The Gift that Keeps on Giving

I regularly get asked questions about Mexican corporations and U.S. taxes of their American shareholders.  Foreign corporations are a minefield that is best avoided, unless there’s no practical alternative. Sadly, many set up entities to run local businesses, without taking time to ponder federal (or state) repercussions or giving it any additional thought.

‘Feds’ get very edgy when Americans set up foreign entities. Why? They don’t have visibility, given those corporations are outside IRS reach. The first “bright idea” that often comes up is “if they don’t know about it, I won’t have to report any money I make from the business”. Wrong.

A foreign corporation may be outside IRS claws, but you aren’t. Congress set up requirements to force disclosure of ownership by taxpayers. The IRS also knows that corporations are used to “park” income, whatever’s left after paying expenses. Some also say “I won’t pay myself dividends and won’t have to pay tax on that money”. If enough of the corporation is U.S. owned, the IRS will require computation of what I’ll call “imputed dividends” adding to the shareholder’s tax bill for the year, even if not a cent was actually paid out.

The new tax law widened the universe of U.S. shareholders required to pay tax on undistributed earnings. Just like big multinationals, little guys are seeing it may be a bad idea to park earnings in corporate bellies. Under the “expanded dragnet”, old corporate undistributed earnings are subject to an immediate tax on the 2017 shareholder’s return, which can be paid under a special installment plan.

Since corporations aren’t born with capital, the IRS also wants to know who contributes and what. If you contribute enough, you also have to report, whether it’s cash or property.  Also, if you sell your shares –of course–the IRS also wants to know, so they can extend their loving hand out to you.

Mexican entities keep books under Mexican accounting rules. Those books will need converting using U.S. accounting standards to have proper numbers for U.S. tax filings. Of course, that’s aside from mere Peso/Dollar conversions.

One more thing: If those corporations have foreign bank accounts, they may also be reportable in your own Foreign Bank Account Report (FBAR).  If you “control” the entity, corporate bank accounts may be reportable by you, the flesh and bones U.S. person.  Oh, what a trip.

Forewarned, forearmed!

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Orlando Gotay
Lawyer
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, online radio at mixlr.com/orlandogotay