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DERREN JOSEPH:
Okay. We are live. Welcome to the latest in our series of live streams on tax. That exciting topic. Thank you for joining us this evening. We have Carlos Morales who is going to join us for discussion on US/ Mexico tax issues. Please know that this is being live stream and it is being recorded. So, if you do not want your image to be captured, please switch off your camera. Otherwise, you will be recorded. And in the box below, you can type your questions. If you’re on zoom, if you’re on Facebook or LinkedIn, similarly, you can type your questions down below and we will get them in the order in which you submit them.
Thank you to those who submitted questions in advance. We got, I think, 10 or 11 questions in advance, which we will go through as well, but feel free to type your questions down below. So, here’s how we’re going to do it. I’m just going to talk for not too long, probably like 10 minutes or so, just on the principles of US tax for those residing outside of the US and then Carlos was going to say a few words and we’ll just jump into the Q and A and just get right to it. So, without further ado, I’m going to share my screen first for a few slides. Okay. All right.
So as previously mentioned, my name is Derren Joseph and I run a small international tax team within Moores Rowland in Asia Pacific. I’m actually based in Singapore where we do international tax in general, but US international tax in particular. Our team is also a member of Fusion International. So that gives us access to expertise predominantly in Europe, but also in Mexico, which is how we have this great relationship with Carlos and his team as well, because I am licensed by the US Department of Treasury. I’m legally required to say that everything that we discuss here this evening should not be construed as advice. I may be a tax professional, but I’m not your tax professional. Considered this an educational piece, nothing that we say here should be construed as encouraging you to pay less than your fair share of taxes in any jurisdiction in which you are exposed. To get advice specific to your situation you need to engage a tax professional who will get to know you inside out and can give advice specific to your situation. So, this evening we’re having a general conversation, general principles. So, disclaimer in writing.
So, some of the quick takeaways, and I’ll just jump into it. As you are aware, the US is one of many countries that practices worldwide taxation. So most developed countries, I dare say. So, Europe, Japan, Australia, New Zealand, Canada, they all practice worldwide taxation. So, once you are tax resident in their jurisdiction, you’re subject to taxes on your worldwide income. As you are in Mexico. What makes the us different is that, it’s really, really difficult to sever tax residency with the US. What it essentially requires is you to surrender your US passport or green card.
With the other jurisdictions, once you leave. And, you check the box in certain things that you need to do, you can to some extent, sever tax residency, with these other jurisdictions, with the US you cannot. So just to cut to the chase, regardless of how long you reside in Mexico, you will be subject to your tax. You will be subject to US tax on your worldwide income, that will not change. So, then people ask, well, you know, hold on, I’m in Mexico, I’m outside of the US how is the US government going to figure out what I’m up to, come on? And the answer is this FATCA, the Foreign Account Tax Compliance Act.
So, what does that mean? Basically around 2010 or so, the US passed certain legislature, certain laws in Congress, and it empowered the US government to go around the world and signed bilateral agreements where countries all over the world and countries that you think would not want to sign anything with the US like China and Russia, they actually did sign. So, I’d say most of the places that you’d want to go to aside from, let’s say, Cuba, North Korea, Iran. Most countries would have signed this bilateral agreement with the US and what does this agreement entail?
These rules allowed countries like Mexico to set aside their domestic bank secrecy laws. I’m going to repeat that they have set aside their domestic bank secrecy laws. And they look at every financial institution, looks through their accounts, look through their account holders and anyone that they suspect of being US exposed the suspect. So even if you, because you know, like many of us, we travel a lot, we have more than one passport. Maybe you could open an account with another passport, but even if you do, if that customer service person suspects that you are US exposed, and then number of ways in which that suspicion can arise, which we don’t probably need to get into, if they suspect that you are, they’re legally required to report you to the US government.
So that’s a check and balance in the system. And that’s basically how FATCA works. So FATCA is not a tax, it’s a framework of information exchange between countries like Mexico and the US government. And there’s something called the common reporting standard, which we can get into as people ask questions about it.
Now here’s really the takeaway. This is an acronym that I created that I thought was really helpful to US exposed persons who reside outside of the US and when I tell them to do is basically do your BEST. And what do I mean by that? B- pay attention to your bank accounts. And when I say bank by extension, I mean all financial accounts, maybe a brokerage account, an investment account, or whatever, every financial account you have outside of the US, once it passes certain thresholds, which we can get into needs to be reported to treasury every financial account that you have once it passes, certain threshold must be reported to treasury. And this is not a new rule, this dates back to 1970, 1971 with the Bank Secrecy Act. So, pay attention to your bank accounts. It doesn’t normally figure in the calculation of any tax liability, it is simply a reporting requirement, because what you’re going to soon figure out is that when it comes to international tax, the US government is less concerned with revenue collection than it is with data collection.
