The IRS Has Special Rules for Mexican Corporations and You Really do Not Want to Ignore Them

If you have your own business in Los Cabos or are developing real estate you generally must use a Mexican corporation as the entity to conduct the business. The Mexican tax and legal rules concerning the operation of such corporations are complex enough, but if you are a US Citizen or permanent resident, Internal Revenue Services also has a lot more rules and regulations. Special forms are required and certain elections must be made or you might be in trouble or even worse, penalized. Unfortunately a majority of the CPAs in the States do not know any of these rules and forms and therefore cannot save you from possible tax disaster.

Though the rules are complex, generally if a US person (Citizen or permanent resident) owns a ten percent or more of a Mexican corporation, they are required to file Form 5471 with their personal U.S. tax return each year. Though this form usually often has no effect on the filer’s taxes, failure to file this form on a timely basis results in a $10,000 penalty for that failure or never filing the return at all. This penalty may only be abated for reasonable cause which is not clearly defined. When you transfer assets to a foreign corporation or dissolve one, form 926 must also be filed.

When you file form 5471 you are required to provide a calendar year income statement and balance sheet. You must also states, names, addresses and social security numbers of all owners.

If the corporation derives all of its income from your own personal services, its income is all currently taxable to the US owners (in addition to any tax it owes in Mexico) as Subpart F income. However, if it operates a restaurant or retail store there is generally no current US income to its owners providing is its not reselling merchandise made in the U.S.A. When its profits are distributed they are taxed as stock dividends to its shareholders.

Be aware if your foreign corporation has significant earnings from investments in stock or bonds or real estate, it could be held to be a Foreign Investment Company and its earnings may be currently taxable to the owners. The rules for such companies are too complex to discuss in this article.

It is also important to choose the proper type of Mexican corporation to own your real estate or Mexican business.

The type of Mexican corporation know as Sociedad Anonina most commonly used can result in double taxation of all income on your US tax return and the inability to pay the lower US capital gains tax and take foreign tax credits for the taxes paid in Mexico when the real property owned by the corporation is sold.

If the correct Mexican entity is utilized using the U.S. “check the box” regulations it is possible to take advantage of the corporations operating losses on your U.S. individual tax return, and take foreign tax credits on Mexican taxes paid by the corporation on your personal return. Only a Sociedad de Responsabilidad Limitada or “S. de R.L” is eligible to be treated as a flow through entity under U.S. tax law and you must file form 8832 to achieve that status.

Who cares about all this you say, I don't have a foreign corporation. I just own a part of a foreign partnership, Limited Liability Company or trust. The IRS has some fairly tough rules with respect to reporting the activities of those entities and special forms for each.

After 911, the terrorists and drug runners, the IRS is very interested in all foreign entities and is on the look out for those Americans who own part or all of a foreign entity but fail to report that ownership with their tax returns. You should keep in mind that the IRS unofficial policy is to go lenient on a taxpayer that comes forward and complies with the law in their own accord versus the taxpayer they first find in violation.

If you need assistance with these forms or preparing the forms for your tax return please contact us. If your tax preparer has failed to tell you about these forms maybe its time to make changes.

The Mexican Hacienda becomes more sophisticated each year and sooner or later data on every entity formed by gringo in Mexico will be exchanged with the IRS under the terms of that mutual tax treaty. Getting into compliance ahead of that potential crackdown will save you a lot of stress and penalties.