U.S. EXPAT TAX GUIDE – MEXICO
How does self-employment in Mexico affect your US taxes?
If you’re self-employed in Mexico, you still need to report your income on your US tax return. Self-employment income is subject to US tax rules, but the totalization agreement between the US and Mexico helps prevent double taxation.
If you’re paying into Mexico’s social security system, you may be exempt from paying US self-employment tax.
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Why does the US-Mexico totalization agreement matter?
The totalization agreement between the two countries is designed to avoid double contributions to social security systems. If you’re self-employed in Mexico and paying social security contributions there, you won’t need to pay US self-employment tax on that income.
This agreement is crucial for preventing the hefty 15.3% self-employment tax in the US from applying on top of Mexican taxes.
What is Form 8858, and do you need to file it?
Yes, if you’re self-employed in Mexico, you’ll need to file Form 8858. This form provides details about your foreign business, including income and expenses.
It is attached to your Form 1040 and Schedule C. Filing Form 8858 is crucial for keeping the IRS informed about your foreign earnings and avoiding penalties.
What happens if you fail to file Form 8858?
Failing to file Form 8858 can lead to significant penalties. The IRS imposes fines of up to US$10,000 for late filing or failure to file. Ignoring this requirement can cause further complications, especially if the IRS discovers the missing form before you address it.
What if you’ve missed filing Form 8858 for multiple years?
If you’ve been self-employed in Mexico for several years and haven’t filed Form 8858, it’s essential to get back on track.
You should consider working with a tax professional to assess whether amending past tax returns is necessary. If you qualify, the Streamlined Foreign Offshore Procedure can help you avoid hefty penalties while getting compliant with the IRS.
What forms are needed to report foreign self-employment income?
- Form 1040 & Schedule C: Report foreign-earned income on Schedule C attached to your Form 1040.
- Schedule SE: Calculate your self-employment tax on Schedule SE.
- Form 2555: If you qualify for the Foreign Earned Income Exclusion (FEIE), use Form 2555 to exclude up to US$126,500 (for 2024) of your foreign income.
- Form 1116: Use Form 1116 to claim a Foreign Tax Credit (FTC) to offset US tax liability.
- Form 8938: If your foreign financial assets exceed reporting thresholds, file Form 8938.
- FBAR (FinCEN Form 114): File an FBAR if the total value of your foreign bank accounts exceeds US$10,000 at any point during the year.
How does your business structure affect your self-employment taxes?
Income from a US LLC is generally reported on Schedule C of your Form 1040, and you’ll pay the 15.3% self-employment tax unless exempt under the totalization agreement.
For a foreign LLC, the tax treatment depends on how it’s classified. If it’s a disregarded entity or partnership, you report income on your personal return, and self-employment tax applies. If the LLC is treated as a corporation, self-employment tax may not apply, but the income may still be subject to other US tax rules like GILTI.
An S Corporation allows you to reduce self-employment tax by taking a portion of your income as a salary, subject to employment taxes, and the rest as a distribution, which isn’t subject to self-employment tax.
What are some things you should consider?
- Currency Conversion: All foreign income and expenses must be reported in US dollars. You can use the average exchange rate for the year or the rate on the date of each transaction. For up-to-date conversion rates, visit the Treasury Reporting Rates of Exchange.
- Documentation: Proper record-keeping is essential. Keep detailed records of your income, expenses, and foreign taxes paid to substantiate any deductions or credits you claim.
- Professional Assistance: It’s wise to consult with a tax professional who specializes in expat taxes. They can help you navigate the complexities of reporting foreign self-employment income and ensure you remain compliant with IRS rules.
Let’s take a look at a frequent scenario
Imagine you’ve been self-employed in Mexico for 10 years, diligently reporting income on Form 1040 and Schedule C, but never filed Form 8858.
In this case, consulting a tax professional could help you file the missing forms and avoid penalties. If you qualify for the Streamlined Foreign Offshore Procedure, you may be able to become compliant without penalties, potentially saving thousands of dollars in fines.
What is the Foreign Earned Income Exclusion (FEIE)?
The FEIE allows you to exclude up to US$126,500 of foreign-earned income from your US taxes, reducing your taxable income. To qualify, you must meet the Physical Presence Test, which requires spending 330 full days outside the US during a 12-month period.
How can the Foreign Tax Credit help?
If you pay taxes on your self-employment income in Mexico, you can use Form 1116 to claim a Foreign Tax Credit (FTC). This credit helps avoid double taxation by offsetting your US tax liability with the taxes paid in Mexico.
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.
