By Raoul Rodríguez
When most people think about financial planning, they think “investments.” As a financial planning professional, when I think about what we do, my mind goes first to “taxes.” Income taxes are a complex matter that touch on practically all we do with clients, and this complication becomes markedly more so if you are subject to tax in the U.S. and a foreign jurisdiction. Tax rates—what is taxable versus what is tax advantaged—formulas, deductions, and all types of other rules and regulations are different. If at all possible, it’s best to avoid being subject to tax in more than one jurisdiction. In this article I will review what is meant by tax residence and thus who is subject to income tax and where.
The first point to highlight is the fact that legal residence is not the same as tax residence. These are two totally different concepts. The U.S. is almost unique in the world in that it taxes based on both residence and citizenship. If you are a U.S. person (U.S. citizen, green card holder, or otherwise qualify as a U.S. resident for tax purposes), you are subject to tax on worldwide income regardless of where in the world you live and regardless of your status as a tax resident abroad.
You must determine if you are a tax resident in the country you are living in. Tax residence is defined in international tax treaties and local laws. Most countries will tax residents based on a physical presence test formula that has some component of around 183 days. A few countries have no income tax at all, such as Bahamas and Monaco. Others may consider you a tax resident at some point but impose income tax on a territorial basis. These countries tax only in-country source income, not caring about any foreign source income. Costa Rica comes to mind. These are exceptions that prove the rule: most countries tax their tax residents on worldwide income, including Mexico.
Mexico eliminated the more typical physical presence test almost 20 years ago. You are now considered a tax resident on the very day you establish an “abode” in the country pursuant to Article 9 of the Federal Fiscal Code. Mexico then looks to see where your “center of vital interests” lies to further help determine tax residence in cases where you have a permanent home available in Mexico and abroad. Mexico has specifically defined “center of vital interests” to be the place where you carry out your principal place of professional activity or where you source over 50% of your income. In other words, from Mexico’s perspective, if you also have a permanent home available to you abroad, you will be considered a tax resident in the county where you work or from where you receive most of your total income. For those of you who have taken Mexican nationality, the same Article 9 of the Fiscal Code states that Mexican citizens are presumed to be tax residents of this country unless they can show otherwise.
I emphasize that legal residence is irrelevant for this test. If you come and go from Mexico on a tourist vista, but this country is where you keep your only home, you are likely a Mexican tax resident. If your immigration status is that of a Permanente, you have another home abroad, are not working in any capacity, and live from your foreign investments and foreign Social Security, you are NOT a Mexican tax resident.
Article 4 of the tax treaties Mexico has ratified mirror the provisions of the Fiscal Code, including the treaties with the U.S. and Canada.
Defining your tax residence is important because Mexico, as mentioned, taxes its residents on worldwide income. Coming from Canada or other countries that tax on residence alone, you may only be subject to income tax in Mexico. But for a U.S. person this may mean being subject to report income and pay income tax in both countries. Your total tax burden may go up, or even may go down, depending on a whole host of factors, but becoming compliant in two or more jurisdictions (if you include state income taxes) will certainly be more challenging. Enforcement can be spotty, especially in Mexico, but times are changing. The Internal Revenue Service has emphasized international enforcement. Automatization of the tax environment and the use of artificial intelligence is being prioritized in both countries. The Foreign Account Tax Compliance Act (FATCA) and the Common Reports Standards (CRS) facilitate the automatic exchange of taxpayer information between countries, and penalties for noncompliance can be exorbitant and even can be considered a criminal offense under certain circumstances.
This is the answer to the question: if you are a retired foreigner living full time in Mexico, you can decide not to be a tax resident if you plan correctly.
1 In the case of green card holders, this continues to be the case even if you have permanently left the U.S. and have allowed your green card to expire.
