APA
Section 14: Payroll for U.S.
Employees Abroad and Aliens in
the U.S.
Cecile Melchior
Marie Kiepura
Deloitte Tax LLP
March 27, 2010
Session Agenda
• US Citizens and Resident Aliens Working Abroad (Expatriates)
Allowances and Reimbursements
Tax Equalization and Tax Protection
U.S. Reporting and Withholding Requirements: Federal, State, Social Security (FICA)
and Medicare
Earnings Adjustment
Tax Gross-Up and Tax Gross-Down
U.S. Social Security Totalization Agreements
• Resident and Non-Resident Aliens Working in the U.S. (Inpatriates)
Visas
U.S. Reporting and Withholding Requirements: Federal, State, Social Security (FICA)
and Medicare
Individual responsibilities
Earnings Adjustment
Shadow Payroll
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Expatriate Payroll – Allowances and Reimbursements
It’s more complex than normal…
•
Rules regarding U.S. compensation reporting and tax withholding for U.S. citizens,
permanent residents and employees working outside of the U.S. are more complex and
require coordination among various departments within an organization.
•
U.S. companies who employ U.S. citizens or permanent residents abroad must
report their compensation on a U.S. Form W-2.
•
U.S. companies sending employees to work abroad may have an international
assignment policy in place to ensure that the employee receives total compensation that
will provide for a standard of living comparable to what he/she would have had if he/she
remained living and working in the U.S.
•
This policy may provide for regularly paid allowances and/or reimbursements for the
cost of various benefits to ensure that the employees do not suffer or benefit financially
in comparison to his/her U.S. counterparts.
•
Depending on the reason or need for the assignment, additional incentives may also be
included in an individual’s assignment package.
•
An individual’s U.S. tax status may also be impacted by an international assignment.
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Expatriate Payroll – Allowances and Reimbursements
Components of Compensation
• Examples of allowances and reimbursements include:
Host country housing and utilities allowance/differential
Goods and services differential (also referred to as a cost of living allowance)
Auto allowance or lease payments
Education allowance or reimbursement for children’s education expenses
Transportation expenses to/from the host location
Shipment and/or storage of household goods
Periodic home leave travel expenses
Location/hardship premiums
International assignment premiums
Host country taxes
Professional fess (i.e., tax preparation services)
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Expatriate Payroll - Allowances/Reimbursements
How are these allowances/reimbursements paid?
•
Assignment related allowances/reimbursements may be paid from various
sources:
-
Home Country Payroll
- Host Country Payroll
- Treasury
- Accounts Payable
- Third Party Vendors
- Host Country Accounts Payable
- Imputed Income
•
Additional payroll codes or “buckets” may be necessary to deliver
allowances or reimbursements via payroll.
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Expatriate Payroll – Allowances and Reimbursements
Why is it necessary to know about all these payments?
•
Any allowances or reimbursements that an expatriate receives (either in
cash or in kind) from his/her employer may be considered compensatory
and/or taxable in the U.S.
This would not apply to most items of compensation received by individuals on
temporary or short-term international assignments (i.e., assignments under 12
months)
•
These allowances and/or reimbursements may need to be added to the
employee’s total compensation and reported on a Form W-2.
•
Assignment related allowances and/or reimbursements included in
compensation often result in Form W-2 wages of 2-3 times the employee’s
per-assignment reportable wages.
•
The additional compensation often triggers additional tax obligations.
•
In most cases, the incremental tax obligations are borne by the employer.
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Tax Equalization and Tax Protection
Employer Tax Reimbursement Policies
•
Many employers follow a policy of Tax Equalization
Tax Equalization is designed to ensure that the tax impact to an employee
of taking an international assignment is neutral – the employee will pay no
more or no less tax than they would have if they had remained in their
home country.
•
Some employers follow a policy of Tax Protection
Tax protection is designed to ensure that the employee pays no more tax
than they would had they remained in their home country; however, if the
actual tax liability is less than what the employee would have paid had
he/she remained in their home country, the employee retains the benefit.
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Tax Equalization and Tax Protection
Hypothetical Tax
• Hypothetical tax represents the home country tax that the employee would
have paid had he/she remained in the home country.
• Hypothetical tax is typically withheld from the employee in lieu of actual tax
(i.e., federal income tax).
• In addition to hypothetical federal tax, the employer may take a hypothetical
state tax depending on the terms of the international assignment and tax
reimbursement policies.
• Hypothetical tax is treated as a REDUCTION to earnings and reduces the
federal and FICA/Medicare wages reported on an employee’s Form W-2.
