Tax Equalization - California Payroll Conference

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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.
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