California Payroll Conference Overview of tax reimbursement plans and related payroll reporting requirements Rajiv Thadani Principal, Tax KPMG LLP [email protected] (408)367-2765 September 11 and 12, 2014 ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. The information contained herein is general in nature and based on authorities that are subject to change. Applicability to specific situations is to be determined through consultation with your tax adviser. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. Agenda What is a tax reimbursement plan and why is it necessary Types of tax reimbursement plans Tax protection and examples Tax equalization and examples Tax Equalization – Payroll reporting requirements Tax Equalization – Payroll reporting for repayments and examples Tax reimbursement plans – Administrative matters Tax Reimbursement Plans Tax reimbursement plans Why is a tax reimbursement plan necessary? Tax on allowances Host country (foreign) income taxes Complexities created by two tax systems (home & host country) Ease of relocation of international assignees Generally removes tax as a criteria to consider for cross-border transfers Competitive advantage Employee goodwill Tax reimbursement plans – key attributes Scope Specify who is covered under the plan and the employer’s intent Differentiate between assignment types Differentiate assignments based on period of length due to varying tax factors Determine the taxes covered under the plan Clearly define employee and employer responsibilities Ensure definitions and key language are consistent with the plan’s intent Examine areas of operation and specifically country combinations of employees on assignment to determine suitable plan Types of Tax Reimbursement Plans Types of tax reimbursement plans Tax protection Tax equalization Tax protection Tax protection – Key characteristics Employee pays all home and host country income and social taxes if applicable Employer continues to pay ER social taxes only If the taxes the employee pays exceed the home country tax obligation the employee would have incurred had he/she not accepted the assignment, the company will reimburse the excess taxes the employee paid. If the actual taxes the employee pays to the home and host country are less than the tax the employee would have paid in the home country had he/she not accepted the assignment, the employee retains the benefit Tax protection is most often used by employers having a small work force of expatriates who go to an assignment country for a limited time and do not move from one country to another. Tax protection – Benefits and disadvantages Benefits: Administration of a tax protection arrangement is generally straightforward In comparison to tax equalization, which will be discussed later, it may be less costly to the employer due to compounding effect of company funded tax payments under tax equalization. This depends on the country combinations and comparative tax rates. Disadvantages: May restrict employee mobility Inequality for employees in different home and host countries May result in employee cash flow issues because of funding Greater risk of non compliance with tax reporting requirements Tax protection – Example 1 U.S. taxpayer assigned to the U.K. Employee Compensation $ 150,000 US Federal Income Tax (Net of FTC and Exclusions) $ -0- Actual U.K. Tax $ 75,000 Total ActualTax $ 75,000 “Hypothetical” U.S. Tax Liability $ (37,500) Amount Due to Employee for Reimbursement $ 37,500 US Tax Gross-up on Reimbursement $ 18,200 Employer Tax Costs $ 55,700 EmployeeTax Costs $ 37,500 In this example, the employee funded the UK taxes for a cash outlay of $75,000 before receiving reimbursement of $37,500. This example illustrates the cash flow concerns that may arise at the employee level. Tax protection – Example 2 U.S. taxpayer assigned to Singapore Employee Compensation $ 150,000 US Federal Income Tax (Net of FTC and Exclusions) $ 5,000 Actual Singapore Income Tax $ 22,500 Total ActualTax $ 27,500 “Hypothetical” U.S. Tax Liability $ (37,500) Employer Tax Costs $ 0 EmployeeTax Costs $ 27,500 EmployeeTax Windfall $ 10,000 In this example, the employee paid the lesser of the actual taxes paid to the US and Singapore and receives a tax windfall of $10,000 relative to his stay at home hypothetical tax obligation. Tax Equalization Tax equalization – Key characteristics Intent of tax equalization is for the employee to remain in a tax neutral position Employer pays all actual taxes (both U.S. and foreign) on all taxable compensation Employee settles “hypothetical” tax on standard non assignment related compensation items (i.e., bonus, equity, salary) to the employer Payroll retains hypothetical tax withholding (not payable to the authorities) in place of actual tax withholding A tax equalization settlement calculation is prepared after finalizing the home and host country tax returns comparing the retained hypothetical tax to the employee’s final. Payment is made either from the employee to the company or company to the employee based on the employee’s final hypothetical tax position. Overwhelmingly accepted as the preferred method by global companies for U.S. expatriates Tax equalization – Benefits and disadvantages Benefits: Promotes compliance with tax reporting requirements Provides equal tax treatment