One of the hardest things to understand when establishing your nearshore operation in Mexico is employees’ payroll and the taxes involved. There are basically two parts of it; the taxes that the employee has to pay and the burden that the company has to pay according to the benefits given. That is the tricky part and the reason why is not easy to give a straight answer like it’s 20% or so.
Don’t worry, At Start-Ops we take care of all the administrative hassle that this implies. However, for planning purposes, a lot of our clients want to understand how the payroll system works. So, we decided to write this post to clear up the doubts. In our post Starting a Business in Mexico: The Ultimate Guide we explain the legal aspect of hiring employees such as mandatory holidays, Maternity leave, Aguinaldo (mandatory Christmas bonus) et cetera. In this post we will explain the numerical aspect of hiring.
To easily navigate this guide you can use the following table of content:
Table of Contents
Employee's Income Tax
Let us begin with the income tax that employees have to pay for the income that they are receiving. This does not have to do with the corporate tax that the company pays on its profits and, essentially it is a tax that the employee pays. Be it as it may, the law requires that employers deduct the proportional amount of income tax contributions from their employees’ paycheck. Then the employer must submit this amount to the government each month. Besides, a lot of employees basically think on how much money goes into their pocket so this needs to be taken into account when negotiating salary.
The following table shows the rates of Income Tax or ISR (Impuesto Sobre la Renta) for natural persons in Mexico according to their salary.
Income Tax In Mexico (For Natural Persons )
|Lower Limit||Higher Limit||Fixed Fee||Surplus Tax Rate|
|MXN $0.01||MXN $578.52||MXN $0||1.92%|
|MXN $578.53||MXN $4,910.18||MXN $11.11||6.40%|
|MXN $4,910.19||MXN $8,629.20||MXN $288.33||10.88%|
|MXN $8,629.21||MXN $10,031.07||MXN $692.96||16.00%|
|MXN $10,031.08||MXN $12,009.94||MXN $917.26||17.92%|
|MXN $12,009.95||MXN $24,222.31||MXN $1,271.87||21.36%|
|MXN $24,222.32||MXN $38,177.69||MXN $3,880.44||23.52%|
|MXN $38,177.70||MXN $72,887.50||MXN $7,162.74||30.00%|
|MXN $72,887.51||MXN $97,183.33||MXN $17,575.69||32.00%|
|MXN $97,183.34||MXN $291,550.00||MXN $25,350.35||34.00%|
|MXN $291,550.01||Onwards||MXN $91,435.02||35.00%|
Ok that’s clear enough but, how do you calculate it? It’s quite easy really. All you need to do is check where the lower limit for the salary you are calculating taxes for ranks, you pay the fixed fee established for that salary plus the percentage applied on the surplus, i.e. the difference between the salary and the lower limit. Here’s an example for a couple of different salaries.
Income Tax Calculation Example
|(-) Lower Limit||$38,177.70||$72,887.51||72,887.51|
|(x) Tax Rate||30%||32%||32%|
|(=) Surplus Taxes||$8,046.69||$676.00||$3,876.00|
|(+) Fixed Fee||$7,162.74||$17,575.69||$17,575.69|
|(=) Taxes to Pay||$15,209.43||$18,251.69||$21,451.69|
So, as discussed, this is the amount of tax that the employee has to pay for his income. However it is the company’s obligation to retain that tax payment from his paycheck and pass it over to the Mexican tax authority.
Now on to some other taxes. We will go from easier to understand to harder to understand. The first and on my opinion the easiest to understand is the state tax over payroll or Impuesto Sobre Nómina (ISN).
State Tax Over Payroll or Impuesto Sobre Nómina (ISN)
For starters there are some federal taxes and some state taxes. The federal taxes are the same all over Mexico and the state taxes as you can probably guess vary according to the state in which the business is located. This tax is pretty straight forward. It is charged as a percentage of the entire payroll and is the employer’s duty to pay it. The rate ranges between 1% and 3% of salaries. In the state of Jalisco, for example, the ISN is of 2%, so if you pay someone a salary of MXN $10,000 you need to pay a tax of $200. As simple as that.