Data is more important than money when it comes to international taxes. And that’s for a number of reasons which we can probably get into in the Q and A. So, if you don’t pay your taxes, okay, well, penalties and interest, right? But if you don’t report bank accounts in Mexico and anywhere outside of the US, it could be up to 50% of the unreported balance. So, I give people the example of a case, where there was a dentist. I think a dentist in Florida, many cases like this typical one, he had a million dollars in a bank account outside of the us, and he did not report it on his tax returns. And what was the penalty? The IRS held that he did not report that bank account for three years, and they went for the maximum, so 50% of the unreported balance. So, in other words, they levied a penalty on him of $1.5 million in an account with $1 million in it. So again, once you have a bank account on one side of the US, there’s no wealth tax or anything like that yet, where you’ll be paying tax on the balance. So, all you need to do is report the existence of the account. And of course, you report the interests or dividends or whatever, but please pay attention to your bank accounts.
Next estimated taxes. When you were in the US, typically you’ll get paid on a W2 and there will be withholding every fortnight every month, though, as the case may be when you’re outside and you’re earning money, there’s typically no opportunity for withholding and money to be sent to the IRS. And the IRS does not like to wait until the end of that a year to get paid on earnings that you made during the year, right? So, you working with whichever tax team you decide to work with, or if you decided to do it yourself, of course, please make sure that you calculate what the estimated taxes would be. So, in this case, it’d be for 2021. So, you should have been calculating what your estimated taxes will be for 2021, and be prepared to make four quarterly payments to the IRS. Otherwise, you’ll be hit with underpayment penalties and interest. So estimated taxes, please pay attention to it.
Next in terms of do your BEST, S as in state tax issues. Some of you sent in questions, and basically you have 50 different states, 50 different rules. And for the most part, most states are domicile states. What does that mean? It means that under certain circumstances, you may still be attached to those states, or if you’re, even if you’re not, and you have state source income, you like you have rental property in whatever state you were last resident in be aware that you may have a state reporting and a tax filing requirement. And again, you need to speak with a tax professional who understands your situation, but pay attention to state tax issues. And again, people tell me, well, I’m in Mexico. I live outside of the US who cares, how are they’re going to do find me? Well, we’ve had so many clients at some point in time, they returned to the US and then returned to their home state. And once the state figures out the franchise tax board figures out that you got hit with a big penalty plus, outstanding and taxes. So, they do wait for you and states talk to the federal government. There’s a communication line between the state and the IRS. So, the states tend to be aware of what you filed with the IRS and vice versa. So please bear that in mind.
Last but not least transfer taxes. Everyone and most people tend to be clued up on the fact that, hey, their income taxes, but there are reporting requirements and sometimes taxes on transfers. And what I mean by transfers, I mean, gifts, you know, you’re living in Mexico, for example, you get into a relationship, personal and professional with someone else in Mexico. And then you may invest, you may transfer, you may gift, or you may receive gifts or whatever the case may be. Again, over certain thresholds gifts made to or received from foreign nationals are reportable on tax returns. And the penalty could be up to 30% of the unreported gift. So, pay attention to that. And unfortunately, it’s a bit of a morbid topic, but estate tax is something to talk about, especially right now, when there’s obviously a health crisis that we’re going through. And this is something that people are becoming more and more painfully aware. So, your need estate planning, it is highly recommended to prevent creating difficulties and challenges to your next of kin, if in the unlikely, an unfortunate event that something happens to you. So, stepping back big picture, do your BEST, B-bank accounts, E- estimated tax, S- state tax issues, and T- transfer taxes. So, what I’m going to do is I’m going to stop there and Carlos, please say a few words and then we just jump into the Q and A. Carlos over to you. Carlos, you’re on mute. You have to unmute yourself.
CARLOS MORALES:
Hello everyone, thank you very much in for this invitation. And we’ll be talking tonight about certain issues that has been questions for several people involved in Mexico and the US taxation at this time. I want to say that Mexico and the US have been neighbors and foreigners for very long time. So, the taxes that we have in Mexico has been as a consequence of the relationships and business within both countries. And even though we have our Mexican income tax law, we started with a Mexican/US treaty to avoid double taxation. Let’s say 20 years ago, it was the first country with whom we start, elaborating a lot of transactions, you know, to eliminate the double taxation and the Mexican income tax law, as the dollars also has a worldwide income source.
So, the Mexican IRS is always looking for everyone to be a Mexican resident. Our Mexican complex law says that in anyone having a permanent house living in Mexico is a Mexican resident for tax purposes. Also, if you have 50% or more of your income coming from Mexican source, also, you are considered US as a national for tax purposes. And if your professional center of business is in Mexico is another way to consider that you are a Mexican tax resident.
So, let’s say that a very aggressive way of trading everybody in the world, because everybody may be a Mexican resident for tax purposes. So, we have another way to see, there are tax publications through the Mexican/ US treaty with whom we have another kind of situations to consider if someone is Mexican resident, first of all, a permanent house of living and if you have a house in Mexico and in the US, then you might answer the question.
If you have personal or economic relationship you have in both countries, then you have to answer a question where you’re living. And if you are living in both countries, then where are national from? Okay. So, we have a lot of opportunities to be a non-Mexican tax resident. If we rely upon the Mexican/US treaty. And another advantage of using the treaty is that you are not crediting the taxes state in the US. Let’s say that if you are a Mexican resident, they were white, you might consider them in your income tax return in Mexico. But if you look at the Mexico/US treaty, you don’t have the obligation of filing a tax return in Mexico. There’s a lot of advantages too, to look at the tax residence within the scope of this treaty. And another issue very important here is where are you taxing your income? So, let’s go through the questions if you agree Derren. I start going one by one. And so, then any other question specifically that will arise.
