Payroll for U.S.
Employees Abroad and
Aliens in the U.S.
Increase in global business
increase in international assignments (both outbound
and inbound)
increase in the need of coordination among corporate
departments (HR (Benefits), Legal, Payroll, Tax)
How do international assignments affect all of these departments?
Expatriate payroll administration is a set of activities that result
in:
 an accurate delivery of compensation, benefits, and other
policy-driven allowances in one or more currencies and
 compliant reporting and tax payments in one or more
countries concurrently
To effectively administer expatriate payroll, you’ll need a
working familiarity with :
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Foreign payroll and tax law
Domestic tax law regarding international transfers
Tax treaty basics
Expatriate policy
Tax protection/equalization
Intercompany accounting
Foreign exchange concepts
Tax Gross ups
Totalization
Home/Host Payroll; Shadow Payroll; Split Payroll
The Making of an International Assignment
1.
Expatriate Policy
HR & Legal
Allowances (Shipment of Goods, COLA, Hardship, Car, Schooling)
2.
Foreign Assignment Agreement
HR
Secondment
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Immigration
Insurance
Salary, Expenses, Allowances
Taxation
HR
HR (Benefits)
Payroll
Payroll & Tax
Totalization, Tax Treaties, Hypothetical Tax Withholding
Taxation
How much does a typical expatriate assignment cost?
Rule of thumb = 3 x the expat’s salary
The majority of these costs are related to tax
Successful tax planning can result in lower costs to the company
Federal Income Tax Withholding
Wages are generally subject to federal income tax withholding,
however, there are certain exemptions applicable to US citizens
Foreign earned income exclusion or housing cost exclusion
 Employers can choose to stop withholding federal income tax if the belief is
that the wages will be excluded from the employee’s income under the
foreign earned income or housing cost exclusion
 Employees must complete form 673 or equivalent created written statement
attesting they meet either:
 bona fide residence test or
 physical presence test
Federal Income Tax Withholding
Wages subject for foreign income withholding
 If the employer is required by foreign law to withhold foreign income
tax from the employee’s wages, the employer is not required to
withhold US federal income tax
 The same is true for US possessions
 The withholding must be required by law
 Signed statement attesting to the foreign withholding should be kept
on file by the employer
Federal Income Tax Withholding
Wages for work in U.S. possessions other than Puerto Rico
 Employer believes that 80% of work will be done in another U.S.
possession—such as Guam, American Samoa & other islands
Wages for work in Puerto Rico
 Bona fide resident of Puerto Rico for the entire year
Extra withholding allowances for foreign tax credit
 Employees who expect to take a credit for foreign taxes paid on income
not subject to the foreign earned income or housing cost exclusion can
take extra allowances on their W-4
Filing and reporting rules still apply to expatriates, ie: must still provide
employee with a timely W-2
Bona Fide Resident & Presence Test for US Possession
Employee is considered a bona fide resident if:
 Is physically present in the possession for 183 days during the year
 Does not have a tax home outside the possession during the year &
 Does not have a closer connection to the U.S. or a foreign country than
in the possession
Presence test:
 Physically present in the possession at least 549 of preceding 3 year
period (current and two previous), present at least 60 days each year
 Spend no more than 90 days in the U.S. during the year
 Sped more time in the possession than in US and do not have more than
$3000 in U.S earned income
 No significant connection to the U.S.
