Moving to Mexico Doesn't End Your U.S. Tax Filing: A Case File

A retired aerospace engineer, single, sold his house in San Diego, moved to a rental on Lake Chapala, and did not file a U.S. return for two years because, as he put it, "I don't live there anymore." He came to me after his bank in Guadalajara asked him to sign a Form W-9 and he panicked, assuming the two were connected. They were not, but the instinct that something was wrong was correct. He had a Social Security check, a modest pension, a brokerage account he had forgotten to update, and roughly $180,000 sitting in Mexican peso accounts that he had never reported. Untangling his file is the whole reason for this article, because almost every mistake he made is one Americans make the moment they cross the border and assume the IRS stopped caring.

The first thing I had to explain to him, over the phone, was the sentence that surprises nearly every new expat: the United States taxes its citizens on worldwide income no matter where they live. This comes from §1 and §61 of the Internal Revenue Code, and there is no "I moved away" exception. A green-card holder or citizen owes a Form 1040 every year the same as someone in Cleveland, reporting the Social Security, the pension, the brokerage dividends, and any Mexican-source income, all of it, in U.S. dollars. His theory that leaving the country ended his obligation is the single largest category of expat problem I see, and it is almost always innocent. Nobody tells you at the border.

Two years unfiled put him into Streamlined, not into trouble

Because his failure to file was genuinely non-willful, the fix was the Streamlined Foreign Offshore Procedures, not a scramble to backfile and hope. The Streamlined program, which the IRS lays out on its "U.S. Taxpayers Residing Outside the United States" page, requires three years of amended or delinquent income tax returns and six years of FBARs, plus a signed certification (Form 14653) explaining that the failure was non-willful. For a taxpayer physically outside the U.S. who meets the non-residency requirement, the miscellaneous offshore penalty is waived entirely. That word "waived" is why I moved fast to get him in before any IRS contact. Streamlined is only available to taxpayers the IRS has not already contacted about the delinquency. Once you get a notice, that door is a good deal narrower.

His non-residency was easy to establish. To qualify for the foreign version of Streamlined, in at least one of the last three years you must have been physically outside the United States for at least 330 full days and not have had a U.S. abode. He had sold the San Diego house, so no U.S. abode, and he had barely left Jalisco. That same 330-day count matters for a second reason, which is where his actual tax bill got interesting.

The Foreign Earned Income Exclusion did nothing for him, and that is the point

Every article about moving abroad leads with the Foreign Earned Income Exclusion under §911, which for 2024 lets a qualifying taxpayer exclude up to $126,500 of foreign earned income. I had to walk him through why it was useless to him. The word doing the work in that section is "earned." A pension is not earned income. Social Security is not earned income. Dividends, interest, and capital gains are not earned income. His entire cash flow was passive, so the §911 exclusion had nothing to exclude. This is the trap in reverse: retirees read that headline number, assume they are covered, and never look at what they actually owe.

What did help him was the Foreign Tax Credit under §901, claimed on Form 1116. Mexico taxes residents on their worldwide income too, and once he became a Mexican tax resident he started paying Mexican tax on his investment income. The Foreign Tax Credit lets him offset his U.S. liability dollar for dollar with the Mexican tax he paid on the same income, which is the primary mechanism that keeps Americans in Mexico from being taxed twice. For someone with foreign investment income, §901 is usually the more valuable tool than §911, and it is the one the brochures bury. His Social Security, as a U.S.-source payment, remained taxable to the U.S. side; there is no U.S.-Mexico tax treaty provision that hands Social Security taxation to Mexico the way some treaties do.

The $180,000 in peso accounts was the real exposure

The unreported bank accounts, not the unfiled returns, were what kept me up. Any U.S. person whose foreign financial accounts exceed $10,000 in aggregate at any point during the year must file FinCEN Form 114, the FBAR, by April 15 with an automatic extension to October 15. That $10,000 is an aggregate ceiling across all accounts, not per account, and it is measured at the highest balance each account touched during the year, not the year-end figure. His $180,000 blew past it in every one of the six years I needed to backfile. The civil penalty for a non-willful FBAR violation runs up to roughly $16,000 per violation per year as adjusted for inflation, and for willful violations it climbs to the greater of $100,000 or 50 percent of the account balance. Streamlined is what let those penalties fall away, which is exactly why I would not let him "just start filing going forward" and ignore the past.

On top of the FBAR, his account balances also triggered Form 8938 under §6038D, the FATCA statement that rides on the 1040 itself. For an unmarried taxpayer living abroad, Form 8938 is required once specified foreign financial assets exceed $200,000 on the last day of the year or $300,000 at any point during it. The FBAR and Form 8938 overlap but are not the same form, filed with different agencies, and one does not excuse the other. He needed both.

One thing he did right saved him a PFIC nightmare

Here is the part of his file I was quietly relieved about. He had kept his investments in the U.S. brokerage account and never bought into a Mexican mutual fund or a local investment product. Had he moved that money into a Mexican pooled fund, he would have walked straight into the Passive Foreign Investment Company rules of §1291, where a foreign mutual fund gets taxed at the highest ordinary rate with an interest charge on the deferred gain, all reported on Form 8621. I have cleaned up PFIC messes that cost more in preparation fees than the investment ever earned. If you are moving to Mexico and someone at a local bank offers you a "fondo de inversión," that is the moment to call your tax adviser before you sign, not after. For the mechanics of why these funds are so punishing, see our fuller treatment at /blog/pfic-foreign-mutual-funds.

His file closed cleanly. Three years of returns, six years of FBARs, a 14653 certification that told the truth about a man who simply did not know, and no penalty. He now files a 1040 every October from Jalisco with a Form 1116 credit, an FBAR, and a Form 8938, and he keeps his money exactly where it was. The lesson he paid two years of anxiety to learn is that moving to Mexico changes where you live, not who taxes you, and the sooner you file as if that were true, the cheaper it stays.

Sources

• IRC §1 and §61 (worldwide income of U.S. citizens and residents)
• IRC §911 and Form 2555 (Foreign Earned Income Exclusion; 2024 limit $126,500)
• IRC §901 and Form 1116 (Foreign Tax Credit)
• IRS Streamlined Foreign Offshore Procedures; Form 14653 (non-willful certification)
• FinCEN Form 114 (FBAR); 31 U.S.C. §5314 filing requirement and inflation-adjusted penalties
• IRC §6038D and Form 8938 (specified foreign financial assets; $200,000 / $300,000 thresholds for unmarried taxpayers abroad)
• IRC §1291 and Form 8621 (Passive Foreign Investment Company rules)