DERREN JOSEPH:
Yeah. Thank you. So, what I’m going to do is go through the questions that were previously submitted. I see people writing questions right now, please continue to do so. And once we go through the list and we get to yours, everything is going to be answered in turn.
So, the first one is just a preamble. Okay. I work for a company based in California and we all work remotely even before COVID-19. All my wages are deposited into my US bank account. I don’t think I’m considered an expat. Question, I live in Mexico and recently gained temporary residence status. I don’t earn any wages from a Mexican source. So, US expat living in Mexico, no Mexico source income, all US source income is deposited into an account in the US. Carlos, what are your thoughts?
CARLOS MORALES:
Okay. I think that then the main situation to be in the last year is that this person is living in Mexico. So, living in Mexico, what in place, if this person is living in Mexico, let’s say, has a house in Mexico could be considered as a Mexican resident. If let’s say that this person is working in Mexico, but has a family outside of the US or he has a passport in the us. So, we can have a double taxation here. Maybe, let say the Mexican authority would look at the bank accounts in the US it doesn’t matter that it’s outside Mexico. It matters that the company is based in California, but they would look at the residents of this person. It will be very important to this person to be clear of what is his Mexican status. And I can say here that if this person is a Mexican resident by his permanent house living, then it will be very important to take him out of that situation.
Maybe if he chooses to be a US tax resident, maybe to file a suspension notice before the Mexican IRS in other to be out of the scope of the Mexican authorities, and also to file another notice in the mailbox of the Mexican IRS is very important to this person to look at his, his permanent house, living to know if he has the risk or not.
DERREN JOSEPH:
Okay. Understood. And from a US perspective, I mean, that’s easy. They’re definitely taxed on their worldwide income. So, you don’t have to pay tax on that at the federal level, if it is according to what you’ve described, if it is that they are exposed to taxes in Mexico, they can offset it against the US liability at the federal level with a Form 1116, but they may fall in potentially to the double tax category. California domiciles stayed very sticky. If they get paid on a W2 and they are deemed to be domiciled in California, California, the state tax return may not. Cause they typically do not recognize the fact that income has been taxed somewhere else. They don’t get tax credits for foreign taxes paid. So, they probably want to revisit their tax status in California as anybody else who is in one of those states. We always advise our clients before they leave the US, pick one of the nine states that does not have an income tax, popularly it’ll be Texas, Florida, Tennessee, Nevada, whichever you prefer. Pick one of those and establish domicile there. How do you do that? Again? You need to speak with a tax advisor because it’s not really a hard and fast rule is, is a test of fact and intent. So, you’d want to, you know, for example, make sure you registered to vote in that state, your whole mail. You have some sort of address, billing address in that state, your driver’s license, which is out state and so on. So, you want to shift your domicile to prevent issues with states like California, especially since California has been contemplating a wealth tax. So again, you just want to be careful with what states like that.
Okay. Moving on to question two, I have a vacation home in Mexico. I do not stay more than six months in the year in Mexico, but when I’m not in Mexico, I leave my home and occupied. I don’t use Airbnb. Am I tax residents in Mexico? Carlos?
CARLOS MORALES:
Well, the question here is that this will assume that this person has, his income outside Mexican source, they have no family in Mexico. The whole life of this persons is in the US and we have regulations here in Mexico that says that when you have a home in Mexico, which is not a permanent one, which is only a vacation home, you are not a Mexican tax resident. Right.
DERREN JOSEPH:
Okay. So, allow me to follow up on that, just so that I’m clear. What’s the definition of a vacation home?
CARLOS MORALES:
Vacation home is the one that you have for vacation, not the one you have for living when you have also your family, or even you can be working alone in Mexico, but it’s related to the income that is generated. So, let’s look at it, even if this person had a vacation home, rented by Airbnb, let’s say, that’s not a situation that is considered as a permanent house living, and it’s not a Mexican tax resident.
DERREN JOSEPH:
Understood. Okay, fantastic. Thank you for that Carlos.
Next question. I run my Belize company from Mexico. Everything is being banked outside of Mexico. Where should I file my taxes? Carlos?
CARLOS MORALES:
This is a very interesting question. Okay. Let’s start from the beginning. I think that this person has a company. So, he is a shareholder of Belize company. Okay. With the leasing, Mexico has a treaty to exchange information. So, we have to be very clear about that. We have this treaty it from November 2011. So, as Belize is considered, let’s say a low tax jurisdiction. So, we have to be very, very wise to know if this shareholder has control over the income of this company. Why? Because maybe this person has a Belize company and tax the administration decisions, heirs, the dividends of that company and in policing is not paying taxes. So, the Mexican I raise will be very aggressive, trying to tax all the in direct income coming from that jurisdiction.
And the main point here is if this person, even if he’s running the company here in Mexico, if he’s a tax resident, maybe if we look up all those situations that are in the Mexico, US trading, maybe we can take him out of the tax resident situation. That will be very interesting to know. And so, if he’s a Mexican tax resident, my recommendation is to look through the Mexico/US trading in order to know if he’s not his not liable of main taxes here.
