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u.s. expat tax guide – mexico

How does being self-employed in Mexico impact your US taxes?

Even if you’re living in Mexico and running your own business, you still need to report your income to the IRS. 

Self-employment income is subject to US tax rules, but thanks to the US-Mexico Totalization Agreement, you won’t have to pay self-employment tax in both countries if you’re contributing to Mexico’s social security system.

Why is the US-Mexico Totalization Agreement important?

The Totalization Agreement ensures that US expats don’t pay social security taxes twice. So if you’re self-employed and paying into Mexico’s social security system, this agreement keeps you from having to also pay US self-employment tax, which is 15.3%.

What is Form 8858, and do you need to file it?

Yes, you’ll need to file Form 8858 if you’re self-employed in Mexico and have a foreign entity like an LLC. 

This form provides a breakdown of your business income and expenses to the IRS. It’s filed along with your Form 1040 and Schedule C and is important to avoid IRS penalties for missing information.

What happens if you forget to file Form 8858?

Failing to file Form 8858 can lead to some pretty steep penalties—up to US$10,000 for each missed filing. If you’ve missed it for multiple years, you might want to look into the Streamlined Foreign Offshore Procedure, which can help you catch up without facing hefty fines.

Which forms are required for foreign self-employment income?

To report your foreign self-employment income, you’ll need:

  • Form 1040 & Schedule C: This is where you report your income and expenses.
  • Schedule SE: To calculate any US self-employment tax you might owe.
  • Form 2555: Use this to claim the Foreign Earned Income Exclusion (FEIE) if you qualify.
  • Form 1116: This lets you claim the Foreign Tax Credit if you’re paying Mexican taxes.
  • FBAR (FinCEN Form 114): If your foreign accounts exceed US$10,000, you’ll need to file this.

How does your business structure affect your US taxes?

The type of business structure you have—LLC, sole proprietorship, or corporation—affects how your income is taxed:

  • If you own a US LLC, you’ll report your income on Schedule C and pay self-employment tax unless exempt under the Totalization Agreement.
  • For a foreign LLC, how the income is taxed depends on its classification. If it’s a disregarded entity or partnership, it’s taxed on your personal return, and you may owe self-employment tax.
  • S Corporations allow you to split your income between salary and distributions, potentially lowering your self-employment tax.

What about currency conversion and keeping records?

When you report foreign income to the IRS, it must be converted to US dollars. The IRS allows you to use either the average exchange rate for the year or the rate on the day of each transaction.

What is the Foreign Earned Income Exclusion (FEIE)?

The FEIE allows US expats to exclude up to US$126,500 of foreign-earned income from their US tax return (as of 2024). To qualify, you’ll need to meet the Physical Presence Test, which requires you to spend at least 330 days outside the US over a 12-month period.

What is the Foreign Tax Credit (FTC)?

If you’re paying income taxes in Mexico, you can use Form 1116 to claim the Foreign Tax Credit. This prevents you from being taxed twice on the same income by crediting the taxes you’ve already paid in Mexico against your US tax liability.

Missed filing Form 8858? What should you do?

If you’ve missed filing Form 8858 for several years, don’t panic. Consider working with a tax professional to amend your tax returns. Programs like the Streamlined Foreign Offshore Procedure can help you become compliant without penalties, saving you from potential fines that could add up.

How can a tax professional help?

A tax professional familiar with expat taxes can ensure that you stay compliant with IRS rules, especially if you’ve missed filings or need to navigate complex forms like Form 8858. They can also help you take full advantage of the FEIE, FTC, and other credits or exclusions available to US expats.

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