Vacations and Vacation Premium
It is not a tax per se but you have to take it into account because it is a part of the company’s burden. Besides the mandatory holidays, which you can check in this table, employees who have worked in the company for one year or more are entitled to a period of paid vacations once a year. The amount of days starts at six working days (meaning you can’t count weekends or holidays) and it increases by two working days for every subsequent year the employee has worked for the company until a maximum period of 12 working days is reached on the fourth year. After the fourth year is reached, vacation period increases by two days for every five years working for the company.
It works as follows:
- After 1 year of continuous employment, an employee is entitled to a vacation period of 6 working days;
- After 2 years of employment, an employee is entitled to a vacation period of 8 working days;
- After 3 years of employment, an employee is entitled to a vacation period of 10 working days;
- After 4 years of employment, an employee is entitled to a vacation period of 12 working days;
- When an employee is employed for a period of 5 to 9 years, he/she is entitled to a vacation period of 14 working days;
- When an employee is employed for a period of 10 to 14 years, he/she is entitled to a vacation period of 16 working days.
Take into account that this is the legal mandatory vacations. In some industries, for example software development, employers may choose to give a little extra vacations to keep the employees happy and prevent pouching.
There is also a mandatory vacation premium of 25% of salary (on top of regular salary). This means that employees earn an additional 25% during their vacation period. The idea behind this premium is for the employee to have some extra money to pay for his vacations and enjoy life. Even though 25% is the legal benefit, some companies provide a vacation premium between 50-100%. It depends on how competitive you would like to be as an employer.
Christmas Bonus or Aguinaldo
By law you must pay your employees a christmas bonus equal or higher to fifteen days of their salary. It must be paid prior to the 20th of December . The idea behind this bonus is for people to have a little extra cash to enjoy the holidays. buy presents and such. For a worker to be entitled to this bonus he must have been working for the company for at least one year.
Again, 15 days is what is required by law but it is up to the company to negotiate with their employees how much they will get. Some high level executives or key personnel may get a little more than that.
Mexican Social Security (IMSS)
As we said, we are going to easiest to understand to hardest to understand. Understanding social security in Mexico is hard. That said, it is not impossible either. You only need to understand all of the factors implied. Let us start with a little background.
The institution in charge of social security in Mexico is the Instituto Mexicano del Seguro Social or IMSS. It’s mission is to provide medical attention and social security to all Mexican workers or employees. Therefore, every Mexican employee in the private sector has the right to several benefits. In order for the IMSS to operate it requires economic support from the government, plus the payments made by all registered employees and their employers.
To properly calculate the payroll for an employee, we need to understand the deductions that go to the IMSS. Since it is the employer’s responsibility to manage it, we need to understand the employee’s deductions and the employer’s deductions. To do so we need to understand all of the concepts and sub-categories that compose social security. So let’s get to it.
Employee - Employer Fees
The total amount that is paid to the IMSS are called Employee – Employer Fees or Cuotas Obrero – Patronales. The company (employer) has the responsibility of paying it. However, a proportion of the payment is contributed by the employee. The idea is that he is contributing, with a little proportion of his salary, to the payment of his social security.
So that sound great but, how do we calculate the deductions we need to pay? Well, to be able to answer that question we first need to know what a Base Listed Salary is.
Base Listed Salary
So, first of all, Base Listed Salary is my own translation. The term in Spanish is Salario Base de Cotización (SBC). It basically means the salary in relation to which you are making your deductions. And the main difference with the regular salary is that it includes bonuses, commissions et cetera.
Let’s get legal. The article 27 of Mexico’s Social Security Law stipulates that the Base Listed Salary is the amount on which the benefits given to the employee are calculated.
The BLS is integrated by all payments made in cash regarding:
- Daily Payment
- Food & Shelter
- Payments in Kind
- Any Other Retribution
To obtain it we need to add all the other benefits (vacations, vacations premium, aguinaldo etc.) to the salary of the employee. So, since vacations vary according to the employee’s continuous employment in the company, each Base Listed Salary needs to be calculated separately.