DERREN JOSEPH:
Understood. And then from a US perspective, assuming when he says that, he or she says that I’m running the company. If they are the key decision maker, they’re the ones making the strategic operational decisions. Plus, the other majority shareholder, it definitely reportable in the US tax turns Form 5471. And the investment they make into the company must also be reported in their personal tax returns, Form 926. Now, if it is a CFC or Control Foreign Corp, as it has to be certain rules would apply. We’d want to sit with this person and see whether Subpart F rules applies, if it’s being taxed only in Belize something called GILTY, the Global Intangible Low Tax Income tax rules may apply. So, when you have a US control foreign company, this control foreign Corp or the CFC rules would very aggressively to basically make it very difficult to defer paying income into lesser distribution, which is of course the holy grail of people to earn money and let it work in the company and only pay when there’s a distribution and works against that. And plus, it puts an additional layer of taxes if you’re in a low tax jurisdiction liability, because essentially what it does, it taxes phantom income because you did not receive the income. You have not constructed. They received that there were no dividends. You didn’t get a bonus or whatever. It’s still sitting on your balance sheet, but GILTY works to put a tax on it, even though it was not distributed to you as a shareholder. And that of course has cashflow implications because you’re going to need to pay tax on money that you did not receive. So, because of situations like that, I think is worthwhile sitting with a tax professional to make sure that it’s the right structure for you. And let’s look at ways as Carlos said in together with someone with Carlos’s expertise to make sure that you minimize the tax burden on that.
CARLOS MORALES:
Okay. And I think that Mexico copies that tax routine for jurisdiction countries is the same as you told US. So, the point here is that somehow this men or women should be very sure where is he a tax resident? Because maybe the amount of taxes will be almost the same. But this is a very interesting question.
DERREN JOSEPH:
Interesting indeed. Okay. Next question. Okay. How do I avoid becoming tax resident in Mexico?
CARLOS MORALES:
Well, this is very, very, very interesting and very complicated also, because to be sure that you won’t be a Mexican tax resident, the advice here is to have all the documents required to demonstrate that you are resident in another country, not to let it open to the Mexican authorities to assume that you are a Mexican tax resident. So, the suggestion here maybe is if this person might be interested to be a US tax resident, maybe he can call this tax resident certificate, which is, I, I’m not an expert. Maybe you can help me, but there’s a Form 882, that brings you tax resident certificate name 6166. This person can request that annually and would that documents and the documents demonstrating where he living, of course his relationships or air economic sources, everything will be, eh, a part of his files to demonstrate that he or she is not a Mexican tax resident.
DERREN JOSEPH:
Well, I completely agree with our Carlos. So, and again, we were discussing here a situation where we can rely on the treaty. We can take a treaty position and we’d claim a closer connection. In this case, presumably the US is a closer connection. To the US probably they still have a place of residence available for them to have an unrented available, empty hole for them back in the US, they still maintain family ties, important family members are still there, so on and so forth. So, in a situation like that, you’re right. They can get the residents certificate and be free of the Mexico tax.
However, just a bit of a disclaimer here. We’ve had clients that come to us. And when we look at the facts and circumstances, they are clearly resident in this case, in Mexico, that is their base. And then they make claims like, well, I can use my sisters address back in the US resident certificate. I know that other tax professionals may encourage that, but we certainly don’t. We follow the law, but definitely if it is that you meet the criteria set out in the treaty, we will definitely help you optimize your tax position between Mexico and the US if that would mean claiming that closer connection to the US but nothing underhanded, please.
CARLOS MORALES:
And everyone is a different story. So we have the very sure to have everything with documents. You absolutely have to demonstrate before next scale authorities, everything, with papers, with documents and because the charge of the proof is on the taxpayer, not on the authority.
DERREN JOSEPH:
All right. Move on to the next one. I see more questions popping up as we go through these.
Do I declare my bank accounts in Mexico or on my US returns?
Yes, there’s a form called 114, otherwise known as FBARS, foreign bank account report. Again, this is not new. This comes from the bank secrecy act. I think I mentioned it in one of the slides. Once it’s above a certain threshold, it needs to be reported on those forms, that’s FBAR’s threshold. There’s also an additional threshold when FATCA came in, it’s called a Form 8938.
Again, there’s some higher thresholds that apply and you can speak to your professional about that, your chosen tax professional. It may be reportable in 8938, which is attached to your personal tax returns. So definitely yes.
CARLOS MORALES:
And of course, Mexico and the US has a broker information exchange treaty. So even though if a person in the US or in Mexico try to hide their bank accounts, sooner or later, the authorities will be able to notice this.
DERREN JOSEPH:
Absolutely, absolutely. Okay.
Next question. I have not filed the US returns for the past four years only Mexico returns. What should I do?
So, okay, so you’re compliant with Mexico. That’s fine. On the US side, when you sit with your US tax professional, we need to understand what was the reason for this noncompliance of the past four years. If it, is it invoke, we need to discuss a legal concept called willfulness and willfulness is not defined in the tax code? We need to rely on case law. And what case law tells us is that they look at the basically, whether it’s a known violation of this legal responsibility, whether you intentionally sought to avoid this responsibility and how do you evidence that intent whether you have well, whether it’s clear that you have knowledge of it and whether, and what type of action did you take, did you use nominees?
