Moving To Mexico: Successful Financial Strategies for Changing Your Latitude
- by David McKeegan, co-founder of Greenback Expat Tax Services.
When you think of US expats in Mexico, you probably think of the two common stereotypes: retirees and fugitives avoiding US laws. Nothing could be further from reality! Mexico is and always has been a favorite destination for US expats. Mexico's proximity to the US, lower cost of living, and many unspoiled, beautiful places to live make it attractive for almost everyone.
With telecommuting gaining popularity and feasibility with US companies, more employees rather than retirees are finding it easier to pull up stakes and to go ‘down Mexico way’ to live.
Individuals who are single, working-age, and want to enjoy life on their own terms are finding their way to Mexico. They’re discovering what it’s like to live the good life of an American expat, while still enjoying close ties to US family and friends.
Even with this influx of younger, single Americans, retirees remain a large portion of the US expats living in Mexico. They have a fixed income that comes from a reliable source such as pensions, social security, and retirement accounts, and their money buys more in Mexico than in most locations in the US
Benefits for US Expats in Mexico
Whether you’re a US citizen or permanent resident, there are many tax and business benefits to being an expat in Mexico. Regardless of where income is earned, as an expat you’re required to report your worldwide income to the IRS on a tax return filed yearly. You are able, however, to take advantage of certain tax laws that help prevent you from being double taxed on your income. That means you will not be taxed in Mexico and the US on the same income.
Some of these expat specific tax incentives include:
Foreign Earned Income Exclusion – You may exclude up to $100,900 of your earned income (wages, salary, etc.) from taxation. This reduces your taxable income on your return, and therefore reduces your overall tax. The basic qualification for this exclusion is that you have to be outside the USA for 330 days out of a 365 day window that begins or ends in the tax year (does not need to be a calendar year).
Foreign Tax Credit – A dollar for dollar reduction in your US taxes based on the taxes you have paid to Mexico. This credit is figured using a calculation of the amount of income earned in the US vs. income earned in a foreign country.
Tax Treaty benefits – There are certain circumstances where a particular type of income is taxed at a lower rate due to the tax treaty forged between the US and Mexico. These benefits are most common in investment income like interest, dividends and capital gains.
In addition to those incentives, you may also qualify for almost all the credits and deductions allowed to those residing in the US including the child tax credit, moving deductions, home mortgage deductions, property tax deductions, child care credits, education credits, and many more!
Tax rates differ from country to country and are dependent upon the laws imposed by those countries. Both the US and Mexico have a progressive tax rate system. This means that as your income increases, your tax rate increases, with different levels of income being taxed at different rates. The US tax rates are based on filing status, the highest rates going to those who are filing single. Mexico only has one filing status, and individuals should file an annual return separate from any spouse.
What To Consider When Deciding To Move To Mexico
No one wants to pay more than their fair share. So as you contemplate your move to Mexico, consider the following questions to keep your finances in order, and minimize your tax burden to both the US and Mexico!
Will you be a resident or non-resident of Mexico?
You are considered to be a resident of Mexico if you establish a home there. If you also have a home in another country, then the country where you have the most interest is your residence. You will be considered a Mexican resident if you have more than 50% of your income coming from a Mexican source and you have a home in Mexico.
Being a resident of Mexico, you will report all your income on your Mexican tax filing. The tax rates are lower in Mexico for residents, yet you potentially will be taxed on more income than a non-resident (as you will have to report your worldwide income).
If you are considered a non-resident of Mexico, you will only pay taxes on your Mexican sourced income. The tax rate is higher for non-residents, but your income will only consist of what comes from Mexico (wages, interest from Mexican banks/investments, etc.)
Not only do you have to consider the Mexican treatment of your income, you will need to consider your residency status for US tax purposes. The US considers your residency for determination of the Foreign Earned Income Exclusion. If you choose to use the bona fide resident status to calculate your exclusion, one of the greatest benefits is the easement of travel restrictions to the US.
As a bona fide resident of a foreign country, you will need to show that you intend to live in Mexico for the foreseeable future. This would include considering yourself a resident of Mexico for tax purposes.
How do you earn your income?
Whether you are a retiree living off your savings and benefit payments, or an employee of a company who is working your way up, where your money comes from will affect your taxes.
Based on the tax treaty, the country of origin gets to tax your money first. This means that income from the US is allowed to be taxed first in the US, before being subject to tax in Mexico. The tax treaty may reduce or eliminate the need to have tax withholding on your non-resident income though, which will save you some time and hassle shuffling money around when doing your returns.
What type of income do I have?
Is all your income coming from retirement benefits, social security payments, wages, self-employment or investment income?
Wages - This is the most common type of income for those not of retirement age. If you earn the wages from a US based company while living in Mexico, the company should withhold US taxes on that income based on the W-4 form information you give them regarding you filing status and dependents.
If you are working for a Mexican company while in Mexico, you will most likely have Mexican taxes withheld from your paychecks. The tax is then computed on both your US tax return and your Mexican tax return. Taxes paid to one country can be used to create a tax credit for the other country, preventing you from being double taxed on the same income.
This income, whether from a US or Mexican source, can potentially be reduced on your US tax return by using the foreign earned income exclusion. This exclusion can only be used on income earned while in Mexico, and not for any income earned while living in or traveling to the states.
Retirement income – This can be any sort of regular or scheduled payment made from a designated retirement account. You will report this income on your US tax return as well as your Mexican annual filing (if you are considered a resident). This type of income is tax similar to wages in the way it is taxed in the US and Mexico except for one major factor: the Foreign Earned Income Exclusion.
Retirement income is not considered earned income for the purposes of the US tax code. You will not be able to use the FEIE to exclude any of your retirement payments from taxation. In the case where your only income is from retirement income, it may be more beneficial for you to claim non-residency in Mexico in order to avoid taxation from Mexico. You would then only pay taxes on your income to the US, reducing your tax filing burdens.
Investment income – This type of income is generally interest, dividends, capital gains, and rental income. While the US taxes you on all types of this income, Mexico has a different approach. If you are a non-resident of Mexico, you will only be taxed on your investment income from sources within Mexico. This type of income, like retirement income, lends itself to being more beneficial to non-residents of Mexico, especially if the only source of income come from investments. Investment income is not considered to be “earned” income for the purposes of the FEIE, just like retirement income.
Living in Mexico shouldn’t be a scary endeavor. The rich history of the country combined with its low cost of living and proximity to the US is ideal for expats. Start with the basic facts, and ask yourself the important questions. The answers will help you make wise decisions for your life and your finances.
And they just might lead you down Mexico way!
Greenback specializes in the preparation of US expat tax returns for Americans living abroad.
Don't forget to check the blogs under the category "Money and Finance" for all the ways that living in Mexico saves you money!
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