Social Security & Medicare Taxes
• US Citizens and resident aliens working abroad generally pay
Social Security/ Medicare tax which the company continues
to match
• Foreign earned income and housing cost exclusions do not
apply to exempt an employee or employer from Social
Security or Medicate tax
• Employees working for foreign affiliate of US employer
generally do not pay the SS/ MED unless opted by employer
• Expatriate employees may also be subject to foreign social
security tax
Totalization Agreements
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Alleviates the double taxation for Social Security
Temporary assignments , < 5 years are paid to US
Permanent assignments > 5 years are paid to the foreign country
Employer must obtain a Certificate of Coverage for the country where
the employee will be assigned to establish that an employee’s wages are
subject to US SS and Medicare taxes but exempt from foreign SS tax
 If employee is permanently working in the foreign country and will be
exempt from US SS and Medicare tax, the employer must seek a
Certificate of Coverage from the SS Official or agency of foreign country
 Certificates of Coverage remain with the employer
US has agreements with: 24 Countries
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Australia
Austria
Belgium
Canada
Chile
Czech Republic
Denmark
Finland
France
Germany
Greece
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Ireland
Italy
Japan
Luxembourg
Netherlands
Norway
Poland
Portugal
South Korean
Spain
Sweden
• Switzerland
• United Kingdom
Pending legislative adaptations:
Mexico
Foreign Affiliate Coverage Elections
A foreign affiliate of a US employer can elect social security
coverage for US citizens and resident aliens working there
(otherwise they are not covered)
 A foreign affiliate is a foreign business entity in which a U.S. company has
at least a 10% interest.
 The U.S. employer is responsible for paying both the employer and
employee shares of the U.S. social security and Medicare taxes.
 The employer is not obligated to withhold or cause the foreign affiliate to
withhold the employee share of the taxes from the employee’s wages,
although the employee can agree to such withholding with the U.S.
employer.
Foreign Affiliate Coverage Elections
 The US must enter an agreement with the IRS through Form 2032
 The IRS will assign the US employer a separate employer identification
number for reporting wages and taxes covered by the agreement
 Employer must report wages and taxes on Form 941, annotating
“3121(l)” agreement
Heroes Earnings Assistance and Relief Act, a foreign employer is treated as an
American employer for social security and Medicare tax purposes with respect to
employees of the foreign employer performing services under a contract between the
U.S. government and any member of any domestically "controlled group of entities"
that includes the foreign employer.
FUTA
• Employment by US citizens working abroad for a US employer is covered
under FUTA (Federal Unemployment Tax Act) if the work performed
would be covered in the US
• Does not apply to resident aliens working abroad or American
employees of foreign affiliates
• Coverage exception for Canada and Virgin Islands to avoid dual coverage
for employees of US companies working where local unemployment
exists
• Employer must pay the full 6.2% FUTA for employees if the state having
jurisdiction does not require employer unemployment insurance tax
payments
• No state payments = no credit against FUTA liability can be taken
Foreign Earned Income and
Housing Cost Exclusion
• Expatriates can exclude the first $95,100 of foreign earned
income from their gross income
• Can also exclude certain housing costs from gross income
• Must have foreign earned income, tax home must be in a
foreign country & meet the bona fide residence or physical
presence test
Foreign Earned Income and
Housing Cost Exclusion
Foreign Country
 Any territory under the sovereignty of a government other
than the US
 Territories and possessions of the US are not considered
foreign countries, nor is Antarctica as a sovereign less region,
nor are international waters and airspace
Foreign Earned Income and
Housing Cost Exclusion
Foreign Tax Home
 Employees tax home must be in a foreign country for the
entire period of residence or physical presence during the
year
 Location of his or her regular place of business or
employment
 If there is no regular or principle place of business, the
employee’s tax home is where the employee regularly lives
 Cannot have a foreign tax home if employee regularly lives in
the US
Foreign Earned Income and
Housing Cost Exclusion
Foreign Tax Home
-Is assignment temporary or indefinite ?