for employees Supports mobility of expatriates to various country locations May lead to tax cost savings depending on country combinations Disadvantages: Administratively time consuming May be costly due to the compounding effect of company funded tax payments Tax equalization – Example 1 U.S. taxpayer assigned to the U.K. Summary: Employee Employer 150,000 150,000 Actual Federal US Income Tax Obligation 0 0 UK Taxes 0 75,000 Employee Hypothetical Taxes (37,500) (37,500) Net Compensation 112,500 197,500 Final Hypothetical Tax Obligation (42,500) Salary Tax Equalization Settlement Balance Total Tax Costs Including Equalization Settlement Repayment 5,000 (5,000) 42,500 32,500 In this example, the employee’s retained hypothetical tax was less than his/her final hypothetical tax obligation and repayment was settled to the employer. Tax equalization – Example 2 U.S. taxpayer assigned to the Singapore Summary Employee Employer 150,000 150,000 Actual Federal US Income Tax Obligation 0 5,000 Singapore Taxes 0 22,500 Employee Hypothetical Taxes (37,500) (37,500) Net Compensation 112,500 132,500 Final Hypothetical Tax Obligation (35,000) Salary Tax Equalization Settlement Balance 2,500 2,500 Total Tax Costs Including Equalization Settlement Repayment 35,000 (7,500) In this example, the employee’s retained hypothetical tax was more than his/her final obligation. The company realizes an overall tax cost savings of $7,500 (net of settlement), primarily driven by lower Singapore taxes. Retained US hypothetical taxes exceeded the actual tax obligations and the company realizes the benefit. Tax Equalization – Payroll Reporting Requirements Tax equalization – Payroll reporting requirements Hypothetical taxes withheld from an employee’s salary under an employer tax equalization program reduces the amount of income subject to tax. Since the hypothetical tax retained is not gross income to the employee, FIT withholding and FICA and FUTA taxes do not apply. Payroll retains hypothetical taxes during each per pay period and reports a negative adjustment to compensation for taxes retained in each period. Tax equalization settlement repayments paid to the company from the employee generally do not reduce reportable compensation unless repaid in the same year. Repayment is subject to claim of right reporting under IRC Section 1231 and is not reportable as compensation. Tax equalization settlement payments owed to the employee should be settled net of taxes and reported in compensation Tax Equalization – Payroll Reporting for Repayments Tax equalization – Payroll reporting for repayments Example 1. The employee’s 2013 final hypothetical tax obligation reconciled per his/her tax equalization settlement exceeds his retained hypothetical taxes by $5,000. The employee pays the company $5,000 for settlement in 2014. What are the payroll reporting requirements? Tax equalization – Payroll reporting for repayments Example 2. The employee’s 2013 final hypothetical tax obligation reconciled per his/her tax equalization settlement exceeds his retained hypothetical taxes by $5,000. The employee pays the company $5,000 for settlement in 2013. What are the payroll reporting requirements? Tax equalization – Payroll reporting for repayments Example 3. The employee’s 2013 tax equalization settlement balance reflects that the employer owes the employee $5,000 for settlement. The employee is a US tax resident on assignment in the UK. The employer settles payment in 2014. The employee is no longer a State tax resident and his/her wages have exceeded the FICA base limit. Should the payment be grossed-up for US taxes? Tax equalization - Payroll reporting for repayments Example 4. The employee’s 2013 tax equalization settlement balance reflects that the employer owes the employee $5,000 for settlement. The employee is a US tax resident and completed his/her assignment in 2013. The employee is living in California during 2014 and the company arranges settlement of the tax equalization payment during 2014. This is the final settlement related to the assignment. What US tax gross-ups should apply to the payment? Tax Reimbursement Plans – Administrative Matters Tax reimbursement plans – Administrative matters For each tax year of the assignment, payroll should maintain the following forms, with appropriate exemptions and exclusions, when operating both tax protection and tax equalization arrangements Form 673 Statement for Claiming Exemption From Withholding on Foreign Earned Income and Eligible for the Exclusion(s) Provided by Section 911 Form W-4 updated with “exempt status” if the employee is not subject to US tax withholding because he is subject to foreign tax withholding and is not expected to have residual US Federal tax obligations. Questions Thank you for your attention Please complete your evaluation Rajiv Thadani, Principal KPMG LLP Background: Rajiv is a global engagement lead for various technology clients in KPMG’s Bay Area office. He joined KPMG in 2001 having previously worked with Arthur Andersen. He has more than 17 years of experience providing a vast array of international tax and human resources services. Prior to relocating to the United States, Rajiv has worked in Belgium, United Kingdom, and India, and is familiar with the tax and HR challenges that accompany the international assignments.