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U.S. Federal Reporting and Withholding Requirements
Residency Status and Commercial Travelers
• Determining U.S. Resident and Nonresident Alien Status
U.S. Resident: meets lawful permanent resident test or substantial presence test
Lawful permanent resident – “green card” test
Substantial presence test
Present in the U.S. for at least 31 days in the current calendar year; and
Total U.S. days of presence meet or exceed 183 days counting:
–
Total U.S. days in current calendar year, plus
–
1/3 U.S. days in first preceding calendar year, plus
–
1/6 of U.S. days in second preceding calendar year
• Commercial Travelers
May be exempt from U.S. federal income tax withholding if:
Nonresident alien is in the U.S. for 90 days or less during the tax year; and
Compensation received for U.S. services does not exceed $3,000 during the tax year; and
Nonresident alien is employed by foreign employer, or a U.S. employer in a foreign country
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U.S. Federal Reporting and Withholding Requirements
What are the federal tax withholding requirements?
•
Expatriates (and working spouses) may qualify for exclusions to taxable income and tax
credits which will reduce the actual tax liability on their U.S. income tax return.
•
To the extent it is believed that the employee will qualify for these reductions and credits,
U.S. federal income tax withholding obligations can be reduced and/or eliminated.
Exclusions
Foreign Earned Income Exclusion ($91,400 for 2009) – Form 2555
Bona Fide Resident (Tax home outside U.S. for entire calendar year)
–
Intention to make foreign country home for duration of the assignment
–
Employment agreement terms and conditions
–
Residence permit or visa secured by the employee
Physical Presence (Physically present outside U.S. for 330 days in a 365 day period)
Housing Exclusion
Qualified foreign housing expenses are approximately $12,796 for 2009
(30% of the Foreign Earned Income Exclusion less base housing amount)
May be higher in “expensive housing” locations
–
Some expenses are excluded from definition of “qualified foreign housing expenses” (i.e.,
personal telephone, cable, furniture, domestic labor)
Credits:
Foreign Tax Credits
Other Normal Credits (i.e., child care credit, AMT, etc.)
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U.S. Federal Reporting and Withholding Requirements
Foreign Housing Exclusion
•
Foreign Housing Exclusion
Example
Jack, a U.S. citizen, qualifies for the foreign earned income exclusion for 2009 under the physical
presence test
During the 2009 year he earned a salary of $75,000 and was present and working in the foreign
country for 335 out of 365 days
Jack spent $15,000 on reasonable foreign housing expenses
What is Jack’s base housing amount for 2009?
Annual base housing amount for 2009 = $14,624
Prorated base housing amount for foreign days in 2009 = $14,624 * (335/365) = $13,422
What is Jack’s foreign housing cost exclusion for 2009?
Reasonable housing expenses – Base housing amount = Foreign housing cost exclusion
$15,000 - $13,422 = $1,578
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U.S. Federal Reporting and Withholding Requirements
What are the federal tax withholding requirements?
How can federal income tax withholding be reduced?
If the individual is…
•
Subject to mandatory withholding in foreign country => automatically
exempt, no documentation required.
•
Will qualify for foreign earned income and/or housing exclusions => can
reduce income subject to withholding by the amount of income that will be
excluded on income tax return, must have Form 673 completed and on file
for first two years individual qualifies for exclusions.
•
Will be able to claim foreign tax credits => can reduce income subject to
withholding by amount of income that generates a U.S. income tax liability
due to foreign tax credits, must have Form W-4 completed and on file
documenting additional withholding exemptions.
After all is said and done, there may still be a residual income tax withholding
obligation for expatriates!
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U.S. State Reporting and Withholding Requirements
Does state follow federal?
•
State compensation reporting and tax withholding requirements will vary based on the
state of domicile/residence before the assignment begins.
•
The state of domicile/residence must be determined.
Domicile – factors used to determine:
Where the employee intends to return
State issuing the employee’s drivers license
Where the employee votes
Residence – factors used to determine:
Where employee is physically present
Where immediate family lives and where children attend school
Where the employee works
•
Certain states will allow the individual to break residency, resulting in no actual state
taxation while on international assignment (e.g., Illinois).
•
In situations where state residency may be broken, state wages should not accumulate
for the period in which the employee was considered to be in non-resident status.
•
In some states it is very difficult to break state residency (e.g., New York) and state
wages may need to continue accumulating as an individual typically continues to be taxed
as a resident while on international assignment.
•
Rules should be reviewed on a state by state basis.
•
In addition, some states (e.g., North Carolina) will recognize foreign tax credits and if
residency can not be broken, tax withholding may be able to be reduced during an
international assignment.
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U.S. Social Security Reporting and Withholding Requirements
Does Social Security follow federal?
• Social security wages include compensatory allowances and/or
reimbursements, employer-paid individual taxes, net of hypothetical tax
withholding.
• Assignment related allowances and/or reimbursements included in
compensation often result in Form W-2 Social Security (FICA) and Medicare
wages of 2-3 times the employee’s pre-assignment reportable wages.
• In general, these wages are subject to standard U.S. Social Security (FICA)
and Medicare tax withholding.