Realistic expectation test
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If employment away from home in a single location is realistically expected to last
(and does last) for one year or less, the employment = temporary
If employment away from home is expected to last for more than one year or
there is no realistic expectation that the employment will last for one year or less,
the employment = indefinite (regardless of whether it actually exceeds a year)
If employment away from home is realistically expected not to exceed one year,
the employment = temporary until the date the expectation changes
Foreign Earned Income and
Housing Cost Exclusion
Business Expenses
 Travel and living expense reimbursements for employees on
temporary assignments may be excluded from income as
reimbursed employee business expenses if the are provided
under an accountable plan
Bona Fide Residence Test
Employees must prove that they have been bona fide residents
of a foreign country for an uninterrupted period that includes at
least one full taxable year (Jan-Dec)
Considerations
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Family accompaniment
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Purchase of a home or a long term lease
Involvement in culture and social life
Terms of employment agreement
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Type of visa or residence permit
*Employees can meet the bona fide resident of a foreign country even if the
intent is to return to the US at the end of the international assignment
*To claim bona fide resident status, Form 2555 must be filed
Physical Presence Test
Another way to qualify for the foreign earned income exclusion
is by meeting the physical presence test
 met if the expatriate is physically present in a foreign country or
countries for 330 full days during any consecutive 12-month period
 The 330 day qualifying days do not have to be consecutive, and all
periods spent in foreign countries (personal and business) count
Foreign Earned Income
Earned by employee from sources within a foreign country, while
employee has a foreign tax home and qualifies for the exclusion under
the bona fide residence or physical presence test
 Includes wages, bonuses, cola, educational reimbursements, etc
Does not include, pension or annuity payments, amounts already
excluded as meals and lodging furnished for the employer’s
convenience
Determining the source of earned income
 Income earned for working in a foreign country; where or how the
employee is paid has no bearing on the source of the income
*Foreign earned income is considered to be income in the year it was
earned, not in the year in which it is paid
*Working spouses are also eligible to take exclusion
Foreign Earned Income Calculation
Partial year calculation for foreign earned income
Number of days worked in the U.S.
Total number of days worked
X
Total income = U.S. source income
Example:
30 days worked in US
240 total days worked
X
89,000 = US sourced income
.125
X
89,000 = $11,125
Foreign earned income
=
$77,875
Foreign Housing Cost Exclusion
• Employees who have a foreign tax home and qualify under
the bona fide residence or physical presence test can take an
exclusion for a limited amount of reasonable foreign housing
expenses exceeding a base housing amount
Reasonable housing expenses
include :
Reasonable housing expenses do not
include:
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Rent
Utilities
Insurance
Occupancy taxes
Fees to secure a lease
Furniture rental
Household repairs
Automobile parking costs
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Lavish or extravagant expenses under the
circumstances
Telephone and cable television charges
Deductible interest and taxes
Capital expenditures, such as a house
(including mortgage payments)
Home improvements or furniture
Cost of domestic labor (e.g., maids or
gardeners)
Foreign Housing Cost Exclusion
• Base housing amount.- The base housing amount is 16% of the maximum
foreign earned income exclusion, figured on a daily basis, multiplied by the
number of days during the year the employee met the bona fide residence
or physical presence test. The maximum foreign earned income exclusion
is determined on January 1 of the year in which the employee’s tax year
begins.
• Housing cost exclusion limitation.- The reasonable housing expenses that
are used to calculate the housing cost exclusion are limited to 30% of the
maximum foreign earned income exclusion, figured on a daily basis,
multiplied by the number of days during the year the employee met the
bona fide residence or physical presence test. The maximum foreign
earned income exclusion is determined on January 1 of the year in which
the employee’s tax year begins.
