Cross-Border Coordination: Mexican Disregarded Entities
In general, foreign owned businesses are taxed to their U.S. owners as if they were setup in the U.S. Therefore, it is very important to determine what the business would be considered for U.S. tax purposes. In some circumstances, the taxpayer can make an election of how the entity will be taxed. For various reasons, a common choice is a disregarded entity (DRE). A DRE for tax purposes is ignored and the taxes are reported by the owner, while for legal purposes it still gives the protection and benefits of a separate entity.
Normally, when making the election to have a DRE taxpayers will first review the “per se” corporation list. This is a list of foreign entities that are not allowed to file such an election. In Mexico, this entity is a Sociedad Anomina or S.A. All other Mexican corporations have the ability to elect to be a DRE, with one major exception / problem. In order to be eligible to become a DRE the corporation must have only a single owner. Under Mexican law, most corporations are required to have multiple owners. Many times the second owner will have a very small, nominal ownership percentage just to meet the requirement, and the taxpayer may not even consider this person an actual owner. However, for the purpose of the election to be a DRE, this is still disqualifying.
This is not the end of the discussion though. There can be planning techniques. Potentially a husband and wife who file a joint return could be considered a single owner for U.S. tax purposes but separate owners for Mexican legal purposes. Also, it may be possible for a U.S. taxpayer to have their U.S. DRE be the other owner – again the U.S. DRE and owner would be two separate people for Mexican legal purposes but a single owner for U.S. tax purposes. These situations are not quite that simple and should be analyzed to make sure they work for the taxpayer, but at least there are potential options. Nevertheless, it is clear that two separate individuals owning a Mexican corporation cannot elect to be a DRE, a fact that has been often overlooked by many tax planners. Since the tax structure may have been based on this election, a situation making it invalid could be a major problem to fix.
Overall, this situation illustrates two important factors for international tax planning. First, make sure you are working with the actual facts and not common assumptions or local parlance. Since the secondary Mexican owner is often overlooked, many times the majority owner will consider themselves the only owner. This makes it very important that analysis is formal, corporate documents are actually reviewed, and there is a thorough examination to make sure the accepted practice in a foreign country actually meets the specific IRS rules. Next, it is important to have coordination with the foreign country tax professional to make sure that both countries are properly addressed and coordinated.
It is not possible for any one person to be an expert on the rules of all countries. However, with good communication and cooperation between professionals, it is possible to make sure taxpayers are covered with their international tax plans.