• Exclusions and/or credits allowable for federal income tax purposes do not
apply to Social Security (FICA) and Medicare tax withholding requirements.
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Earnings Adjustment
How does everything make it to the W-2?
• All allowances and/or reimbursements paid outside of the normal payroll
process should be collected and reviewed to determine if the amounts are
compensatory.
• Since U.S. citizens and permanent residents are taxed in the U.S. on
worldwide income, all elements of company paid compensation should be
considered regardless of the source of the payment.
• Certain reimbursements may be excluded from wages based on IRS rules.
Factors to consider include:
Intended length of the assignment
Nature of the payment
Form of the payment
Policy provisions
• Certain relocation expenses may be excludable but reportable in
Box 12 Code P of Form W-2.
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Tax Gross-up
What is it?
• Generally a tax gross-up will be calculated to account for the additional
federal, state, local and/or social taxes that may be associated with the
assignment related compensation elements that are being added to the
employee’s taxable wages.
• An adjustment should be made to the employee’s wages and withholdings to
add the additional compensation elements as well as the tax withholding.
• The tax gross-up should be paid to the appropriate tax authority as
withholding on behalf of the employee and reported on Form W-2.
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Tax Gross-up
Example of a Tax Gross-up
•
Tax Gross-up - common mistake
Net payment = $50,000
Tax rate = 20%
- 50,000 * 20% = 10,000 … additional tax of $10,000
- Company pays tax of $10,000, so gross payment is $60,000
- Employee should pocket $50,000, but receives $2,000 less than intended
$60,000 * 20% = $12,000
$60,000 - $12,000 = $48,000
Calculation doesn’t work!
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Tax Gross-up
Example of a Tax Gross-up
• Tax Gross-up – correct calculation
Net Payment
=
Gross Amount
(1-Tax Rate)

Net payment = $50,000

Tax rate = 20%
- 50,000/ (1-.20) = $62,500
- Additional tax of $12,500 = $62,500 * .20
- $62,500 – 12,500 = $50,000
Calculation works!
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Tax Gross-Down
What is it?
• In some situations earnings may be adjusted by reducing income for
assignment related payments that an employee paid back to the company.
• This may result in the need for a tax gross-down which will reduce the amount
of the tax payments reported on the W-2 and return these funds to the
company.
• The application of the reduction and the gross down will depend on the
company’s international assignment policy.
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Earnings Adjustment
Form W-2 Reporting
• Earnings adjustment for assignment-related compensation:
Federal wages = include
Medicare wages = include
FICA wages = include to the extent that the employee has not reached the
maximum wage base ($106,800 for 2009)
State/local = include only if the employee is considered a resident of that
state/locality
• Tax gross-ups should be included in the appropriate tax withholding box
• In general, expatriates will have an earnings adjustment for each year of the
assignment and typically for an additional one to three years beyond
repatriation.
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Earnings Adjustment
How is the company accounting for these extra costs?
• Hypothetical tax withholding is generally used to help offset incremental
assignment related costs.
• Adjustments to earnings are payments that have already been made and
therefore most likely have been accounted/accrued for by the paying party.
• Tax gross-ups are new payments that have often not been
accounted/accrued for by the paying party.
• Generally tax gross-ups are charged to the cost center bearing the cost of the
assignment, while hypothetical taxes are credited to that cost center.
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Earnings Adjustment Example with Gross-up
• Base Wages (without assignment income) = $125,000
• Add company paid benefits:
Host Housing
$ 60,000
Auto Assistance
$ 20,000
Education Assistance
$ 30,000
$110,000
• Gross Up Rates
Federal
28.00%
State
3.00%
Medicare
1.45%
1
x
110,000 = $162,842
(1 - .28 - .03 - .0145)
Total Additional Compensation = $162,842
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Tax Gross Up Breakdown
EXAMPLE
• Breakdown of tax gross-up
$162,842 * .28 = $45,596 = Federal Taxes
$162,842 * .03 = $4,885 = State Taxes
$162,842 * .0145 = $2,361 = Medicare Taxes
Total Taxes
=
$ 52,842
Total Allowances
=
$110,000
Total Adjustment =
$162,842
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Example
• Adding it to Form W-2 wages
Box 1 Federal Wages:
$
162,842
Box 2 Federal Taxes:
$
45,596
Box 3 Social Security Wage *:
$
0
Box 4 Social Security Tax *:
$
0
Box 5 Medicare Wage:
$
162,842
Box 6 Medicare Tax:
$
2,361
Box 16 State Wage:
$
162,842
Box 17 State Tax:
$
4,885
new cost
new cost
new cost
* Assumes annual FICA maximum has already been met.