Foreign Housing Cost Exclusion
Maximum Foreign Earned Housing Cost Exclusion
Maximum Foreign Housing
Income Exclusion
Limitation
Base Housing Amount
Cost Exclusion
2011 $
92,900.00 $
27,870.00 $
14,864.00 $
13,006.00
2012 $
95,100.00 $
28,530.00 $
15,216.00 $
13,314.00
Example of calculation
Foreign housing cost exclusion = reasonable housing expenses –base housing
amount
Base housing amount = maximum foreign earned income exclusion x 16%
US Income Tax Treaties
The US has more than 55 income tax treaties with foreign countries
designed to clarify each country’s taxing jurisdiction and to avoid double
taxation of income
Some common treaty benefits:
 resident aliens working abroad is that the nondiscrimination clauses in
most treaties allow them to qualify for the foreign earned income and
housing cost exclusions under the bona fide residence test as well as the
physical presence test
 An employee’s wages may be partially or totally exempt from taxation by
the foreign country if the employee is in the foreign country for a limited
number of days
US Income Tax Treaties
 Wages received by professors and teachers in a treaty country are exempt
from foreign taxes under most treaties for temporary periods up to 2 or 3
years
 Amounts received by US residents to study, research, or business and
technical training are generally exempt from the treaty’s country income
tax
 Provide for credits and deductions to reduce taxes imposed by the foreign
country to avoid double taxation
 Tax saving clauses provide that treaties do not affect US taxation of its own
citizens and residents therefore most treaties’ benefits related to a treaty
country’s taxes are available only to US citizens who are not residents of
the treaty country and US resident aliens who are not citizens of the treaty
country
Tax Reimbursement Policies
To ensure that employees do not suffer in comparison to their US
counterparts, most companies offer one or more additions to the
expatriate’s basic compensation package:
 Housing allowance
 Shipment of household goods
 Education allowance
 Vacation allowance
 Hardship allowance
 Automobile allowance
 Cost of Living allowance
 Foreign service premium
Tax Equalization- Tax Protection
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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.
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Some employers follow a policy of Tax Protection
Tax protection is designed to ensure that the employee pays no more tax
than they would have paid 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.
Tax Equalization Settlement Calculation
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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.
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Some employers follow a policy of Tax Protection
Tax protection is designed to ensure that the employee pays no more tax
than they would have paid 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.
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.
Expatriate State Tax Issues
• State income taxes are imposed on all state residents based on total
income, with the tax being federal adjusted gross income or taxable
income
• Nonresidents are taxed only on their income from state sources
• The tax burden on expatriates will necessarily be less in most situations
if they can show they are no longer state residents while on assignment
• Domicile is a legal concept similar to residence, but it is distinct and turns
on an individual’s attachments to the state
Expatriate State Tax Issues
The determination of residency is based on various tests depending on the
state, but often depends on whether the expatriate remains a domiciliary of
the state
Determining Domicile
• Where the employee votes
• Where the employee maintains a residence
• Where the employee’s immediately family lives and where children
attend school
• Whether the employee returns after vacations or other leaves from work
• The state issuing the employee’s driver’s license
• Where bank accounts and business associations are maintained
The domicile is also considered the place the employee intends to return to
upon completion of the international assignment
Expatriate State Tax Issues
Determining Residency
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Physical presence
Where family lives and where children attend school
Whether the employee works, has business interests, and owns property
Where bank accounts and business interests are maintained
For tax purposes
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State specific
Nearly all states treat a domiciliary as a resident of the state for tax purposes
Many treat nondomiciliaries as residents depending on how long they are in the state
during the year and whether they have a permanent place of abode in the state
A number of states treat domiciliaries as nonresidents for tax purposes if the are absent
from the state for a certain period of time, even though they may intend to return
Not all states allow for foreign earned income and housing cost exclusions
Resident and Nonresident Aliens in US
Resident aliens
 Taxed on worldwide income and are usually treated the same way as US
citizens
Nonresident aliens
 Taxed only on their income from US sources, with some exceptions
An alien can be both a resident and non resident and be taxed as one or the
other for part of the year
Resident and Nonresident Aliens in US
Lawful permanent residence test
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If an alien is a greencard holder, or lawful permanent resident of the US, he/she is
considered to be a US resident for tax purposes and this would apply for the full
year even if only physical present part of the year
Substantial presence test
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If an alien is present in the US for at least 31 days during the entire calendar year
and the total number of days of US presence during the current calendar year, plus
one-third of the US days during the preceding calendar year, plus one-sixth of the
US days during the second preceding calendar year is at least 183 days, he/she is
considered to be a US resident for tax purposes
Resident and Nonresident Aliens in US
What is presence?
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When an alien is present in the US on any day in which he or she is physically
present for any part of the day
When are days present excludable?
