How to Legally Pay Zero US Taxes as an Expat in Mexico

US expats in Mexico can legally pay zero US federal income tax using the Foreign Earned Income Exclusion (FEIE) which excludes up to $130,000 in earned income (2025 threshold) if you establish a foreign tax home and pass either the Physical Presence Test (330 days outside US in any 12-month period) or Bona Fide Residence Test (genuine resident for entire tax year). Also, the Foreign Housing Exclusion adds $15,000-$30,000+ in housing cost exclusions, and Foreign Tax Credits (Form 1116) offset any remaining US tax with Mexico taxes paid (up to 35% Mexican rate vs 37% US top rate), but you MUST file Form 1040, Form 2555, FBAR, and FATCA forms to claim these exclusions, penalties for non-filing are 25-50% of account balances.

One of the biggest shocks when I first moved to Mexico City as a US citizen was realizing that I still had to file US taxes. The US taxes its citizens and green card holders on worldwide income, regardless of where they live. For years, I thought I was trapped paying American taxes forever.

Then I discovered the Foreign Earned Income Exclusion (FEIE). It literally changed my financial life.

Here's the truth that nobody tells you: if you structure your income correctly and meet specific requirements, you can legally pay zero US federal income tax as an expat. I'm not talking about sketchy tax evasion, I'm talking about legitimate, IRS-approved strategies that have been embedded in US tax code for decades.

Understanding the Foreign Earned Income Exclusion (FEIE)

The FEIE is your most powerful tool. It allows you to exclude "earned income only" up to an annual threshold from US federal income tax. For 2025, that threshold is $130,000. That means if you earn $130,000 or less from active income (salary, freelance work, business compensation), you owe zero federal income tax to the US.

But there are two critical requirements:

1. You Must Establish a Foreign Tax Home

This isn't as complicated as it sounds. A foreign tax home essentially means your principal place of business or employment is outside the United States. If you're working remotely from Mexico City, that counts.

2. You Must Pass One of Two Tests

The Physical Presence Test (PPT): You must be outside the US for at least 330 full days during any 12-month period. This is strict, you're counting calendar days, and partial days don't count. Many expats use this test because it requires less documentation than the alternative.

The Bona Fide Residence Test (BFRT): You must be a genuine resident of another country for an entire tax year. This is harder to prove but some people prefer it because you don't need to worry about day-counting if you're properly established.

I use the Physical Presence Test. I keep meticulous records of every time I leave Mexico, flights, border crossings, everything. It's tedious but essential.

The Foreign Housing Exclusion (Bonus!)

Even better: beyond the FEIE, you can also exclude housing expenses. The government allows you to exclude housing costs that exceed a base amount (roughly 16% of the FEIE threshold). This can add another $15,000-$30,000+ to your exclusion, depending on where you live and your housing costs.

For Mexico City, where rent is significantly lower than in the US, this is still valuable. Documented rent, utilities, home insurance, and repairs all count. Keep receipts.

What Doesn't Qualify for FEIE

This is crucial to understand: the FEIE only covers earned income. It does not cover:

• Investment income (dividends, capital gains, interest)
• Rental income
• Passive income
• Retirement account distributions

If you have $100,000 in earned income and $30,000 in investment income, you can exclude the $100,000, but you still owe tax on the $30,000. This is why many expats structure their finances to prioritize active income when living abroad.

Foreign Tax Credits (Form 1116)

Here's where it gets interesting: if you earn more than $130,000, or if you have investment income, you're not completely stuck. You can use Foreign Tax Credits (Form 1116) to offset what you owe to the US with taxes you've already paid to Mexico.

Mexico's income tax rates (up to about 35% for high earners) are actually higher than the US federal rate (top rate 37%). If you pay Mexican taxes on your income, you can often credit those taxes dollar-for-dollar against any US liability. This frequently results in zero or minimal US tax owed.

Self-Employment & Business Structures

If you're like me, a freelance consultant, you have more options. The FEIE applies to your business income too. Running a US disregarded LLC doesn't automatically make your income "foreign," but as long as your work is performed abroad and you meet FEIE requirements, you're covered.

However, if you're considering setting up a Mexican company or a foreign corporation, things get more complex. Foreign companies trigger additional reporting requirements (Form 5471, GILTI inclusions, etc.). Unless your foreign effective tax rate meets approximately 18.9%, you might face additional US taxation on certain types of income. This is where you really need a tax professional.

Critical Compliance Requirements

This is non-negotiable: you MUST file your US taxes and claim these exclusions. Failing to file creates massive audit exposure and potential penalties. Here's what you need to file:

• Form 1040: Your standard US tax return
• Form 2555: To claim the FEIE
• FBAR (FinCEN Form 114): Required if your aggregate foreign bank accounts exceed $10,000 at any point during the year
• FATCA (Form 8938): Required if your foreign financial assets exceed $200,000-$400,000 depending on filing status

The penalties for not filing these are brutal, we're talking 25-50% of your account balance for FBAR violations. It's not worth risking.

Don't Forget About State Taxes

Here's something that trips up a lot of expats: these federal exclusions don't protect you from state income tax. If you maintained residency in California or New York, those states might still claim you owe state tax.

The solution: establish domicile in a zero-income-tax state (Florida, Texas, Nevada, Wyoming, South Dakota, Alaska) before you leave the US. Eliminate your voter registration, driver's license, and property ownership in your original state. Create a clean break. Once you're abroad, those states won't pursue you.

My Personal Strategy

As a freelance UX consultant earning around $120,000 annually from US clients, here's how I structure my finances:

1. I maintain a bona fide foreign tax home in Mexico City
2. I track my physical presence obsessively (I travel occasionally but always stay above the 330-day threshold)
3. I claim the full FEIE on my Form 2555 (~$130,000)
4. I claim the housing exclusion on legitimate rent and utilities (~$18,000)
5. I file my FBAR and FATCA forms meticulously
6. I established Florida domicile before I left the US
7. Result: Zero US federal income tax owed

I do pay Mexican income tax on my earnings (roughly 15-18% depending on deductions). But even combined with Mexican tax, I'm paying less than I would have paid in Austin.

Get Professional Help

I cannot stress this enough: while the FEIE is relatively straightforward, international tax law is genuinely complex. The penalties for getting it wrong are severe. I work with a CPA who specializes in expat taxation. It costs me about $1,200-1,500 per year, but the peace of mind and the assurance that I'm maximizing my exclusions correctly is worth every penny.

Some CPAs offer flat-rate expat returns. Look for someone who specifically handles Form 2555 and FBAR compliance. This is not the place to save money by filing yourself.

The Bottom Line

Moving to Mexico doesn't mean you're trapped in a US tax nightmare. The Foreign Earned Income Exclusion is a real, legitimate way to legally reduce your US tax liability to zero if you structure your income and residence correctly. Millions of expats use it.

But it requires three things: understanding the rules, meeting the requirements consistently, and filing your taxes properly. Do those three things, and you can build a sustainable financial life abroad without worrying about the IRS.

I didn't move to Mexico to live a complicated life. The FEIE and proper tax planning have allowed me to simplify my financial situation while pursuing my citizenship journey. That's a win.

Related Mexico City Resources

• Mexico City Complete Guide
• Professional, Legal, and Financial Services in Mexico City
• Add Your Business to ExpatsList