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Treaty Agreements
Eliminating the double income tax burden
• Income tax treaty benefits may include:
Credits and deductions to reduce taxes imposed by the foreign country (i.e., to avoid
double taxation)
Nondiscrimination clauses allowing resident aliens (Green Card holders) to qualify for
the foreign earned income and housing cost exclusions under the bona fide residence
or physical presence test
Partial or total exemption from taxation by the foreign country for an employee’s
wages for personal services performed in the treaty country
Wages received by a U.S. teacher or professor in a treaty country are exempt from
foreign taxes under most treaties for up to 2-3 years
Amounts received by U.S. residents for study, research, or business and technical
training
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Totalization Agreements
Eliminating the double social tax burden
• While living and working outside the home country, assignees may become
subject to host country social tax.
• In order to eliminate the burden of double social tax, the U.S. government has
entered into bi-lateral social security totalization agreements with 23 countries.
• Obtaining coverage under a totalization agreement alleviates the need to
contribute to host country social system. The employee continues to contribute
to the home country social system where they will ultimately obtain a social
security benefit.
• Certificates of coverage under a social security totalization agreement can be
applied for via the U.S. social security administration website:
http://www.ssa.gov/international
• In general, certificates of coverage are effective for 5 years (with the exception
of Italy (unlimited) and Germany (9 yrs).
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Totalization Agreements
List of countries
Australia
Japan
Austria
Luxembourg
Belgium
Netherlands
Canada
Norway
Chile
Portugal
Finland
South Korea
France
Spain
Germany
Sweden
Greece
Switzerland
Ireland
United Kingdom
Italy
Czech Republic
Poland
Denmark
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Inpatriates
Visas
•
Immigrant Visa – I-551
Permanent Resident Card (i.e., green card)
•
Most common nonimmigrant visas include:
•B-1: Visitors for business
Students, workers, or foreign press being paid by a foreign employer
•H-1B: Professional and technical workers
College-educated or experienced professionals
•J-1: Exchange visitors
Students, trainees, and teachers in the U.S. to participate in an exchange
program
Federal income tax withholding exemptions available
Exempt from social wage reporting and withholding
•F-1: Students
Full-time students at an approved U.S. educational institution
Federal income tax withholding exemptions available
Exempt from social wage reporting and withholding
•O-1 and O-2: Extraordinary Ability
Extraordinary ability in the arts, sciences, education, or athletics
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Inpatriates
Reporting and withholding for U.S. resident aliens
• In general, U.S. resident aliens are subject to the same U.S. federal, state
and unemployment tax reporting and withholding obligations as U.S.
citizens/permanent residents.
• Employers must report compensation and withhold federal, state, local and
social tax (also state disability and unemployment taxes where required).
• Employers must also fund the employer portion of FICA, Medicare, and
federal and state unemployment taxes.
• In general, federal unemployment (FUTA) applies to all wages paid for work
performed in the U.S. regardless of the citizenship or residency status of the
employee or the employer.
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Inpatriates
What do resident aliens need to do?
•
Resident aliens should obtain a U.S. social security number or ITIN
(Individual Taxpayer Identification Number).
•
Resident Aliens should complete a Form W-4, Employee’s Withholding
Allowance Certificate, and Form I-9, Employment Eligibility Verification.
Social security card is not required to be provided as authorization to work
•
Wages paid to and taxes withheld from resident aliens must be deposited and
reported by the employer in the same way it does for all other employees,
using Form 941 and Form W-2.
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Inpatriates
International Assignment Policy
• Just as with expatriates, inpatriates will generally be covered by a company
International Assignment Policy to alleviate any financial or tax burden as a
result of accepting the international assignment.
• Inpatriates may be covered under a policy of tax equalization or tax
protection.
• The inpatriate may be responsible for paying their own U.S. taxes.
• Inpatriates covered by a certificate of coverage should not be subject to FICA
and Medicare tax.
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Inpatriates
Earnings adjustment and tax gross-up
• While the inpatriate may continue to be paid in his/her home country, wages
received for work performed in the U.S. should be reported in the U.S. and
the appropriate taxes should be paid to the appropriate tax authority on
Form W-2.
• The assignee may also receive other company paid benefits.
• An earnings adjustment may be required (as with an expatriate) to ensure
proper reporting and withholding on Form W-2.
• Where taxes are paid on behalf of the assignee by the company, a tax grossup will be added to the individual’s compensation each pay period to result in
a neutral net effect to the employee.
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Inpatriates
Reporting Monthly Pay in U.S. – Shadow Payroll Example
Monthly Base Pay in UK = GBP 5,000
Converted @ 1.9 = $9,500
Federal Taxes = $2,375
State Taxes = $285
Monthly Pay = $12,160
Less: Federal Taxes <$2,375>
Less: State Taxes <$285>
Less: Pay Received in UK <$9,500>
Net Pay in U.S. = $0
(In this example, no FICA or Medicare taxes are paid due to Totalization Agreement)
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Questions?
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