Talking Expat Taxes #2

Hi, my name's Alex McGowin, and I'm your host again for Talking Expat Taxes. Are you interested in moving to Mexico or maybe you're already there and you're wondering how that affects your U.S. taxes or what is the tax implication of spending time in Mexico or moving there? Well, today's podcast is specifically for you and for that situation.

We're going to be talking with Juan Antonio. He specializes and has been doing it for a long time in individuals that are moving to Mexico from somewhere else. He obviously does other things too with businesses and local individuals, but he's been working in the mobility sector for a long time. So he's going to be able to give us his insight on practical things.

But yeah, so with Juan, what we're going to talk about is a lot of the practical stuff with filing requirements, residency. What does it mean to own real estate in Mexico, and how does that affect your taxes? So yeah, really looking forward to it. Juan's going to give us some good stuff.

If you haven't listened to this podcast before, again, my name is Alex McGowin. I'm the owner of McGowin Tax LLC, where we help international individuals with their U.S. tax compliance and consulting. You can find me at my website, www.mcgowintax.com, or email me at alex.mcgowin@mcgowintax.com. But enough of all that. Let's jump into the podcast and talk to Juan. Enjoy.

Hey, Juan, good to see you again. And I hope you're doing well. Thanks for being here. Juan is, you know, one of the leaders in Mexico for global mobility taxation, has his own firm and is coming onto our podcast today to give us a little background on tax residency in Mexico.

Yeah, good to see you again. Hope everything's going well. Hope the tax world in Mexico is treating you well.

Yeah, you're a former PWC guy, just like myself.

In Mexico City, right?

Yeah, understood... So yeah, I thought today we could talk a little bit about on the individual side, you know, a lot of what I deal with in my client base is, you know, Americans, US people. Either with flexible employment situations where they can move abroad and they move to Mexico with a U.S. employer, or they're self-employed and moved to Mexico somewhere. A lot of the questions I get, obviously I get the questions on the U.S. side and we have to deal with the worldwide taxation situation for citizens. But in Mexico, most people, or most Americans at least, don't know where that line is in Mexico or, you know, when do you have to start filing in Mexico and what do you have to include at that point? So maybe if you give us a little background on when are you considered a Mexican tax resident? And what does that mean exactly once you've become that?

Because I think, and maybe we'll drill down into that a little bit, one of the misconceptions that I think a lot of people have is the 183 day rule that a lot of people are familiar with is that in the US, for state taxation, crossing that 183 days state tax residency. And a lot of foreign countries, or non-U.S. countries, have that same rule. And that is a rule of Mexico, right? It's just that they have added an additional rule.

Okay, I understand it doesn't go backwards. So, say you establish a home or a dwelling in Mexico... If you came and established a home on December 30th, even though you only spent two days in Mexico for the year, you'd be a resident for two days because of that rule.

Right. Yeah, and that's always the - I don't know if calling it a game is the right way to phrase it - but I mean, what we're talking about here is really the technical rule. And then there's kind of the practical application of those technical rules for sure. Like, if you move on December 31, and you have a home there, December 31, technically, you have a tax residency in Mexico, but practically, who's going to actually file a tax return for one day of tax residency? And how would you even determine what income would be allocated to it? So, I agree, there'd be some practical issues there. But I guess going back to that, the home concept, is like a lot of times in the US, we have terms like that, that are very poorly defined, if at all. Then we have to look at the case law and figure out what that means. I mean, clearly a home, if you purchased a home and moved into it with your family, I think that would clearly be a definition of establishing a home in Mexico. But, what if you're a single person and you have a short-term lease or an AirBnB, a short-term rental agreement in Mexico, and you stay there for the rest of the year, if you moved today, in June, and you just kind of went to short term rentals for the rest of the year... What is the line of attack for a home in Mexico? Or is it a blurry line?

So, if you're renting, then...oh at your disposal, I see what you're saying. So, if you're renting, it's 100 at your disposal.

Right. I guess it's these short term rental places like an Airbnb or VRBO, that confuses that rule a little bit, right? Because technically, you know, they have that house at their disposal, but it may just be for a short-term period of time. In which case, they're probably okay to not call that a home. It's more of these lease agreements. Like, if you have a six month or a year lease, or certainly if you purchase a home and you live there.

I see. So, it really comes down to long-term versus short-term at the end of the day, it sounds like. Maybe there's not a specific number of months or weeks that you have to rent it, but subjectively, purchasing a house or a medium to long term lease agreement would be a Casa Habitación as opposed to a shorter term rental where in the same year you may be at different shorter term rentals, in which case, you wouldn't have established that home concept. In that case, you're probably still a non-resident. So in that situation, let's say, you don't cross that line to be a resident but you are spending a couple of airbnb months in mexico and work remotely from those places. So, you're a non-resident, but working in Mexico for a foreign company, or maybe for your own company, what are your technical filing obligations in Mexico, if any? And, I guess we can talk about the practical side of that as well.

Because that's where you're really providing the services?

