US-Mexico Tax Treaty Summary: Key Provisions
Clarify your tax responsibilities between the U.S. and Mexico. This summary explains how the treaty allocates taxing rights to prevent double taxation.
The U.S.-Mexico tax treaty provides a framework for the tax obligations of individuals and companies with financial ties to both nations. Its function is to prevent double taxation by establishing rules that determine which country has the primary right to tax different types of income. These guidelines apply to U.S. citizens living or working in Mexico and Mexican nationals with income from U.S. sources.
Determining Residency for Treaty Purposes
The U.S.-Mexico tax treaty benefits are available only to “residents” of one or both countries. A person is a resident of a “Contracting State” if they are liable for tax there based on domicile, residence, or place of management.
When a person qualifies as a resident of both countries, the treaty uses “tie-breaker” rules to assign a single country of residence. The rules are applied sequentially, starting with the location of a “permanent home.” If that is not decisive, the test becomes the “center of vital interests,” followed by “habitual abode,” and finally, citizenship. If an individual is a citizen of both countries or neither, the tax authorities must settle residency by mutual agreement.
Taxation of Specific Income Types
Business Profits
A business’s profits are taxable only in its country of residence unless it operates through a “Permanent Establishment” (PE) in the other country. A PE is a fixed place of business, like an office or factory. The source country can only tax profits attributable to the PE and allows deductions for expenses incurred for the PE, including a share of administrative costs.
Dividends, Interest, and Royalties
The treaty reduces withholding taxes on passive income. For dividends, the 30% U.S. withholding tax is lowered to a maximum of 5% for a company owning at least 10% of the paying company’s voting stock, and 10% for all other dividends.
Interest payments are limited to a source-country tax between 4.9% and 15%, depending on the interest type. For royalties, the treaty establishes a maximum withholding tax of 10%.
Income from Employment
Income from employment is taxed where the work is physically performed. An exception, the “183-day rule,” exempts this income from source-country tax if three conditions are met.
The employee must be present in the source country for 183 days or less in a 12-month period. The salary must be paid by an employer who is not a resident of the source country. The compensation cannot be borne by a permanent establishment of the employer in the source country.
Pensions, Annuities, and Social Security
Pensions, annuities, and similar remuneration are taxable only in the recipient’s country of residence. A distinct rule applies to Social Security and other public pensions, which are taxable only by the country that pays them. Therefore, U.S. Social Security benefits paid to a resident of Mexico are taxable by the United States.
Capital Gains
The treaty’s rules for capital gains differ based on the asset type. Gains from selling immovable property, like real estate, are taxed by the country where the property is located. Gains from other assets, such as stocks and bonds, are taxable only in the seller’s country of residence.
Exceptions exist, as gains from selling shares in a company whose assets are mainly real property may be taxed where the property is located. The source country may also tax gains from a stock sale if the seller held at least a 25 percent interest in the company within the 12 months before the sale.
The Saving Clause and its Exceptions
A “Saving Clause” allows the United States to tax its citizens and residents on their worldwide income as if the treaty did not exist. This means a U.S. citizen in Mexico generally cannot use the treaty to reduce U.S. tax on their income. For U.S. persons, relief from double taxation comes primarily from the foreign tax credit, not treaty exemptions.
The saving clause has exceptions for certain treaty benefits, including the articles governing Social Security payments, child support, and relief from double taxation. The “Relief from Double Taxation” article is what ensures U.S. citizens can claim a foreign tax credit for income taxes paid to Mexico.
Claiming Treaty Benefits
For Non-U.S. Persons Receiving U.S. Income
Residents of Mexico receiving income from U.S. sources claim the treaty’s reduced tax rates using IRS Form W-8BEN. This form is not filed with the IRS but is given to the U.S. entity making the payment, known as the withholding agent. On the form, the Mexican resident certifies their foreign status and claims treaty benefits, which allows the U.S. payer to withhold tax at the lower treaty rate instead of the standard 30%.
For U.S. Persons
U.S. persons who use a treaty provision to modify U.S. tax law must disclose this position to the IRS by filing Form 8833, Treaty-Based Return Position Disclosure. This form is attached to their annual U.S. income tax return and is required when a treaty position reduces U.S. tax. For example, a dual-resident taxpayer using the treaty’s tie-breaker rules to be treated as a resident of Mexico must file Form 8833. Failure to disclose a required treaty-based position can result in penalties.