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Full time employee of international organization or with diplomatic status
In the US under student or traineee visa status, such as J-1, F-1, M-1, Q-1
Crew member of foreign vessel engaged in transportation between the US and a
foreign country or US possession
Medical condition which arose in the US
Professional athlete to compete in charitable sporting event
Days on which residents of Mexico and Canada regularly commute to the US to
work and then return home
Days spent in transit between 2 points in foreign countries during which the alien
spends less than 24 hours in the US
Resident Aliens Working in U. S.
 Wages subject to federal and state withholding and employment taxes
 Resident aliens must obtain a U.S. social security number
 Resident aliens must complete a Form W-4, Employee’s Withholding
Allowance Certificate, and Form I-9, Employment Eligibility Verification
 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
Resident aliens working abroad generally treated as US citizens
Nonresident Aliens Working in U. S.
 US sourced income is subject to federal and state withholding and
employment taxes
 Nonresident aliens must obtain a U.S. social security number or ITIN
(Individual Taxpayer Identification Number).
 Nonresident aliens must complete a Form W-4, Employee’s Withholding
Allowance Certificate, and Form I-9, Employment Eligibility Verification.
 Wages paid to and taxes withheld from non 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
Students, agricultural workers, work performed on foreign ships or plans, worked
performed for the federal government are generally exempt from FICA and FUTA
Commercial Travelers
Exceptions to withholding rules
The specific conditions that must be satisfied for this “commercial traveler”
exception to apply are as follows:
 The nonresident alien employee is in the U.S. for no more than a total of
90 days during the taxable year;
 Compensation received for work performed in the U.S. totals no more
than $3,000 during the taxable year; and
 The nonresident alien is employed by: a U.S. employer in a foreign
country or a U.S. possession or by a foreign employer not engaged in a
trade or business in the U.S.
If the commercial traveler exception does not apply, the employer must
withhold federal income tax
Social Security & Medicare Taxes & FUTA
Social Security, Medicare, & FUTA taxes generally apply to all wages paid for
work performed in the US, regardless of citizenship or residency status of
employee
This is true even if the employee may be exempt from federal income tax but
there are exceptions:
 Nonresident alien students (F-1, J-1, M-1, Q-1)
 Agricultural Workers
 Work performed on ships or planes
 Work performed for a foreign government
 Work performed for international organizations
Depositing and Reporting Obligations
 In general, U.S. resident and nonresident aliens are subject to the same U.S.
federal, state and unemployment tax reporting and withholding obligations as
U.S. citizens/permanent residents
 Employees must be issued a W-2
 Employers must report compensation and withhold federal, state, local and
social tax (also state disability and unemployment taxes where required) using
form 941
 Employers must also fund the employer portion of FICA, Medicare, and federal
and state unemployment taxes
 Amounts paid and taxes withheld from nonwage compensation must be
reported on Form 1042
 If withholding agent has 250 or more Form 1042 to file, it must do so
electronically
Types of 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
 D-1- Foreign Crewman
Types of Visas
• E-l - Treaty traders
Traders in the U.S. only to carry on trade between the U.S. and the visa
holder's home country
• E-2 - Investors
Foreign investors who are in the U.S. to direct a business in which they have
invested or will invest a substantial amount of money.
• E-3 - Specialty occupations
Residents of Australia coming to the US. to work in specialty occupations,
and their spouses and dependents. 10,500 annual limit
Types of Visas
• 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
Types of Visas
• L-1 (A & B)- Intra company transfers
 Managers and executives in a specialized field of knowledge
• M-1 – Non academic or vocational students
• O-1 and O-2: Extraordinary Ability
 Extraordinary ability in the arts, sciences, education, or athletics
• P-1- Entertainers, athletes
• Q-1- Cultural exchange visitors
• R-1 Religious occupations
• TN-NAFTA-Canadians, Mexicans working under the North American Free
Trade Agreement
Form I-9
Where immigration and tax sometimes do not meet!
Under IRCA, employer cannot require any new hire,
(resident or nonresident) to produce any particular
document, including a social security card
However, E-Verify employers are required to obtain a
SSN