U.S. TAX GUIDE IN MEXICO
How does self-employment in Mexico affect my US tax return?
Self-employment in Mexico requires you to report your income on your US tax return and may be subject to self-employment tax.
However, due to the totalization agreement between the US and Mexico, you may be exempt from paying US self-employment tax if you are paying self-employment taxes in Mexico.
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Why is the totalization agreement between Mexico and the US important for self-employed individuals?
The totalization agreement between Mexico and the US is important because it exempts US expats from paying US self-employment tax if they are already paying self-employment taxes in Mexico.
Normally, self-employment tax in the US is about 15.3% of net income. However, due to the totalization agreement, if you are a resident of Mexico, you don’t have to pay US self-employment tax on your income generated in Mexico.
What is Form 8858, and do I need to file it if I have self-employment income in Mexico?
Yes. You’ll need to file Form 8858 since it is an informational form that needs to be attached to your US tax return (Form 1040) and Schedule C if you have self-employment income.
This form details the type of self-employment income you have, as well as your income and expenses. Essentially, it reports the same information as Schedule C but in a different format.
What happens if I don’t file Form 8858?
Failure to file this form can result in significant penalties, up to US$10,000 for late filing.
What if I haven’t filed Form 8858 for several years?
If you have been self-employed in Mexico for several years and have reported your income on Form 1040 and Schedule C but never filed Form 8858, it is advisable to consult a tax professional.
They can assess your situation and provide guidance on the best course of action. In some cases, amending past returns to include Form 8858 may be necessary.
They can also provide support with the Streamlined Amnesty Program, which can help you avoid penalties for late filing of Form 8858. If you are eligible for this program, it allows you to become compliant with your US tax obligations without facing hefty penalties.
Example Scenario
Imagine you have been self-employed in Mexico for the past ten years and reported your income on Form 1040 and Schedule C but never filed Form 8858.
Consulting a tax professional could help you determine if you qualify for the Streamlined Amnesty Program, which could save you from significant penalties and ensure you are fully compliant with US tax laws.
What forms do I use to report foreign-earned self-employment income?
- Form 1040 and Schedule C:
- Report your foreign-earned self-employment income on Schedule C (Profit or Loss from Business) attached to your Form 1040. This form will calculate your net earnings from self-employment.
- Schedule SE:
- Use Schedule SE (Self-Employment Tax) to calculate your self-employment tax, which includes Social Security and Medicare taxes. The rate is 15.3% of your net earnings.
- Form 2555 (Foreign Earned Income Exclusion):
- If you qualify for the Foreign Earned Income Exclusion (FEIE), complete Form 2555. This form allows you to exclude up to US$126,500 (for 2024) of your foreign-earned income from US taxation, reducing your taxable income.
- Form 1116 (Foreign Tax Credit):
- To avoid double taxation, you can use Form 1116 to claim a credit for foreign taxes paid on your self-employment income. This credit can offset your US tax liability.
- Form 8938 (Statement of Specified Foreign Financial Assets):
- If you have significant foreign financial assets, file Form 8938 to report these assets to the IRS. This form is required under FATCA and includes details of your foreign accounts and investments.
- FBAR (FinCEN Form 114):
- If the aggregate value of your foreign bank accounts exceeds US$10,000 at any time during the year, you must file an FBAR. This form reports the details of your foreign bank accounts and is filed separately from your tax return.
How exactly does my business structure affect my self-employment taxes?
US LLC
If you operate your business as a US LLC, your self-employment income is typically reported on Schedule C of your Form 1040. You will be subject to self-employment tax (SECA), which includes Social Security and Medicare taxes, at a rate of 15.3% on your net earnings.
The income is also subject to regular income tax based on your tax bracket.
Foreign LLC
A foreign LLC might be treated as a disregarded entity, partnership, or corporation. If treated as a disregarded entity or partnership, you will report your share of the income on your personal tax return and pay self-employment tax.
However, if the foreign LLC is treated as a corporation, you might avoid self-employment tax but could be subject to different tax rules, such as GILTI.
S Corporation
An S Corporation provides a way to reduce self-employment tax.
As an S Corporation owner, you are required to pay yourself a reasonable salary, which is subject to employment taxes. The remaining profit can be taken as a distribution, which is not subject to self-employment tax.
What other considerations do I need to think about?
- Currency Conversion: Ensure that all foreign income and expenses are reported in US dollars. You can use the annual average exchange rate or the exchange rate on the date of the transaction. You can find it here (https://fiscaldata.treasury.gov/datasets/treasury-reporting-rates-exchange/treasury-reporting-rates-of-exchange).
- Documentation: Keep detailed records of your foreign income, expenses, and taxes paid. Proper documentation is crucial for claiming deductions and credits.
- Professional Assistance: Consider consulting a tax professional who specializes in expat taxes. They can help you navigate the complexities of reporting foreign self-employment income and ensure compliance with all US tax laws.
