u.s. expat tax guide – mexico
How does GILTI impact US business owners in Mexico?
If you’re a US citizen with a business in Mexico, Global Intangible Low-Taxed Income (GILTI) may significantly affect your tax obligations.
GILTI applies if you own more than 50% of your business, classifying it as a Controlled Foreign Corporation (CFC). The US taxes this type of foreign business income, even if profits stay within the company and aren’t distributed.
What is a Controlled Foreign Corporation (CFC)?
A Controlled Foreign Corporation (CFC) is a foreign business where US shareholders own more than 50% of the company’s stock. As a result, the IRS requires additional filings, including Form 5471; you’ll need to report detailed information about the company’s finances, like profit and loss statements, balance sheets, and shareholder information.
How does GILTI apply to retained earnings?
One of the major consequences of GILTI is that it taxes your share of the company’s profits, even if you don’t take that money out of the business.
These retained earnings are still subject to US taxes under GILTI rules, so you may owe US taxes even if the profits are reinvested back into the company.
Can I use Mexican corporate taxes to reduce my GILTI tax?
Yes, you can lower your US GILTI tax by using Foreign Tax Credits (FTC). This credit allows you to subtract the taxes you paid in Mexico from your US tax bill, preventing you from being taxed twice on the same income.
However, the credit can only be applied if the taxes are for the same type of income.
What is the high-tax exclusion for GILTI?
You may qualify for the high-tax exclusion if your foreign income is taxed at a rate higher than 90% of the US corporate tax rate.
This exclusion allows you to avoid paying GILTI on income that is already taxed at high rates abroad, offering relief for US owners of businesses in high-tax countries like Mexico.
What is Section 962, and how does it help?
Section 962 is an election that lets individual shareholders be taxed at corporate rates, rather than at personal income tax rates (which can go as high as 37%).
If you elect Section 962, your GILTI income is taxed at the 21% corporate rate, and you can claim a 50% deduction on that income. However, any dividends you later receive will be taxed again when distributed.
Can I restructure my business to avoid GILTI?
Yes, one common strategy to avoid GILTI is to reclassify your business as a disregarded entity or a sole proprietorship. This eliminates GILTI, as the business’s income flows directly to your personal tax return, bypassing GILTI reporting requirements.
To do this, you must file Form 8832 with the IRS, reclassifying your Mexican business from a corporation to a different entity type.
What are the benefits of reclassifying a business?
Reclassifying your Mexican business simplifies your tax obligations by eliminating the need to file Form 5471 and avoiding GILTI taxes.
However, it also means the business’s income is treated as personal income, potentially increasing your self-employment tax. Under the US-Mexico Totalization Agreement, though, you won’t have to pay social security taxes in both countries, so this reclassification can reduce complexity.
How does GILTI impact small business owners?
For small business owners, GILTI can be a significant tax burden since it taxes your company’s earnings, even if you haven’t taken out those profits as distributions.
Using tools like the Section 962 election, the Foreign Tax Credit, or even reclassifying the business as a sole proprietorship can help reduce or eliminate your GILTI liability.
Can splitting ownership with a spouse reduce GILTI?
Unfortunately, splitting ownership with a non-US spouse doesn’t avoid GILTI. The IRS uses constructive ownership rules, meaning they combine ownership among family members. So, even if you own less than 50% of the company directly, if combined family ownership exceeds 50%, GILTI still applies.
Should I consider reclassifying my business to avoid GILTI?
If GILTI presents a heavy tax burden, reclassifying your business as a sole proprietorship or disregarded entity can be a smart move.
By doing so, you report the income on your personal tax return, avoiding GILTI reporting and Form 5471. However, it’s essential to consult with a tax advisor before making this change.
What happens if I reclassify my business?
If you reclassify your Mexican business as a disregarded entity or sole proprietorship, its income will be reported directly on your personal US tax return.
You’ll no longer need to file Form 5471 or deal with GILTI, but you’ll need to pay self-employment taxes on the business’s income. The US-Mexico Totalization Agreement can help prevent paying social security taxes in both countries.
Should married couples reclassify jointly-owned businesses?
No. Reclassification as a sole proprietorship is only available to businesses with a single owner. If you and your spouse jointly own the company, you’ll still need to file Form 5471 and report any GILTI income. Both spouses will be considered for ownership purposes, and GILTI will still apply.
How do I start reclassifying my business to avoid GILTI?
To reclassify your business, file Form 8832 with the IRS, requesting a change in entity classification. Once approved, you can start reporting the business’s income directly on your personal tax return, simplifying your tax obligations and eliminating GILTI.