The first step is to calculate the employee’s daily salary. Let us see an example. Let’s think about Alejandro, a nice employee that has work in the company for two and a half years and makes MXN $10,000 a month.
Alejandro’s Daily Salary = $10,000 / 30 = $333.33
Since Alejandro has continuously work for your company for two years, he is entitled to 8 days of vacations annually. He has a vacation premium of 25%. Regarding the Aguinaldo (Christmas Bonus) you give him the mandatory 15 days. So the way you calculate this is by first obtaining a factor. Let’s see how it’s done.
- Aguinaldo 15 days.
- Vacations 8 days.
- Vacation Premium of 2 (8 days * 25%).
Integration Factor = (365 + 2 (vacation premium) + 15 (Aguinaldo)) / 365
Integration Factor = 1.0466
Now we just multiply Alejandro’s daily salary times the integration factor to obtain the Base Listed Salary.
BLS = 333.33 * 1.0466 = 348.86
Alejandro’s Base Listed Salary is $348.86 and all the benefits will be calculated on that amount.
Current Daily Minimum Wage
Why is this important? Well, as its name states it, it is the minimum wage that you can pay an employee. So you would not be able to list an employees salary that is less than the current minimum wage in Mexico.
As of the writing of this article, and we will update it periodically, the daily minimum wage is $123.22 pesos. In the Northern Border Region, which is an area of 15.5 miles from the Mexico – US border it is $185.56 pesos.
Measurement and Updating Units or Unidad de Medida y Actualización (UMA)
The Unidad de Medida y Actualización (UMA) is an economic reference unit linked to inflation that is used in Mexico to pay things like taxes and fines and social housing loans. Before 2016 we used to use the minimum wage as a reference but whenever there was an increase on it, there was a debacle of people not being able to pay their loans and taxes. The UMA is calculated by the National Institute of Geography and Statistics (INEGI in Spanish). You can see it published here.
Why is it important to calculate payroll? Because IMSS allows for a maximum Base Listed Salary limit of 25 UMAs. As of the writing of this article daily UMA is $86.88, which means that the maximum limit is MXN $2,172.
Now that we know the limits and the Base Listed Salary let us go on to the subcategories of the IMSS and the proportion of the salary that they charge as deductions.
IMSS Employee's Benefits
By being listed in the IMSS your employees are entitled to 5 different benefits or subcategories. Each is deducted as a percentage of the salary. As we said earlier, this are called Employer-Employee Fees, which means that each pay a part of it.
Work Risk Insurance
Every industry and type of employment environment has a different level of risk linked to it. So the IMSS has identified and divided 5 different levels or categories of risk. Level I refers to jobs with insignificant risk, such as working in an office. Level V, on the other hand, could be some types of mining activities.
To each level they have associated a risk premium. This premium is the percentage that is used to calculate the work risk insurance payment. This payment is done by the company. The following table specifies the risk category and the corresponding premium.
Disease and Maternity Insurance
This is the medical insurance that covers the employee and his family. For women, maternity insurance applies during and after the pregnancy. This insurance is separated into two different categories: benefits in money and benefits in kind. What this means is that in the eventual case of needing the insurance the employee can either obtain money from the IMSS or he can get medical treatment and medicines.
Benefits in Kind
- Fixed Fee: 20.40% of the current UMA value. (Paid by the company)
- Surplus Fee: If the employee makes more than 3 times the value of UMA, a fee is paid on the surplus as follows.
- Company 1.10%
- Employee 0.4%
Pensioners and their Beneficiaries.
- Company contribution: 1.05% of the BLS.
- Employee contribution: 0.375% of the BLS.
Benefits in Money
- Company contribution: 0.7% of the BLS.
- Employee contribution: 0.25% of the BLS.
Disablement and Life Insurance
This insurance benefit is for workers that are disabled and cannot provide for themselves or their families. It is also a life insurance.
