One of the best things about leaving my job in the United States and moving to Mexico is that I have a lot more time to play pickleball. On the flip side, though, I left behind a six-figure salary. Since my pickleball game isn’t good enough to land me a sponsorship and I haven’t won any big purses at tournaments, I have to make money the old-fashioned way: working.
Really though, my wife and I weren’t counting on me to support the family by playing pickleball. We were both practicing attorneys in the U.S. and although we planned to give up our practices when we moved to San Miguel de Allende, we knew we had transferable skills. After twenty years of working for the Internal Revenue Service, I planned to prepare individual U.S. tax returns. That work has kept me plenty busy between pickleball court reservations.
My wife leveraged the language and interpersonal skills she honed as an immigration attorney into week-long Spanish language courses for English-speaking lawyers. She’s branched out into hosting language courses for psychologists and organizing accommodations, transport, and other logistics for photography tours. She also curates cultural visits to neighboring Indigenous communities.
These endeavors don’t net us close to what we used to earn, but we don’t need as much because the cost of living in Mexico is less. But no matter how much we earn — and whether we call ourselves self-employed, independent contractors, contractors, entrepreneurs, sole proprietors, solopreneurs, gig workers, or digital nomads — I know the IRS has only one name for us: taxpayers.
Employee versus self-employed
Throughout my working life before moving to Mexico, I had been an employee. I received a bi-weekly paycheck with taxes automatically taken out and I was given a Form W-2, “Wage and Tax Statement,” at the end of each year. All I had to do to prepare my tax return was transcribe numbers from the W-2 onto Form 1040, “US Individual Income Tax Return.”
It wasn’t going to be that easy for me as a self-employed person. On the one hand, I knew I would have to keep track of how much money I earned from each client — that figure would be my gross income. But I also knew that I could deduct business expenses, which employees generally do not get to do. Keeping records of what money I spent that was related to my businesses was new territory.
Everything you ever wanted to know about Form 1099
Let’s talk first about income. As I said, since I was no longer an employee, no one was going to send me one tax record at the end of the year, such as a W-2, that was going to aggregate my income into a single document.
However, U.S. clients who pay me US $600 or more are required to send me a Form 1099. Before 2020, income paid to individual contractors was reported on Form 1099-MISC, “Miscellaneous Income,” as non-employee compensation. Starting in 2020, business payments made to individuals should be reported on the new Form 1099-NEC, “Nonemployee Compensation.” These documents are not required to be issued to corporations.
Don’t worry if you receive a Form 1099-MISC instead of a Form 1099-NEC: some businesses have just been slow to make the transition from one form to the other. If you get a 1099 and it accurately shows what you earned from that client, you should report the figure as business income. The IRS also receives a copy of any 1099 issued to you. If you don’t put that income on your return, you can one hundred percent expect the IRS to contact you.
When you begin working with a U.S. client, they should ask you to complete a Form W-9, “Request for Taxpayer Identification Number and Certification.” This form gives them the information they need to prepare a correct Form 1099. Of course, U.S. clients who pay you less than $600 during the year don’t have to give you a 1099, and non-U.S. clients also have no obligation to provide you with a record of earnings for the year. It’s good practice to keep accurate records for all your clients, but especially critical for clients who won’t give you a Form 1099 or other earnings record.
If you accept payment for your services via credit card or a payment app such as PayPal or Venmo, beginning in 2023, the vendor should be sending you a Form 1099-K, “Payment Card and Third Party Network Transactions.” Note that the gross payment amount — Box 1a — on Form 1099-K reports the total payments you received for your goods or services. It doesn’t include adjustments for fees, credits, refunds, shipping, or discounts. These items are not income. When reporting on your Form 1040, you can deduct them from the gross amount.
Form 1099-K should also not include amounts you receive from friends or family as a gift or reimbursement of a personal expense if the payment is identified as personal when made. For example, if you go to dinner with friends and pay the bill and then accept reimbursement from your friends through PayPal, your friends should mark the payment as personal by using the Friends and Family option. This will also avoid fees being deducted from the payment by the online platform.
Failure to identify the payment as personal means the reimbursement will be included in the gross amount reported on your 1099-K. In this case, it is your responsibility to maintain records showing what transactions were business as compared to personal. You are not required to include this information with your tax return, but keep it handy in case the IRS comes knocking.
One final thing to say about working with U.S. clients: Because many of them are unfamiliar with U.S. tax law as it relates to overseas workers, you may be asked to complete a Form W-8BEN, “Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Individuals),” instead of the Form W-9. Don’t do it! Form W-8BEN is for individuals conducting business in the U.S. but not U.S. citizens.
Now that I have my 1099s, what income should I report?
Unfortunately, the answer is all of it. The United States is one of the few countries in the world that taxes its citizens on their worldwide income. This means that even if you live outside of the U.S., the IRS still gets to tax everything that you make.
Don’t fret, however. If you do live in Mexico, or another country that is not the U.S. or one of its territories, you may qualify for the foreign earned income exclusion (FEIE). This tax provision allows you to exclude foreign earnings up to an amount that is adjusted annually for inflation.
Use Form 2555, “Foreign Earned Income,” to claim the FEIE. In order to do so, you must have foreign earned income, your tax home must be in a foreign country and you must meet certain time thresholds for being outside of the U.S. during the year. The rules can get complicated, so talk to a tax professional to determine if the FEIE is appropriate in your situation.
It’s important to note that the amount of income excluded only reduces your regular income tax. The FEIE does not apply to social security or medicare taxes. Because employees have these taxes automatically deducted from each paycheck, they might not even notice how much they pay throughout the year. But a self-employed person who is solely responsible for paying this tax certainly will.
For example, if you are self-employed and have a foreign earned income of $70,000 in 2023 and claim the FEIE, you would pay no income tax but still owe social security taxes of approximately 15% of the earned income. On $70,000, that could be as much as $10,500 that you would have to pay with your tax return. Ouch!
To lessen the pain, you can make estimated tax payments during the year so that you don’t have a big lump sum tax bill due when you file your return. You can use the IRS’s estimated tax withholding estimator tool to determine the correct amount to pay. Generally, the tool will break down your tax liability into four equal payments due in April, June, September and January of the following year. You can mail the payments or pay online after establishing an account on the IRS website.
Of course, some people prefer to keep the money in their pocket during the year and don’t mind having a big tax bill in April. Be aware, though, that if the tax liability shown on your return is too large — generally more than $1,000 — the IRS could impose penalties.
If you also receive wages in addition to self-employment income, you can ask your employer to take more tax out of your earnings rather than making estimated tax payments. To do this, file a new Form W-4, “Employee’s Withholding Certificate,” with your employer. Similarly, if you receive a distribution from an IRA, pension, or annuity, you can use Form W-4P, “Withholding Certificate for Periodic Pension or Annuity Payments,” to start or change your withholding from these payments.
Another great way to reduce your tax liability is to track all of your legitimate business expenses and deduct them from your earnings. In the next article, I’ll break down Schedule C, “Profit or Loss from Business,” and describe the different categories of deductible business expenses.
Paul Carlino is an attorney living in San Miguel de Allende and the founder of Pickleball Mexico. He writes for Mexico News Daily.
