US Tax Filing Requirements for a Mexican or Foreign Corporation

If you, a US Citizen, own your Mexican real estate or small business through a Mexican corporation you have a U.S. Tax filing obligation with the IRS each year. This form is generally required if you own 10% or more of the stock or equitable interest in the foreign corporation.

• The form is due yearly on the extended due date of your US. Income tax return. It is filed with your personal return and includes information on the foreign corporation's ownership, formation, income and expenses, and assets and liabilities. Usually it will not result in any additional tax due with your personal return, but that is possible if it has Subpart F income.

• In most situations (unless the flow through election is made as explained below) the form 5471 does not result in any additional tax on your US tax return. However, if the foreign corporation has a sufficient amount of investment income, income from the sole owners personal services, or income from reselling goods made by an affiliate in the US, its income may become immediately taxable to you the shareholder. Subpart F income is complex which means a careful analysis of the sources of the corporations income must be made to determine if it is immediately taxable to its shareholder. If another owner of the foreign corporation files the form, you just need to identify data on that owner in an attachment to your tax return.

• If the corporation owns real estate, and possible for other reasons, it is advisable that it is formed a a Sociedad de Responsibilidad Limitada (SRL). You as the owner of the SRL can make an election for US income tax purposes to treat it as a flow through entity on the US return of its owner. (This is the same as the treatment of an LLC or partnership for US tax purposes.) This means all of its income or losses flow through to you on your personal tax return and becomes a part of your US taxable income each year. It also allows you to take a foreign tax credit on your personal return for any taxes the foreign corporation pays in Mexico on its income. This election also stops any possibility of double taxation or converting capitals gains into ordinary income on your US income tax return.

• If the IRS discovers you filed late or you should have been filing this form and did not the penalty is $10,000 per year for each unfiled form. There is a tax treaty between Mexico and the U.S which allows both countries access to the other countries records. Your US passport is included with other documents in the bureau where your Mexican corporation is is registered in Mexico.

• We recommend to you that you file this form each year if you have the requisite stock ownership in a Mexican Corporation. Failure to file could result in extreme IRS penalties if they discovered you failed to file.

FOREIGN CORPORATION FORM 5471 NON-FILING OR LATE FILING

The IRS recently announced that starting in 2009 they will start imposing the $10,000 penalty onf corporations that file Form 5471 late or not at all. This form is required of anyone (US corporation, LLC, trust, individual or partnership) owning more than 10% of a foreign corporation. It usually includes a yearly income and expense statement and balance sheet and information on the corporation, its distributions, business, owners, etc. This form is due with the regular or extended due date of the owner's regular tax return and is attached to the regular tax return.

It appears a large number of US taxpayers operating businesses abroad (and often also living abroad) form a corporation to operate their small business, but never file this form due to lack of knowledge or neglect. Often attaching a written excuse to the form will abate the penalty but ater the end of 2008, it appears this might not be as successful as it has been.

It is entirely possible that in the future the IRS will extend the automatic penalty assessment to individuals who file Form 5471 late or fail to file it. Right now they often will waive that penalty if the taxpayer attaches a reasonable excuse.

Watch Out for Foreign Mutual Fund Investments

We have learned that a lot of US expats are being sold foreign mutual funds or shares in foreign corporations that invest solely in securities. They are being told that those investments will grow tax free (legally) until such time as they decide to take a distribution. That statement is true but the brokers and sales people are not telling their US citizen and permanent resident clients all of the facts how a distribution will be taxed when it is finally made.

When you purchase a foreign investment company or mutual funds it is general classified for US tax purposes as a Passive Foreign Investment Company (PFIC). These have special treatment under US tax law. To learn the technical details read the instructions to IRS Form 8621.

It is true that you are not taxed until a distribution is made, but unless you file a special election and special IRS form to have the fund marked to market each at the end of each calendar year the results can be disastrous. When the distribution is finally made (if no election has been made and no form 8621 filed) it will all be taxed at the highest personal income tax rate then in effect and the profit included in that distribution will be treated as if earned ratably during each year the investment was held without distribution. You cannot get capital gains rates on capital gains or any qualified dividend rate on dividends. In addition to paying the highest tax rate, you must pay interest calculated on those ratable earnings for each year on the taxes you should have paid if it were taxed in each of those years you did not take a distribution. The interest added onto the tax rate can mean you pay 50 to 75 percent or more of the distribution in taxes and interest on your US tax return. .... depending on how long you held it without making a distribution, leaving you with little net cash profit.

If you own a PFIC you can avoid this result by electing to mark the fund value up to market at the end of each year and paying tax on any gain at ordinary income rates with your tax return that year. You will not then owe any interest on past distributions and if you are not in the highest tax bracket, you will only pay taxes at the rate you are in for that year. Their is a third choice which is difficult to comply with and rarely used.

So if you do own a PFIC, it is important under most circumstances to file Form 8621 each year and make the mark to market election (you can also take losses if that is the result of the year) on your tax return. If you delay, you may have to pay a lot or almost all of your profits as taxes and interest. How do you avoid this problem? Invest directly in a foreign stockof an individual foreign company. Then the dividends will be taxed as such each year (and if there is a treaty with the country of incorporation those dividends might be qualified) and when you sell the stock you can pay tax on the gain at long term capital gains rates.