Gone but not forgotten.
January 19, 2020
Although things cost less here than back in the US, you decide you will become a real
estate agent with one of the local firms to earn a few extra pesos to help pay for that extra night out to dinner each week. The agency said not to worry, that they will take care of the Mexican taxes for you. And you go to sleep happy thinking that everything will be just fine.
That’s when you could be in for a rude awakening from your Uncle … Uncle Sam.
You see, the United States is the only “developed” country and member of the G7 that taxes its citizens on their worldwide income. Some of the others include such bastions of democracy as Libya, North Korea, Eritrea and the Philippines.
So, in addition to including your other sources of income from the US on your Form 1040, the income you earn here is supposed to be included on your US tax return. Failure to do so could even constitute criminal tax fraud, just like Al Capone (criminal tax fraud is when you omit 25% or more of your gross income).
“NO!” you say … “Isn’t that double taxation?” Simple fact is that it does wind up NOT being double taxation.
Holding the blue US passport comes with rights and obligations which means you must voluntarily report all your income annually when you file your return regardless of where the income was earned and whether or not it was reported to the IRS (like your W-2s, 1099s, etc.). But there are ways to avoid the double taxation.
Going back to our real estate agent example, the agency’s accountant reports her income and
files her Mexican tax return for her. They give her a report that shows the income was reported to SAT (Mexican version of IRS) and the taxes paid.
At that point, she is eligible for a Foreign Tax Credit (FTC). She can use the Mexican taxes paid to offset the US income taxes calculated based on that income. The FTC is claimed on Form 1116.
An example of how it works: The US equivalency of the earnings is US$7,000 and the Mexican taxes paid is US$450. When the US tax return is prepared, the taxes on the US$7,000 are calculated and they turn out to be US$700. So, the FTC applied is US$450 and you would then pay US$250 in tax on your US income.
But let’s say that your other sources of income were low (which is why you went to work) and you wind up with no US tax. You do not get a refund of the FTC. That is only available to offset any US taxes calculated as a result of them. If not used, it can be carried over to future years to offset US taxes again calculated based on your earned income.
The net effect in the latter case is that you paid the US$450 in taxes to Mexico, properly reported your income to the US so that you are in compliance with the laws and if you earn a higher amount of money the following year, and have US taxes, you will have credits available to help reduce your US tax, even if you don’t pay any Mexican tax in the 2nd year. The carryover is always there to offset and similarly generated income tax. (By the way, did you know
the taxes paid to SAT on your interest income can also be used to offset your US income tax when you report your Mexican bank interest income to the US? – Wait …. you didn’t know you had to report your Intercam interest to the US?)
Yes, there is another way you can avoid US income tax called the Foreign Earned Income Exclusion (FEIE). There is more to that and I will discuss that and other issues in future
Have questions about the FTC? Contact me directly by e-mail, firstname.lastname@example.org.