Running payroll in Mexico

Strategically located at the junction between North and South America, Mexico is a popular business location for multinationals looking to grow their presence in the region. Its strong trade links with the US and its low wage levels create an abundance of opportunities for foreign businesses. 

That being said, doing business in Mexico also has its challenges, mainly when it comes to processing payroll for local employees. The tax system is quite complex and the social security contribution rates and caps vary heavily depending on the employee’s income level. No wonder the Global Payroll Complexity Index 2021 ranked Mexico as the 15th most challenging country in the world to run payroll in. 

Foreign companies that want to hire employees in Mexico are not required to establish a legal entity to do so; however, they have to undergo the same registration processes as local employers, which is why creating a subsidiary or branch is usually recommended. Registration for employers mainly includes: 

• Registration with the Tax Administration Service (Servicio de Administración Tributaria, SAT) to obtain a tax identification number for the Federal Registry of Taxpayers (Registro Federal de Contribuyentes, RFC)

• Obtaining an electronic signature for tax filing

• Registration with the respective state tax authority for payroll tax

• Registration with the Mexican Social Security Institute (Instituto Mexicano del Seguro Social, IMSS) and the National Workers Housing Fund Institute (Instituto del Fondo Nacional de la Vivienda para los Trabajadores, INFONAVIT)

New employees must also be registered with the three bodies mentioned above, i.e. the SAT, the IMSS and the INFONAVIT. Companies should keep in mind that all these registration processes need to be completed before they can process payroll and issue payments to employees. 

It is necessary to open a local bank account to make payments to employees and authorities in Mexico. A tax ID is needed for this, and processing times can take longer than expected due to the fact that it might be necessary to provide additional information in line with regulations against money laundering.

Mexico’s tax and social security system can be difficult to navigate for foreign organizations. There are 11 different tax bands with progressive rates and numerous social security funds with varying contribution rates and caps.

Tax considerations

The income tax system in Mexico is progressive, with rates ranging from 1.92% to 35%. The same rates apply to all residents, regardless of whether they are Mexican nationals or foreigners; however, nonresidents are subject to different tax rates and rules.

Individual income tax is levied on the federal level, but there are also payroll taxes which need to be paid to the tax authorities in the respective state. Payroll tax is levied on organizations at rates between 1% and 3%. The calculation base used for calculating payroll tax varies from state to state.

Taxable income includes salaries and wages, overtime pay, bonuses, commissions, seniority premiums, shared business profits as well as any other cash benefits provided by the employer; however, some fringe benefits like food allowances may be exempt from income tax. Social security contributions are (at least partially) tax-free. 

Other deductions include charitable contributions, medical expenses, mortgage interest payments and education expenses. It should, however, be noted that different conditions and limits apply. The general limit is either 15% of the employee’s annual income or five times the annual UMA (economic reference unit used for calculation of social security contributions and more) - whichever one is higher. 

Residents pay income tax on their worldwide income. Nonresidents, on the other hand, only pay tax on income from Mexican sources. Residency is determined depending on whether the individual has a permanent home in Mexico and/or if their center of vital interests lies in Mexico. 

Tax withholding and reporting 

Income tax in Mexico is withheld at source and directly submitted to the tax authorities by the employer, along with a monthly withholding tax return. The competent authority is the Tax Administration Service (SAT). 

Employers are further responsible for paying state payroll tax. Both income and payroll tax must be submitted on a monthly basis. For withheld income tax, the remittance date is the 17th of the following month.

As part of their year-end duties, employers have to prepare an annual declaration of withheld income tax which must be sent to the federal tax authority. Employees must also receive an annual information return on payments and withholdings.

Individuals whose income exceeds certain thresholds must file an annual tax return. The due date is April 30 of the following year. Joint filing is not permitted. Under certain circumstances, the employer may be responsible for making the necessary adjustments to the employee’s annual tax withholdings. The tax year is the calendar year.

Nonresidents working in Mexico and residents working for foreign employers are required to file a monthly provisional tax return by the 17th of the following month. 

Social security contributions

The social security system is administered by the Mexican Social Security Institute (IMSS) and financed by contributions from employers, employees and the government. In addition to the IMSS, there are three other bodies in Mexico that are in charge of employee welfare, namely the National Workers Housing Fund Institute (INFONAVIT), the Retirement Savings Programme and the National Fund Institute for Workers’ Consumption (FONACOT); however, only INFONAVIT is relevant for employers in terms of mandatory contributions.

IMSS contributions are mandatory for both employees and employers and go towards different social security funds covering pension insurance, unemployment insurance, maternity insurance, health insurance, disability insurance, old-age insurance, occupational insurance and survivor benefits. INFONAVIT contributions are levied on employers only. 

Contribution rates and limits vary greatly, but employers typically contribute between 15% and 25% of the employee’s salary to social security, pension and housing funds. Employees contribute around 5% of their earnings to social security and pension.

Employers can further provide their employees with supplementary pension plans. In this case, contribution levels for both employee and employer are raised above the legally prescribed minimum. 

It is the employer’s responsibility to withhold and submit social security and housing fund contributions for every employee. Payments to the housing fund INFONAVIT are due by the 17th of every other month. IMSS contributions must be submitted on a monthly basis, with payments also being due on the 17th of the month.

Employees in Mexico are entitled to various benefits. These include:

• Annual leave and public holidays: 6 paid days off after 1 year of service; thereafter, annual leave entitlement increases progressively; 25% holiday bonus; plus at least 7 mandatory public holidays

• Maternity leave: 84 days of maternity leave, split into 42 days before and 42 days after birth; benefits paid by Social Security; 1 hour of breastfeeding leave per day upon the mother’s return to work, split into 2 intervals of 30 minutes each

• Paternity leave: 5 days of paid paternity leave

• Parental leave: no legal provisions

• Sick leave: starting with the 4th day, employees receive sickness benefits from Social Security amounting to 60% of their normal wages for a period of up to 52 weeks (100% pay rate for work-related injuries)

For more information on employee benefits and other employment requirements in Mexico (including severance pay and termination procedures), check out our Global Hiring Guide.

In the beginning of 2022, the minimum wage rose to MXN 172.87 per day - up by 23% compared to 2021. The current minimum wage rate along the Northern Border Zone (i.e. along the border with the US) is MXN 260.34 per day. 

Employees who have to work on an official public holiday are entitled to double pay. The pay rate for overtime is also 200% of the employee’s normal wages - increases to 300% if the employee works more than 9 additional hours within one week.

In addition, employers have to provide their staff with an annual holiday bonus equal to 25% of what the employee earns during their vacation days. Paying employees an annual Christmas bonus is also mandatory. The latter must be paid out by 20 December and should be equal to at least 15 daily wages.

It is possible to pay employees in Mexico either weekly, bi-weekly or monthly, but the pay period must be stipulated in the individual employment agreement. Employees should be paid via bank transfer, since cash payments are strictly regulated. Payslips must be provided electronically as so-called CFDIs. Payroll records in Mexico must be kept for 5 years.