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.
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