Did you look at accounts in certain secret jurisdictions? Did you tell the financial institution to hold the mail so that the mail wouldn’t go back to your dress? You know, things like that. But let’s fast forward and let’s just assume that your non-compliance was normal. You know, like just got back in Mexico and you try to make things work and you, maybe you forgot, or maybe your circumstances, you have personal difficulties or whatever. Then there’s something called a streamline compliance procedure. Streamline is an amnesty and all but name. They look back, period is three years for the last three years which has already passed, which in this case will be 2019, 18, 17. We get those returns filed. And assuming that everything goes okay, well, you don’t have to pay. You don’t have to worry about penalties. And this is civil and criminal penalties, which would typically apply. You will pay taxes if any taxes plus interest, but more importantly, you avoid those penalties So, and even if you did not file for longer than four or five years, it doesn’t matter. They look back period because of the statute of limitations is three years. So, we worked with you on that. And it’s six years for FBARS. We go back as long as six years, again, driven by the statute of limitation. So, we work with clients through that process to get on the right side of the IRS.
And of course, they agree to do the right thing going forward. So, the point I want to make is don’t stress out toward, you know, the world is going to handle whatever the important thing is that you recognize, hey, I should have filed and I’m going to make things right now. I’m going to make things, right? So, you, you stick with your chosen professional and you get that streamlined package and as soon as possible, and then you can breathe this afternoon.
CARLOS MORALES:
And for the Mexican point of view, if this person files his returns in Mexico, the we help that he accurately income in worldwide basis. So, if we are in that situation, it’s okay. If not, if he lacks of declaring income from all those sources, maybe he has to start also file complimentary tax returns of the five previous years here in Mexico. There, we have to be aware of five years in this statute of limitations.
DERREN JOSEPH:
Gotcha. Perfect. Okay. And this is a really popular one. Now, how is crypto tax both in Mexico and the US? Carlos crypto in Mexico?
CARLOS MORALES:
Well, eh, this is a very, very new situation is not forcing us in specific gain of income in Mexico, both here, individuals are obligated to accrue their income, even if it is in cash and goods in credits or what other kind of income. So, let’s assume that this can have of crypto as an income, whatever it be. So, in general terms, this person having income from this kind of transactions should be paying taxes in Mexico without, regardless if this is a foreign company or Mexican company or wherever the source of income comes from.
DERREN JOSEPH:
Understood, understood. And from a US perspective, I think it’s also straightforward to the extent that yeah, you’re going to have to pay taxes on it right now. I think it was last year, they redesigned the main tax form for personal tax returns is Form 1040 and the first one, the first question is on page one is, do you trade in crypto. So, it’s, it’s definitely a prior to the US government in terms of how it’s actually tax. Unfortunately, it depends if it is that you do it on the side and you just kind of buy and hold kind of person. Then whenever you do sell it, you will be looking at capital gains tax. If you sell within a 12-month period will be short term capital gains. If it’s longer than 12 months, as long-term capital gains, if it is, we have clients that it’s not something to do on the side, they actually trade. So, they do several transactions per day. It is their main thing with clients that do hundreds of transactions per day, algorithmic trading, then that is a business and that’s not capital gains, that’s trading income and you would tend to do that through a company. So, you looking at corporate tax issues that you don’t need to look at, we have people that do mining crypto lending.
If you lending you get interests, obviously you’re going to declare the interest on schedule B. So, it really, it really depends. But the bottom line is that it’s all taxable. And the important thing is to keep track of all the trades, which I know can be very difficult. The software tools that help you do it, depending on which platforms do you use, whether it’s Coinbase or cracking or whatever, there are options to print reports. You try to get those as accurately as possible in terms of valuing the transactions. It can be random. You need to decide whether you’re going to use life four, five four, high four, whether it’s last in first out, which is not that popular, but some people do use it. Most people would use first in, first out, you need to track each token, each, each item you need to track when you sell it. When did you buy that? And that transaction also key, please bear in mind that crypto to crypto can also be taxable. Some people think it’s just crypto to Fiat, crypto to crypto can also be taxable. So again, sit down with your tax professional and get solid advice.
Next one, what happens if I don’t report my offshore business to the IRS? Yeah, I guess that kind of ties back into the previous question on streamline. And this reminds me, I had a client that actually had a situation like that recently, where he had, he was dealing with another tax team who was based in the US so obviously if you’ve based in the US you tend to know domestic tax, because that’s what you do day in, day out, not international tax and his domestic tax team was unaware that there was a responsibility to report companies outside of the US just didn’t know, because you don’t do that every day. We do, right? So, I informed him of this responsibility and the fact that perhaps you need to consider streamline, like we just discussed. And he got really upset because, you know, he found out that the penalty for not reporting a company, that you have an interest in and should be on your tax return could be up. You know, it could be $10,000 per year. And the company’s been running for a few years. So, you know, he was screaming on the phone and stuff like that. But the point is that they, it does mean the world is coming to an end, you know, set of your chosen tax professional. You can potentially get on streamline procedure, that fits your circumstances, and you can file those returns and make things right with the IRS.
CARLOS MORALES:
I’m from the Mexican IRS. The situation is very similar, but we have the obligation to file that someone has of short business. But even if you do not declare those investments, it’s just said, consider as a criminal act. So, it’s very important so be aware of this.
