Like most countries, Mexico has an income tax system. If you earn money there, you'll have to pay taxes on it. Furthermore, as a U.S. citizen or a resident alien, you also have to pay U.S. income tax on part or all of the money you make, regardless of where you make it. The good news is, the Internal Revenue Service lets you offset your U.S. income tax with the tax you pay abroad.
General U.S. Tax Rules
The United States tax code taxes all of the money you earn wherever you earn it. Taxes aren't tied to place -- they're tied to you. There are two ways you can avoid double taxation. First, the IRS lets you exclude a certain amount of foreign income -- $97,600 for the 2013 tax year -- if you meet a set of stringent requirements. Second, you can either claim a deduction or a credit against your U.S. income taxes for the taxes you pay to Mexico or just about any other foreign country.
Mexican Income Tax
Like the United States, Mexico has an income tax system that is based on income brackets. As of the 2014 tax year, incomes up to 500,000 pesos, or roughly $38,461, are taxed at rates of 30 percent or less. Incomes over 3 million pesos -- about $230,769 -- are taxed at 35 percent. In addition, Mexico allows itemized deductions, although it caps them at 10 percent of your income or four times Mexico City's annualized minimum wages.
Mexico also has a value-added tax, which is similar to a sales tax. Most items that you buy in Mexico have a 16 percent tax built into them. This means that an item that would cost 100 pesos would actually be priced at 116 pesos. VAT is built into just about everything you buy -- including many consumer goods and travel expenses. The U.S. foreign income tax credit or deduction doesn't apply to VAT, so you won't get any credit for paying it.
Special Mexico Considerations
When you live in Mexico, you become eligible for two types of special treatment under U.S. tax law. First, if you are taking care of a Mexican relative while you live there, you may be able to claim him as a dependent on your U.S. taxes even if they are not U.S. citizens or aliens. Second, you can deduct money that you give to some Mexican charities in addition to being able to deduct money you give to U.S.-based charities. However, you can usually only deduct donations to Mexican charities if you have Mexican income.
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