- Company contribution: 1.75% of the BLS.
- Employee contribution: 0.625% of the BLS.
Nursery and Social Benefits
This benefit is for day nursery for the children of workers while the parent is at work.
- Company contribution: 1% of the BLS.
Employee contribution: None.
Retirement and Old Age Impediment
This are two different benefits under the same category. one is the pension or retirement fund; an amount that the worker will get for the rest of his life once retired. The other is an insurance that is given to the worker if he is over 60 years of age and cannot carry on with his duties. It is important to notice that this payment is done every two months, however you have to pay the equivalent of to months so for calculation purposes you calculate it monthly. You just submit the money to the government every two months.
- Company’s contribution: 2% of the BLS.
- Employee’s contribution: None.
Old Age Impediment:
- Company’s contribution: 3.15% of the BLS.
- Employee’s contribution: 1.125% of the BLS.
INFONAVIT (Social Housing)
Another benefit that employees get is social housing. The Institute of the National Housing Fund for Workers (INFONAVIT for its name in Spanish) is the Mexican federal institute for worker’s housing. INFONAVIT provides mortgage products to workers. These include a mortgage to buy a new or existing home, a mortgage to remodel a home or a mortgage to build a new home. This payment is also made every two months.
- Company’s contribution: 5% of the BLS.
- Employee’s contribution: None (Unless they have a mortgage).
The afore mentioned are mandatory benefits that employees must get by law. Besides that there are some other optional benefits that the company can give to its employees. There are some tax incentives in this so, in order to be competitive as an employer, it is a good idea to take them into account.
Savings Fund or Fondo de Ahorro
So the idea behind this benefit, as you can probably guess, is to encourage workers to save. The Savings Fund, in simple terms, is a pool of money to which the company and the employee make contributions. Once a year, the employee has the option of withdrawing that money or he may choose to leave it there and continue saving. Not all companies are obliged to provide a Savings Fund for their employees. However it has a tax benefit.
So, what’s the benefit to the company?
The main benefit to the company is that that the amounts contributed are fully deductible of income tax as long as they comply with the legal guidelines, which pretty much just establish a limit to how much can be contributed. The Savings Fund usually fluctuates between 7% and 13% of the employee’s salary as long ait does not exceed 1.3 UMA’s, which we explained earlier in this article.
So, how does it work?
It’s quite simple actually. The company deducts the amounts directly of the employee’s payroll and contributes an equal amount. The fund is managed by a commission of employee’s with the company’s supervision. The fund can be used to make short term loans amongst employees. At the end of the 12 month period the money, with its correspondent interest, is given back to the employee, who may choose to leave it for another year.
Food Vouchers or Vales de Despensa
Food Vouchers are untransferable certificates that companies give to their employees to purchase food and groceries. They are given as part of a compensation package. This is an optional benefit. Food Vouchers used to be paper certificates but lately they have been developing other means such as plastic cards or even virtual certificates.
So, what’s the benefit to the company?
Again the benefit is that they are fully deductible from the company’s income for tax purposes as long as the legal guidelines are met, which basically are a limit of 40% of the UMA.
So, how does it work?
Well UMA for 2020 is $86.88 pesos. Since the limit is 40% we calculate it like this: 86.88 * 0.4 = 34.75. So the daily limit for Food Vouchers you can give your employees as a part of the compensation package is MXN $34.75. To find out the monthly amount you multiply it by 30. So the monthly maximum amount would be MXN $1,042.50.
Mexican Payroll Calculation Example
Ok so let’s get to it. We will use Mariana as an example. Let’s say that Mariana has just applied for a position as a secretary in your company. You have an interview with her and consider her to be fairly capable of fulfilling the position. You talk about salary and agree that she will earn a gross wage of MXN $10,000. How much will she be getting into her bank account? What will be the expense for the company? Well, let’s find out.
