U.S. TAX GUIDE IN MEXICO
I own a business in Mexico, what do I have to report to the IRS?
If a US person owns a share of a foreign corporation, such as an LLC or SRL in Mexico, specific reporting requirements apply.
Let’s take a look at a few details. If your ownership is less than 10%, you don’t have to report anything to the IRS. However, if you own more than 10%, you must report this on Form 5471 and provide detailed information including the income statement and balance sheet.
Table of Contents
When do I need to file Form 5471?
You are required to file Form 5471 if you own more than 10% of the foreign corporation or if you hold a significant role, such as a shareholder, director, or officer.
If the majority owners are US individuals holding more than 50%, the entity is considered a Controlled Foreign Corporation (CFC), which adds more filing requirements and additional schedules to Form 5471.
What if a US person owns a majority stake?
If the US person owns a majority stake (more than 50%), the corporation is classified as a Controlled Foreign Corporation (CFC).
What is a CFC?
A Controlled Foreign Corporation (CFC) is any foreign corporation in which more than 50% of the total combined voting power of all classes of stock, or the total value of the stock, is owned by US shareholders.
In this context, a US shareholder is a US person who owns at least 10% of the corporation’s total voting power or value.
What are the filing requirements for a CFC?
Form 5471 includes several schedules that must be completed, depending on the type of filer and the information being reported.
Here are some of the key schedules:
- Schedule B: Information on US shareholders of the foreign corporation.
- Schedule C: Income statement of the foreign corporation.
- Schedule E: Income, war profits, and excess profits taxes paid or accrued.
- Schedule F: Balance sheet of the foreign corporation.
- Schedule G: Other information, including questions about the foreign corporation’s activities and transactions.
- Schedule H: Current earnings and profits of the foreign corporation.
- Schedule I: Summary of shareholder’s income from the foreign corporation.
What is Subpart F income?
Subpart F income refers to certain types of income earned by a CFC that are immediately taxable to US shareholders, even if the income is not distributed.
This includes passive income, such as dividends, interest, and rents, as well as certain types of business income.
Can corporate taxes paid in Mexico offset US tax liability?
Yes, the corporate taxes paid in Mexico can often offset the US tax liability on the same income, helping to avoid double taxation.
What if a married couple tries to avoid filing Form 5471 by splitting ownership?
If a married couple, where one spouse is a US person and the other is not, splits ownership to stay below the 10% threshold for the US spouse, it’s important to consider constructive ownership rules.
The IRS looks at the combined ownership of related parties, so even if the US person owns only 5%, the combined ownership with the non-US spouse (who owns 95%) can trigger the need to file Form 5471.
Can I avoid filing Form 5471 by transferring ownership to a family member?
No, transferring ownership to a family member to reduce your ownership percentage does not exempt you from filing Form 5471. Even if a family member, like a daughter, owns the majority of the business, constructive ownership rules apply.
This means the IRS considers the combined ownership of related parties, so you would still need to file.
Is there a way for small business owners in Mexico to avoid filing Form 5471?
Yes, small business owners can avoid filing Form 5471 by reclassifying the entity.
Instead of treating it as a foreign corporation, you can treat it as a sole proprietorship, making it a flow-through entity taxed at the individual level.
This means you would file it on Schedule C as part of your individual tax return, avoiding the inconvenience and costs of Form 5471.
How is company income treated as self-employment income?
If you reclassify your Mexican LLC as a sole proprietorship, the income you pay yourself is treated as self-employment income on your US tax return.
This can be beneficial because of the totalization agreement between Mexico and the US, which exempts you from paying self-employment taxes to the US.
Can married couples jointly owning a company use this reclassification?
No, reclassifying the entity as a sole proprietorship only works if you own 100% of the company. If you and your spouse jointly own the business, you cannot make this election.
What is the process for reclassifying an entity to avoid Form 5471?
To reclassify your Mexican LLC to be treated as self-employment income, you need to file Form 8832 with the IRS. This form requests permission to change the entity’s classification.
Do I need the IRS’s approval before treating my income as self-employment?
Yes, you must file Form 8832 and wait for IRS approval before you can start filing your income as self-employment on your US tax return.
Should I seek professional help for this process?
Yes, it is advisable to seek professional help when reclassifying your entity.
Filing Form 8832 and handling the reclassification process can be complex, and a tax professional can ensure everything is prepared efficiently.