DERREN JOSEPH:
Absolutely, absolutely. There’s another question on foreign rental property. So of course, if it is that you have property in Mexico and you have investment properties, not like the previous questioner who has it for their own personal use, if it’s an investment property and you derive income from it, whether it’s through Airbnb or a long-term rental arrangement, it needs to be declared in your personal tax returns now. So that it won’t goes to a question. Now you have to declare that income, but just like if it were a rental property back in the US, you get to deduct the expenses. And one of the key expense line items, just like it is an S is depreciation. Now, the question is, how long? The number of years that the depreciation basis, if it is the person didn’t specify, I assume it’s a residential rental property. If it’s residential, it can be depreciated over 30 years, if it’s non-residential, it’s over 40 years. So that’s, I hope that answers that person’s question.
They asking about appreciating an investment property in Mexico. They did not specify the person who sends them this question. You did not specify whether it was residential and non-residential. So, I’m going to give you both. If it’s residential, it’s over 30 years, if it’s non-residential commercial, for example, there’ll be able to 40 years, Carlos, any comments on that?
CARLOS MORALES:
This is a very interesting situation because when a foreign resident has an investment in real estate investment in Mexico, then when this person sales appropriately, they have to pay a 25% over the whole price of the, of their real estate property. It’s a lot of money, but we have an option. The second option here is very interesting, because if you are the owner of the property and you assign a Mexican representative, then this person could make the calculation of the right tax over the profit game. So, you have the price less of this purchase. And although the game may calculate the income tax. So, it’s a very interesting option to consider.
DERREN JOSEPH:
No, sorry. The first point you made that 25%, that’s 25% of the gross price, the selling price or net.
CARLOS MORALES:
Yes. It’s the world price.
DERREN JOSEPH:
Wow. Yeah, there’s a lot of money that is aggressive, but the US has an equivalent called FIRPTA the foreign investor property tax act. So where, I guess they’re afraid that foreign investors are going to file tax returns. They take a big chunk of the headline price or the gross selling price. So, it mirrors a US situation, which is interesting. Okay.
Next question. If a US citizen who qualifies for the foreign earned income exclusion as a bonafide resident by the IRS. So, okay. The US citizen qualifies for the foreign earned income exclusion under a bonafide residents test, will he or she one need to file tax returns and to pay taxes for the state of Colorado, very, very specific. So, I’ll answer it from the US side first. So, section 911, the foreign income exclusion, which is perhaps the tax benefit available to the average US expat. So, I think with 2020, it’s a 107, 108,000, roughly dollars would be excluded plus your housing deduction, but the point to drive home, and it’s a common misconception. So, I’m glad this person asked it, even though your earnings are below defined, earned income, exclusion, it still needs to be reported. You’re still going to file a tax return even to the US even though there are no taxes due, a tax return still needs to be filed. So, whether you qualify on the bonafide residence or the physical presence test either. So even though you don’t have to pay taxes, because it’s under the threshold, a tax return is still due.
Now that’s the second part of the question to the State of Colorado, like California, Colorado is a domiciles state. So again, so typically if you have established bonafide residence somewhere else, for example, in Mexico, it can relieve you, under certain circumstances can relieve you of the obligation to file a resident tax return to Colorado. And in that scenario, you’ll just be filing a non-resident tax return based on state source income. But regardless my same comment to the person from would apply to this situation. You should pick one of the nine states in which there is no income tax and redomicile there, so that there’s no confusion with Colorado. So, that’s my comment on that. Carlos?
CARLOS MORALES:
I have no comments here because Mexico, those not consider to get a tax residence for a specific state. So, mainly for Mexican tax purposes, we need only a federal tax residence certificate.
DERREN JOSEPH:
Okay. I’m just stretching. Okay.
Next question. It’s a long question. So, I’ll try and summarize it rather than read everything. So, this US citizen is married to a Mexican national and they’re living in Mexico and getting confirm. Okay. So, I guess, the one that filed together, which is a tax strategy that we do recommend for some of our clients, even though your spouse is not a US person for tax purposes under Section 7701, you can elect them to be a US person, and you can file together under Section 613(g). And it could be a good strategy for a couple in a specific situation. Her question, however, is the process for applying for tax ID for her husband, from Mexican husband, she’s having problems dealing with CPA firms and the ITIN, which is the individual tax identification number. Now, typically, if someone is not, does not qualify for social security number by virtue of them not being a US person for tax purposes. So, they are not a citizen, they’re not a green card holder, they don’t own a trigger, substantial presence. Then they would typically need to file for an individual tax identification number, otherwise known as an ITIN. And that’s the principle in practice. It can be very challenging because in her case, the firm that she’s approached, I think in Mexico City they don’t want to apply for the ITIN for her. They want to do the tax returns at the same time. Now this happens more often than you may think. The reason is it’s really tricky to do the ITIN application on its own without doing the tax return together.
If the ideal is for them to be done at the same time, by the same team, otherwise it leads to complications. I can get into the details, but is not necessary. I’ll just leave it there. It can lead to complexity and it can lead to misunderstanding between the team that’s doing the return and the team that’s doing the ITIN application. So that’s why it tends to be done at the same roof. Our team, we were certified acceptance agents as well. We do an application, and I am very hesitant to do an ITIN application when we’re not doing the tax return because of that complexity. So, my point to this person who wrote that question is that it’s not unusual, but if they don’t want whoever they’ve approached to do their tax return, they want to keep that separate.