First, we will calculate how much income tax we have to deduct from her paycheck to pass it over to the government.
|(-) Lower Limit||$8,629.21|
|(x) Tax Rate||16%|
|(=) Surplus Taxes||$4.97|
|(+) Fixed Fee||$692.96|
|(=) Taxes to Pay||$697.93|
Alright, so now we know that out of the $10,000 that Mariana receives, we need to retain $697.93 pesos which is the income tax she is obliged to pay and we, as her employers, are obliged to retain and pass it on to the tax authorities.
Now on to the payroll state tax. For the purpose of this example we will asume that we are in the state of Jalisco, where the payroll tax is 2%. This tax is applied on the entire payroll.
$10,000 * 0.02 = $200
So this tax doesn’t affect Mariana’s paycheck. It is a burden for the company. Now let’s calculate the Base Listed Salary so we can see how much IMSS and Infonavit needs to be paid and by whom.
Mariana’s Daily Salary = $10,000 / 30 = $333.33
Since Mariana is new to the company, she is not entitled to vacations yet. Regarding the Aguinaldo (Christmas Bonus) you give him the mandatory 15 days.
- Aguinaldo 15 days.
- Vacations 0 days.
- Vacation Premium of 0 (0 days * 25%).
Integration Factor = (365 + 0 (vacation premium) + 15 (Aguinaldo)) / 365
Integration Factor = 1.0411
Now we just multiply Mariana’s daily salary times the integration factor to obtain the Base Listed Salary.
BLS = 333.33 * 1.0411 = 347.03
Now let’s make it monthly so that it’s easier to understand.
Monthly BLS = 347.03 * 30 = $10,410.90
Mariana’s Monthly Base Listed Salary is $10,410.90. Now we can move on to calculate IMSS and INFONAVIT. We will consider for the purpose of this example a Class I risk, whis is for example administrative work in an office.
Payroll in Mexico: Company's Contribution
|Disease and Maternity Insurance||Fixed Fee||20.4%||$517.08|
|Pensioners and their Beneficiaries.||1.05%||$104.11|
|Benefits in Money||0.25%||$208.22|
|Disablement and Life Insurance||-||0.625%||$327.95|
|Nursery and Social Benefits||-||1%||$104.11|
|Retirement and Old Age Impediment||Retirement||2%||$208.22|
|Old Age Impediment||3.150%||$327.95|
* Surplus is calculated like this: $10,410.90 (monthly BLS) – ($ 2,641.15 (Monthly UMA) * 3) = $2,487.45
Payroll in Mexico: Employee's Contribution
|Disease and Maternity Insurance||Surplus Fee*||0.4%||$8.31|
|Pensioners and their Beneficiaries.||0.375%||$37.50|
|Benefits in Money||0.7%||$70|
|Disablement and Life Insurance||-||1.75%||$175|
|Retirement and Old Age Impediment||Old Age Impediment||1.125%||$ 112.50|
Ok, so now we have everything calculated. Let’s see out of the gross salary of $10,000 how much is the burden to the company and how much will Mariana see reflected in her bank account.
Deductions for a Gross Salary of $10,000
So, now we know that, if we pay $10,000 pesos to one of our employees, the expenditure to our company is those $10,000 pesos plus $2,329.75 that we need to pay in mandatory benefits. The reason I don’t calculate the percentage that represents over that particular salary is that you cannot replicate it for a different salary. You cannot even replicate it in a different employee with the same salary if he has been working longer in the company (because of vacations).
With this exercise we also know that our employee will be seeing $8,898.76 reflected in his bank account out of the $10,000 that we are paying him. A lot of potential employees negotiate their wages like that. The reason is that they don’t really know all of the information that you just read.
Payroll in Mexico is complicated but it isn’t impossible to understand either. You just need to know the underlying concepts and the rates that are charged. At Star-ops we help you by taking care of all of the administrative hassle implied in opening a nearshore office. We are experts at providing all-inclusive soft-landing solutions. For everything your company needs to establish in Mexico, you can rely on us.
If your company is thinking about exploring nearshore options, get in touch with us. We can develop a business plan that takes into account all of the costs involved in moving a part of your business to Mexico.