U.S. TAX GUIDE IN MEXICO
What is GILTI, and how does it affect business owners in Mexico?
GILTI stands for Global Intangible Low-Taxed Income.
If your corporation has a majority of US individuals as owners, the IRS considers it a controlled foreign corporation (CFC).
The CFC’s net income is taxable to US shareholders based on their ownership percentage, even if the income is not distributed. This can be a significant concern for business owners.
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How does the IRS categorize Controlled Foreign Corporations (CFCs)?
The IRS views CFCs as entities where US shareholders own more than 50% of the stock.
This classification means that the corporation’s net income is considered taxable to the US shareholders proportionate to their ownership.
Remember, this taxation occurs regardless of whether the income is actually distributed to the shareholders.
What is the impact of GILTI on undistributed earnings?
GILTI impacts business owners because it taxes undistributed earnings.
Even if the profits are left within the corporation, they are still subject to US tax under GILTI rules. Many business owners find this frustrating because it means paying taxes on money not received personally.
Do higher corporate taxes in Mexico offset GILTI?
If Mexico’s corporate tax rate is higher than the US tax rate (depending on which state you’re in), GILTI may not be a significant concern.
The higher taxes paid in Mexico can often offset the US tax liability under GILTI, reducing or eliminating the additional tax owed in the US.
What can business owners do to manage GILTI?
To manage GILTI, business owners should consult with a tax professional who understands both US and Mexican tax laws.
They can help you understand the complexities of GILTI, ensure compliance, and explore strategies to minimize your tax liability. One approach might be using the Foreign Tax Credit (FTC) to offset US taxes with the taxes paid in Mexico.
Are there exceptions to GILTI?
Yes, there are exceptions to the Global Intangible Low-Taxed Income (GILTI) tax.
GILTI tax applies to the earnings of controlled foreign corporations (CFCs) owned by US shareholders, but certain exceptions and provisions can mitigate or eliminate this tax burden, such as:
- High-Tax Exclusion: The GILTI high-tax exclusion allows US shareholders to exclude from their GILTI calculation any foreign income that is subject to an effective foreign tax rate greater than 90% of the highest US corporate tax rate.
- Section 250 Deduction: For US corporations, there is a Section 250 deduction that effectively reduces the GILTI inclusion amount. US corporations can deduct up to 50% of their GILTI, resulting in a lower effective tax rate.
- Foreign Tax Credits: US shareholders can use foreign tax credits (FTCs) to offset their GILTI liability. However, these credits are subject to certain limitations and may not fully offset the GILTI tax.
- Section 962 Election: Individual US shareholders can make a Section 962 election to be taxed as if they were a corporation. This allows them to take advantage of the corporate tax rate and the Section 250 deduction, potentially reducing their GILTI tax liability.
What are the ways a US business owner in Mexico is affected by GILTI?
Individual Shareholder
For individual shareholders, GILTI income is taxed at their personal income tax rates, which can be as high as 37%. Without corporate tax deductions, this can result in a significant tax burden. However, individual shareholders can elect to use Section 962 to mitigate this impact.
Section 962 Election
By making a Section 962 election, individual shareholders can be taxed at the corporate tax rate on their GILTI income, allowing them to benefit from the Section 250 deduction and FTCs. This election can reduce their effective tax rate on GILTI income, but they must include subsequent distributions as income, which could be subject to additional tax.
Disregarded Entity
If the business in Mexico is structured as a disregarded entity (e.g., a single-member LLC), the owner is treated as directly owning the assets and income of the foreign business. GILTI income from the disregarded entity will be included in the owner’s personal income and taxed accordingly. Making a Section 962 election could still be beneficial in this scenario.
US Corporation
For US corporations owning a CFC in Mexico, GILTI income is subject to a lower effective tax rate due to the Section 250 deduction, which allows a 50% deduction of GILTI. Additionally, US corporations can utilize FTCs to offset their GILTI tax liability. This structure can be more tax-efficient for managing GILTI income.
Here are a few example scenarios:
- Individual Shareholder without Section 962 Election:
- GILTI income is taxed at personal rates (up to 37%).
- No access to Section 250 deduction.
- FTCs may be limited.
- Individual Shareholder with Section 962 Election:
- GILTI income is taxed at corporate rates (21%).
- Access to Section 250 deduction (50% reduction).
- Potentially lower effective tax rate but with future tax on distributions.
- Disregarded Entity:
- GILTI income included in the owner’s personal income.
- Can make a Section 962 election for tax benefits.
- Direct tax implications for the owner.
- US Corporation:
- GILTI income taxed at a lower effective rate due to Section 250 deduction.
- Ability to use FTCs effectively.
- More advantageous for managing international income.