Just look at the IRS website and the probably hundreds, if not thousands of firms that do it, and just picking up the firm until you find one that that can work with you, otherwise you have to do it yourself, which would mean surrendering his passport. And I would not advise that because processing times when the internal revenue service are really, really long right now because of social distancing and stuff within the IRS offices. So, use a certified acceptance agent where possible, but be prepared for difficulties. If you don’t want to give them the entire job to do so. Sorry, that’s probably not what you want to hear, but that’s the reality.
Moving on to the list of questions. I know we almost have the hour mark we have about 10 minutes to go. Someone has asked if you are the owner of a company, or I guess a partnership sorry, I’m not seeing the full question. Could you, I think your question got cut. So, can you type it out again, please? I’ll wait for you.
Next one. What classifies you as a tax resident in Mexico? Carlos?
CARLOS MORALES:
Okay, tax here in Mexico and let’s say that we have two ways to see it. The first one is within our Mexican income. We also mentioned that if a person has permanent house living in Mexico, the other situation is if this person has more than 50% of the income coming from a Mexican source is the second situation. And the third one is if his professional center is located in Mexico, even though, if you are a national, if you born in Mexico, if you have a Mexican passport, then it’s assumed that you are a Mexican resident.
That’s the assumptions that the Mexican law has. So, we prefer to use the US/Mexico treaty because we have a much more wider situations to be analyzed in order to see if someone is, or is not a Mexican tax resident.
DERREN JOSEPH:
There’s a lot of facts that we would need to analyze to make that determination.
CARLOS MORALES:
Yes, within the treaty, we have a permanent house living is one, second is have personnel and economic relationships without regarding a percentage of income source in Mexico where is living person, if his national net, and with that, we have a lot of information and documents that we have to file in order to do direct everything right as we want.
DERREN JOSEPH:
Understood, I’m following up from that point I guessed is when you say a promoted house, does it mean a house that you purchase and you own it? Or what about if you’re renting that house?
CARLOS MORALES:
Well, this is not as clear. So, it is in order to see if someone has a house own or rent it in Mexico and you have another one owned or rented in the US so you are even, you don’t know, at this point, if you are a Mexican or you’re a resident, you have to go further on the next questions to define, whereas this person.
DERREN JOSEPH:
Hmm. So, in other words, the home is one fact, but it’s not the only fact. So, one would need to look at the picture to make that determination.
Okay. Next question, wife and I, US military vets, thank you for your service. Receiving VA paid benefits going into our US bank account. I have dual citizenship and my wife is a permanent resident of Mexico. So, one husband, dual citizen, US/ Mexico wife, a permanent resident of Mexico. We’re living in Mexico, renting. Will Mexico touch the payments? The veteran’s military pay question?
CARLOS MORALES:
Well, I understand that this man is receiving wages from the US military service, is that correct?
DERREN JOSEPH:
So, he’s retired, but he’s dual, he’s retired living in Mexico with his wife.
CARLOS MORALES:
Okay. And the source of income is coming from a US source.
DERREN JOSEPH:
Correct. And it’s being paid in the US, not in Mexico, but in the US.
CARLOS MORALES:
It’s been the US okay. So, in that situation, I think that they are Mexican resident because they are living there. They have a family there have their interests of living there. So, they are Mexican tax resident. I don’t know if in this case, the military service is withholding some income tax in the US in that case, this person in Mexico could credit the amount paid in the US. That will be very useful in order to have his annual tax return in Mexico.
DERREN JOSEPH:
Right. Okay. So potentially yes. Once assuming the center of life is in Mexico, which is it is, but they’ll get a credit potentially for taxes paid in the US already on that income when they’re filing the Mexico tax returns potentially. Right.
CARLOS MORALES:
Yes. And also in Mexico, we have the, the option to consider that amount in annual returns for each one, for wife and husband.
DERREN JOSEPH:
Right? Like in the US you can file married, married filing separately. So, I hear that. So, another question. He would like to start a small business in Mexico, the question is will both the US and Mexico tax my business, Carlos?
CARLOS MORALES:
Okay. If they want to start a business in Mexico, we have several options. You can start business like an individual, which has benefits because of the tax rate. You can start with a 3% income tax rate up to 35%. It’s an advantage because if you start a business, having a company, there’s a flat 30% income tax rate. So, to start a business my recommendation is to start as an individual. And if it starts growing and growing, then you can set up a company
DERREN JOSEPH:
Right. And that’s similar to the US as well, in that you can start the business as a sole proprietor. And on the US return, it’ll be on your schedule C. Or you can incorporate a company and the company trades and a company file its own returns. And you as a person pay tax only when you get a distribution from the company and from dividends or salary or something like that. So, I think in a situation like this, perhaps they’d want to sit with a tax professional, like you, especially on the Mexico side to see what makes the most sense for them. What’s optimal from a tax point of view, given that the disparity in terms of tax rates is so high, that’s a big difference between three 80%, right?