Right. So, if you're providing services, the source of income is where you're physically providing it. It doesn't matter who the payor of the services are and where they're paying them from, or where the bank account is. So yeah, this is a good point. I think one thing we've left out at this point, maybe you're about to get to that, is the tax treaty between the US and Mexico, right? Is that we have the technical rules of what is considered a Mexican tax resident and we talked about the taxed home in Mexico triggering residency. But then our fallback is the treaty between the US and Mexico, which has its own test for breaking residency, and it's called the Treaty Tiebreaker Test. And it's basically what you just mentioned. It goes down a list of specific requirements to see which way you break to Mexico or to the US. So even if you fall under the Mexican tax residency rule, we can still look to the treaty to say, all right, where are you actually a resident under the treaty? And like you said, center of vital economic interest is a big one. You may break back to the US, even though the technical rule in Mexico is that you're a resident under the law. So we have some options to keep you as a non-resident of Mexico, even if you're technically breaking over that under the Mexican law perspective.

Right. So, in that case, how would a non-resident be taxed? Let's say you are a non-resident either because of the treaty, or because you didn't meet the home test in Mexico, how is a non-resident tax based on Mexican sourced income? So, providing services in Mexico?

On Mexican source income. Right?

But it has to be Mexican sourced, right?

So if you're a non resident of Mexico, and you get a dividend from a US company, that's not going to be taxable in Mexico, but if it's a Mexican company, it's back to the sourcing rule like you said you have to go through it in phases. Are you a resident or non-resident? And then is the income sourced to Mexico? And if it is, as a non-resident, you have to pick up Mexican sourced income, which is really the same rule as in the US. Same concept. There are varying levels of people following that rule. Like, for example, if a Mexican comes to the U.S. and they're not a U.S. citizen or green card holder, and they spend 10 days working in the U.S., and earn over a certain amount of money, then technically that's US sourced income. It could be taxable in the US, but actually the treaty drills down on that under specific articles of the treaty that would exempt that individual from having to pay tax on the US sourced income. I think it could be the same in Mexico in a non-resident perspective, we could fall back on the treaty potentially to help us out with service-based income for a short-term period. We have to look at this specific treaty article, can't quote that here off the top of my head. I think that's the progression, right? That's how I think about it as a progression. Does the law call you a resident or non-resident? If you're a non-resident, do you have any Mexican source income? If you do, technically you're going to need to pick that up and pay tax on it. But then the next rule is, can you get any help from the tax treaty? In a lot of cases, you can. So I think that's kind of the progression I go through, if you agree with that concept...

Right, that's what we call marginal tax rates. So depending on your income, there's a progressive rate structure where the rate grows depending on how much income you have.

For sure. The first step is making sure we're paying tax to the right country. And then the U.S. decides to make everything difficult by not really caring what the residency rules say. And they just tax you anyway, because regardless of where you're actually a resident, they tax you anyway. So, yeah, we have mechanisms here in the U.S. like the foreign tax credit to make sure you're at least not getting paid tax twice on the same income.

Right. Exactly. Yeah, I agree. That actually made me think of another question, and this may be a hard one to answer, so feel free to tell me if you don't really know for sure, what is the practical risk to somebody? Like an American that goes down to Mexico for half a year, or a year, and works remotely, depending on their visa restrictions, that's always a question too... but let's say they go down there and work remotely for a company, or for themselves, in Mexico, and technically, they have tripped a taxation requirement in Mexico... How practical, like what is the real risk to them from the concept of the Mexican IRS, they're going to have their own name that I've forgotten, but how aggressive are they for people like that? And what is the kind of the practical risk there for people just not filing tax returns in Mexico when they should?

I see. That's one difference, like in the U.S., at least in my experience, the IRS and immigration, they don't really talk to each other. So, if you come to the US and you're on a work visa, that doesn't necessarily tell the IRS to look out for a tax return for this guy because he's on a work visa. But I agree with you. It is the same thing. If you start opening bank accounts and earn interest, that gets reported to the IRS and then they're going to start looking for tax returns. It sounds like it's similar in Mexico. If you move to Mexico and you open no bank account, you're on a temporary visa, and you're just flying under the radar completely, yes, technically, there's probably little risk there if you're able to pull that off like the James Bond of tax. But in the practical world, if you stay there long enough, you probably are going to need a real visa that gives you working rights. You might want to open a bank account there, and now they know who you are. And they're going to start expecting to know the income that you earn. So that's really where that line crosses a little bit, I guess.

Right. Understood. Okay, well... Honestly, I think we may leave it at that. That's a good place to stop. I think, to understand the risks associated with not filing correctly in Mexico. But, just to summarize, Mexican tax residency can get triggered when you have a home in Mexico. And that home, an easy way to think about it would be based on it being a long-term situation, long-term lease, long-term home. Temporary things where you could be at different places during a single year probably aren't going to trip that. But then once you do trip that, or even if you don't, and you're a non-resident and you have Mexican source income, you need to look at the US Mexican treaty and really at that point, it's worth talking to a professional that has experience looking at the treaty documents because it's not written in normal English or Spanish, depending on your language, but it's its own language, I guess.

Right. Yeah, our favorite answer, right? It depends. It depends on the information at the end of the day.

All right, Juan, this is really good information. Appreciate you coming on, giving us some insight into these residency rules. Yeah, I look forward to having you back on in the future and we can talk about some other Mexican tax stuff. I appreciate it.