U.S. EXPAT TAX GUIDE – MEXICO
What must I report to the IRS if I own a business in Mexico?
If you’re a US citizen owning a business in Mexico, IRS reporting is mandatory if you hold more than 10% of a foreign corporation, such as a Mexican LLC (S. de R.L.) or a stock corporation (S.A. de C.V.). In this case, you will need to file Form 5471.
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It requires you to submit details on the company’s income, profits, balance sheets, and other financial information.
If you own less than 10% of the business, reporting isn’t necessary for the IRS. However, make sure you monitor any changes to ownership percentages, as crossing the 10% threshold would trigger reporting obligations.
When do I have to submit Form 5471?
You must submit Form 5471 if you own more than 10% of the foreign corporation or serve in key roles such as a director, officer, or significant shareholder.
If US shareholders (like yourself) hold more than 50% of the business, the IRS classifies it as a Controlled Foreign Corporation (CFC). In this case, you’ll need to file additional schedules within Form 5471 to provide further information, including profit/loss statements and balance sheets.
What is a Controlled Foreign Corporation (CFC), and why does it matter?
A CFC refers to any foreign corporation where US shareholders own more than 50% of the company’s total shares. Shareholders must be US persons holding at least 10% of the company’s stock or value.
CFCs bring additional filing obligations under Form 5471, where specific schedules, such as earnings, income, and ownership details, are required. It also introduces Subpart F income rules, which may affect your US tax bill, as certain types of income will be taxable even if they haven’t been distributed.
How is Subpart F income treated for US tax purposes?
Subpart F income includes passive income such as dividends, interest, rents, and royalties, which are immediately taxable to US shareholders in a CFC.
This means that even if these earnings stay within the company and are not distributed, they are subject to US tax.
Can I use Mexican corporate taxes to lower my US tax bill?
Yes. Corporate taxes paid in Mexico can offset your US tax obligations under the Foreign Tax Credit (FTC).
This credit applies to taxes paid on the same income, helping to prevent double taxation. For example, if you paid taxes to the Mexican government on your company’s income, you can claim this as a credit on your US tax return to reduce your total US tax liability.
Does splitting business ownership with my spouse avoid Form 5471?
No. Splitting ownership with your non-US spouse (or another family member) to keep your ownership below the 10% threshold does not exempt you from Form 5471 requirements.
The IRS applies constructive ownership rules, which combine ownership interests among family members. Even if your non-US spouse owns a larger portion, the IRS counts combined ownership when determining reporting thresholds.
What if I transfer my shares to a relative—will this help avoid filing?
No. Even if you transfer business shares to a relative, you can’t avoid the requirement to file Form 5471. Under the IRS’s constructive ownership rules, related parties (like your children or spouse) are considered together for ownership purposes.
As a result, transferring shares won’t shield you from the reporting requirements.
Can I avoid Form 5471 by reclassifying my company?
Yes. If your business qualifies, you can elect to reclassify the company and treat it as a disregarded entity or sole proprietorship for US tax purposes.
This way, you avoid the complexities of Form 5471 and report your business activities on Schedule C as part of your individual tax return. However, reclassifying your entity requires filing Form 8832 with the IRS to request this change.
What happens when I reclassify my company?
Reclassifying your Mexican business as a sole proprietorship means the income is treated as self-employment income on your US tax return. While this increases personal tax obligations, it eliminates the need to file Form 5471.
Moreover, the totalization agreement between the US and Mexico prevents double payment of social security taxes, as your contributions to Mexico’s social security system (IMSS) exempt you from US self-employment taxes.
Can married couples reclassify jointly owned businesses?
No. Reclassification to a sole proprietorship is only available if you are the sole owner. If you and your spouse jointly own the business, you cannot elect for sole proprietorship treatment.
In this case, you’ll still need to file Form 5471 for the company, and both owners must be considered for reporting purposes.
What’s the process to reclassify a business?
To reclassify a business from a foreign corporation to a disregarded entity (sole proprietorship), you must file Form 8832, requesting a change in classification. The IRS will then review and approve the request, allowing you to start reporting income directly on your personal tax return.
Do I need IRS approval to treat my business income as self-employment income?
Yes. You cannot simply start treating your Mexican company as self-employment income without IRS approval.
You must file Form 8832 to request reclassification, and only after the IRS approves can you report it as part of your US tax return. This step ensures your income is taxed correctly and according to US law.
Should I get help reclassifying my business?
Yes. Consulting with a tax professional is highly recommended when reclassifying your business. The process can be complicated, and mistakes in filing Form 8832 or misclassifying your business can result in penalties.
Why partner with a specialist Expat accountant?
Living outside of the US can make your tax filing requirements complicated. To ensure you pay the minimum amount of taxes, it’s critical to work with an accountant who understands every aspect and avenue for reducing your tax liability. We have a dedicated team of tax accountants who work exclusively with US expats earning and investing in Germany. Partnering with a specialist expat accountant can help you navigate complex tax regulations and optimize your tax situation.