CARLOS MORALES:
It’s lot of money. And also, if they can set up a company as a foreign resident. Few years ago, they were only allowed to set up company with Mexican partners. So, with two people, if they’re a US resident, they can do it without losing their tax status. They can file everything within their Mexican company and they can comply with their personal obligations in the US.
DERREN JOSEPH:
Okay, wonderful.
Next question. Is it possible to quantify as bonafide residents under the US foreign earned income exclusion by living in Mexico without being tax resident in Mexico? The answer is yes, because you can qualify for the section 911, foreign income exclusion in two ways. One is the modified residence test, which is it’s qualitative, and it’s a test. It’s, it’s a bit subjective. And that, you know, it’s on Form 2555, the IRS ask you certain questions to determine whether your center of life really has shifted to that foreign jurisdiction. It’s a judgment call. The other way of qualifying for the foreign and income exclusion is a physical presence test, which unlike bonafide residents test it is subjective. And it’s quantitative. So basically, you counted the number of days in the US and once you don’t cross out a number, what you don’t spend more than, let’s say 30 days in the US and you spend the rest outside, including Mexico. You could the Mexico plus Panama plus Chile plus, wherever else, once you stay out of the US, you can trigger and you can enjoy the protection of the foreign earned income exclusion. So, to answer your question, yes, you can qualify. Look at the physical presence test when you’re doing Form 2555.
Next question. Okay. It’s a statement plus a question. Okay. It sounds like I’m a Mexican tax resident. Then I’m married to Mexican national and have temporary residency. My US tax situation is okay. This is a person with a W7, who wants to get a tax ID for their Mexican national husband? What do I need do to keep Mexico happy too? I do not have any Mexican accounts or property, and all my income is moving through US bank account. So, this is one for you, Carlos. I’ll start over. So, this is a US national resident in Mexico, married to a Mexican national, and she has a temporary residency, and they seem to resolve the issue with the US tax returns and the tax ID stuff. So, she’s asking, what do I need to do to keep Mexico happy too? I do not have any Mexican accounts or property, and all my income is moving through us bank accounts, Carlos?
CARLOS MORALES:
Let me see, as a foreign resident sometimes is difficult to start a bank account here. Maybe if he let’s say, if the husband is a Mexican tax resident, maybe he can open a bank account and allow the wife to sign and have all the rights of that bank account. In that case, you can operate everything through that bank account.
DERREN JOSEPH:
Okay. And from a tax perspective, I mean the central of life is Mexico. So, she’s going to be taxed in her worldwide income?
CARLOS MORALES:
Well, she could be a potentially, but also, she has the option to file the return jointly with his husband without having a Mexican IRS and a Mexican tax ID. All the other option is they are, let’s say having different income. No, let’s say that she’s working in a company and he’s working in another one. So, in that case she might be requesting a Mexican tax ID.
DERREN JOSEPH:
Right. So, the choice is whether she follows alone or jointly with her husband and again, setting with a tax professional, like yourself might be the best way to make that sort of determination. Okay. All right.
Moving down. This is okay. Military question again. Oh, it’s someone just made a comment. Mexican billionaire Ricardo’s Salinas is big into crypto. I’m sure in Mexico.
Next question. What is the difference in capital gains of real for US expats versus a Mexican national? For example, if you buy a house for a hundred K and sell it for 200 K years later, what are the tax rates for each, from a Mexico perspective? Because you get that.
CARLOS MORALES:
In terms of it’s similar to a previous question, if they’re selling in 200 and the cost was 100, the first option is that they must pay 25% over the 200. So, over the world sales price, so a lot of money and the other situation, the other option that you have is that this person gets assigned a representative in Mexico. And that person must calculate over the difference between the 200 and 100, which is a goal. So, they will be paying 35% over the profits.
DERREN JOSEPH:
Right. So just, just to clarify that, so the two options, if there were to just kind of keep it in front and do it themselves, then the Mexican tax is going to take 25% of the gros. You’re going to grab 25% of that, which is of course huge. If it is a Mexican national to the percent, more or less take responsibility for this situation, then it will be tax on the difference between the 200-solid price on the 100. And it’ll be taxed on whatever the tax rate is, depending on how much it is. Right.
CARLOS MORALES:
That’s right. And in this example, we might say that they will pay much more on the second option. They will be paying a 35 and when the first one, 25. So they have to do to see that the specific situation in order to do elect, to choose which one of the options is better understood. And every one of the transactions regarding real estate should be before the public notary. So, it’s very important to choose before going with a public notary, because they in charge of looking, eh, of the compliance of taxes.
DERREN JOSEPH:
Fantastic. And with that, we’re going to have to say thank you. Thank you, Carlos for sharing your expertise and your time this evening. And thanks for all of those who joined us here on zoom, as well as on Facebook, LinkedIn, Twitter and on YouTube. Everything will be recorded and if you want to watch this video again, it’ll be on the various platforms, we also put it on podcast platforms as well. So, wherever you get your favorite podcasts, if you want to go to Carlos specifically to follow up and engage him and his team, his email address is in the chat box below on zoom it’s carlosmag.estat@gmail.com. I’m going to repeat it, carlosmag.estat@gmail.com. Thank you for joining us and we’ll see you next time. Bye.
Thank everyone. Have a nice evening.
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