax credits reduce the tax bill on a dollar-for-dollar basis. Here are some key points:

  • Foreign Tax Credit: Expats who pay taxes in both Mexico and their home country may be eligible for a foreign tax credit. This credit is designed to prevent double taxation on the same income.
  • Education credits: Credits may be available for education expenses, particularly for expats with children attending qualifying educational institutions in Mexico.
  • Energy Efficient Investments: Credits may be available for investments in energy-efficient technology or renewable energy sources in homes or businesses.
  • Childcare credits: For expats with children, credits may be available for childcare expenses, helping to reduce the overall tax burden.

The tax treaty between the USA and Mexico

The United States and Mexico have a tax treaty designed to prevent double taxation for individuals and companies operating in both countries.

This treaty covers various forms of income and provides specific rules for taxation.

Benefits of tax treaties

  1. Avoid double taxation: The main benefit of a tax treaty is to ensure that income earned in one country is not taxed in both countries.
    It provides mechanisms for tax relief through credits, exemptions, or reduced tax rates.
  2. Clearer withholding tax rates: The treaty provides for reduced rates or exemptions for certain types of cross-border payments, such as dividends, interest, and royalties.
  3. Residence determination: The treaty helps determine the tax residency of individuals and companies, which is crucial for understanding tax obligations.
  4. Mutual agreement procedure: The treaty provides a framework for resolving tax disputes between the two countries, offering a clearer path for taxpayers facing double taxation issues.

Most popular tax forms for US expats

For US expats living in Mexico, it is important to comply with both US and Mexican tax laws. This includes understanding and correctly completing various tax forms.

Some of the most common tax forms for US expats include:

  1. Form 1040: The standard IRS form for US citizens and residents to file an annual income tax return.
  2. Form 2555 (Foreign Earned Income Exclusion): This form is used to claim the Foreign Earned Income Exclusion, which allows US expats to exclude a certain amount of their foreign-earned income from their US taxable income.
  3. Form 1116 (Foreign Tax Credit): For those paying taxes in Mexico, this form is used to claim a credit for income taxes paid to a foreign government, helping to avoid double taxation.
  4. FBAR (Foreign Bank and Financial Accounts Report): US expats with foreign bank accounts that exceed certain thresholds must file an FBAR electronically using FinCEN Report 114.
  5. Form 8938 (Statement of Specified Foreign Financial Assets): This form is required for US citizens with specified foreign financial assets that exceed the reporting threshold.

Mexico tax forms for US expats

US expats in Mexico need to be familiar with Mexican tax forms, especially if they have sources of income or assets in Mexico.

Some of the most important forms are:

  1. Declaración Anual (Annual Tax Return): This is the primary form used for filing individual income taxes in Mexico.
  2. Declaración de Pagos Provisionales (Declaration of Provisional Payments): For those who make monthly provisional tax payments, this form is used to report and pay these taxes.
  3. Aviso de Compensación (Notice of Compensation): Used to report any tax offsets or compensations.
  4. Various VAT forms: For those involved in activities subject to VAT, specific forms are required for reporting and payment.