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The Myth, the Legend, the Tax Treaty

ORLANDO tlc-1

By Orlando Gotay, Tax Attorney

I hear it all the time in conversations and in social media: people making reference to the famous? infamous? US-Mexico tax treaty. Soon into those conversations, I often see that there are many misconceptions about what it is, what it does, and how it could affect you.

A tax treaty is an agreement between countries, deciding what is subject to tax under the jurisdiction of each. The idea is to reduce the likelihood of double taxation, although a far from perfect goal. In practice, the overlap in tax systems is such that you could be subject to tax by both countries on the same income.

The US taxes people on citizenship, no matter where they live, Mexico on residency. It is easy to see how some people, absent the treaty, could have very poor tax results.

For the most part, US persons anywhere will not be able to claim any US tax benefits from the treaty. It is important to understand that a US person’s American tax bill may not be reduced on account of anything the treaty says, independent of whether you are a Mexico resident or not. It may, however, affect one’s Mexico tax bill.

It is also important to understand that the treaty does not override one’s state tax obligations. In fact, states (American states) are not bound by the treaty itself.

Then, you say, what benefit is there for me?

If you are an American who is also a resident of Mexico (and I mean residents in the fiscal sense of the word, subject to Mexican income tax), the treaty may become relevant.

In the case of social security, for example, it provides that benefits shall be taxable only in the state that makes the payment. This would mean that US Social Security is taxed only by the US, not Mexico, and I add, only to the extent US tax laws do, in fact, tax it (some pay tax on part, some do not).

The treaty also provides special instructions for the tax treatment of pensions, alimony, child support, capital gains, interest, dividends, and many others. The language is tedious but important.

Another important benefit may be withholding of taxes at a reduced rate on cross border payments. For example, US withholding on pensions and annuities (not Soc. Sec.) can be at 0 percent (versus the “regular” 30 percent), but it has to be claimed.

As you can see, there can be important tax treaty benefits, but not for all, and in any event, they have to be claimed!

 

Orlando Gotay is a California licensed tax attorney (with a Master of Laws in Taxation) admitted to practice before the IRS, the U.S. Tax Court and other taxing agencies. His love of things Mexican has led him to devote part of his practice to the tax matters of U.S. expats in Mexico. He can be reached at tax@orlandogotay.com or Facebook: GotayTaxLawyer.

 

 

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