apa section 14: payroll for u.s. employees abroad and aliens in the u.s. kathy holmes

APA

Section 14: Payroll for U.S. Employees Abroad and Aliens in the U.S.

Kathy HolmesKaya Studway

Deloitte Tax LLPMarch 29, 2014

Copyright © 2014 Deloitte Tax LLP. All rights reserved.2

Session Agenda

• Expatriates - US Citizens or Resident Aliens Working Abroad

Expatriate Payroll

Tax Equalization and Tax Protection

U.S. Foreign Earned Income Exclusion/Credits

Income Tax Treaty Agreements

U.S. Reporting and Withholding Requirements: Federal, State, Social Security (FICA) and Medicare

Earnings Adjustments and Tax Gross-Up/Tax Gross-Down

• Inpatriates -Residents or Non-Resident Aliens Working in the U.S.

Tax Equalization and Tax Protection

U.S. Resident/Nonresident Alien Status

Visas

Payroll Documentation and U.S. Reporting/Withholding

U.S. Resident Aliens

U.S. Nonresident Aliens

Earnings Adjustments and Shadow Payroll

• U.S. Social Security Totalization Agreements


Expatriates PayrollAllowances and Reimbursements• 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.


Expatriates PayrollComponents 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)


Expatriates PayrollAllowances/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.


Expatriates Payroll Allowances and Reimbursements Why is it necessary to know about 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 pre-assignment reportable wages.

• The additional compensation often triggers additional tax obligations.

• In most cases, the incremental tax obligations are borne by the employer.


Expatriates Tax Equalization and Tax Protection 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.


ExpatriatesHypothetical 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.


ExpatriatesU.S. Foreign Income Exclusions/Credits• Expatriates 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 ($97,600 for 2013) – Form 2555

Bona Fide Resident (Tax home outside U.S. for entire calendar year)

Physical Presence (Physically present outside U.S. for 330 days in a 365 day period)

Housing Exclusion

Qualified foreign housing expenses are approximately $15,616 for 2013

(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., childcare credit, AMT, etc.)


ExpatriatesDetermining the Source of Earned Income

• Source of earned income is determined by where the employee performed the services that produced the income.

• Generally the following formula is used to determine the portion allocable to the U.S.:

Number of days worked in the US X Total income = U.S. Source Income

Total number of days worked

ExampleJack, a U.S. citizen, is a bona fide resident of Canada. Jack’s total income is $89,000 and worked for a total of 240 days after subtracting vacation time. He worked 30 days in the U.S. during the year. What is Jack’s U.S. sourced income?

30 days worked in the U.S. X $89,000 = U.S. Source Income of $11,125

240 total days worked

• Jack’s foreign earned income= $89,000- $11,125 = $77,875


ExpatriatesForeign Housing Exclusion

• Foreign Housing Exclusion

ExampleJack, a U.S. citizen, qualifies for the foreign earned income exclusion for 2013 under the physical presence test

During the 2013 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 2013 ?

Annual base housing amount for 2013 = $15,616

Prorated base housing amount for foreign days in 2013 = $15,616 * (335/365) = $14,332

What is Jack’s foreign housing cost exclusion for 2013 ?

Reasonable housing expenses – Base housing amount = Foreign housing cost exclusion

$15,000 - $14,332 = $668


ExpatriatesIncome Tax Treaty Agreements

• 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 are generally exempt from foreign taxes


ExpatriatesReduction in Federal Income Tax Withholding

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!


ExpatriatesU.S. State Reporting and Withholding Requirements• 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; provided the wages are not sourced to a state.

• 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 cannot be broken, tax withholding may be able to be reduced during an international assignment.


ExpatriatesU.S. Social Security Reporting and Withholding Requirements

• 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.


ExpatriatesEarnings Adjustment

• 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.


ExpatriatesTax Gross-up

• 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.


ExpatriatesExample of a Incorrect 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!


ExpatriatesExample of a Correct 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!


ExpatriatesTax Gross-Down• 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

• The application of the reduction and the gross down will depend on the company’s international assignment policy.


ExpatriatesForm W-2 Reporting for Earnings Adjustments

• 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 ($113,700 for 2013; $117,000 for 2014)

State/local wages = 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.


ExpatriatesEarnings Adjustment Example - Gross-up Calculation• Base Wages (without assignment income) = $205,000

• 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* 5.00%

Medicare 1.45%

Additional Medicare .9%

1 x 110,000 = $170,146.95

(1 - .28 - .05 - .0145 -.009)

Total Additional Compensation = $170,146.95*Assumes earnings adjustment occurs while the individual is a state tax resident.


ExpatriatesEarnings Adjustment Example - Gross Up Breakdown

EXAMPLE• Breakdown of tax gross-up

$170,146.95 * .28 = $47,641.15 = Federal Taxes

$170,146.95 * .05 = $8,507.35 = State Taxes

$170,146.95 * .0235 = $3,998.45 = Medicare Taxes

Total Taxes = $ 60,146.95

Total Allowances = $110,000.00

Total Adjustment = $170,146.95


ExpatriatesEarnings Adjustment Example – W-2 Adjustments

• Adding it to Form W-2 wages

Box 1 Federal Wages: $ 170,146.95

Box 2 Federal Taxes: $ 47,641.15 new cost

Box 3 Social Security Wage *: $ 0

Box 4 Social Security Tax *: $ 0

Box 5 Medicare Wage: $ 170,146.95

Box 6 Medicare Tax: $ 3,998.45 new cost

Box 16 State Wage: $ 170,146.95

Box 17 State Tax: $ 8,507.35 new cost

* Assumes annual FICA maximum has already been met.


Expatriates Treatment of Additional Employer 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.


Inpatriates


InpatriatesTax Equalization and Tax Protection Policies

• 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.


InpatriatesU.S. Resident/Nonresident Alien Status• 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

Nonresident aliens taxed on U.S. sourced income, with exceptions

• Business 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


InpatriatesVisas

• 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


InpatriatesPayroll Documentation and Reporting/Withholding

• Inpatriates should obtain a U.S. social security number or ITIN (Individual Taxpayer Identification Number).

• Inpatriates should complete a Form W-4, Employee’s Withholding Allowance Certificate, and Form I-9, Employment Eligibility Verification.

• Wages paid to and taxes withheld from inpatriates 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.


InpatriatesReporting 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.


InpatriatesReporting and withholding for U.S. nonresident aliens

• In general, U.S. nonresident aliens are subject to the same U.S. federal, state and unemployment tax reporting and withholding obligations as U.S. residents.

• If an income tax treaty applies, the nonresident alien employee may be exempt from U.S. income tax withholding

Form 8233 must be provided to the employer for the income tax withholding exemption to apply

Form 8233 should be mailed by the employer to the IRS within 5 days of receipt

A copy must be given to the employee upon submission


InpatriatesIncome Tax Withholding Calculation for Nonresident Aliens

• Special procedure required to calculate Federal income tax withholding for nonresident alien employees

• The income tax to be withheld is determined by applying the withholding tables to the sum of the wages paid for the payroll period plus the additional amount below:


InpatriatesEarnings adjustments and shadow payroll

• 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 gross-up will be added to the individual’s compensation each pay period to result in a neutral net effect to the employee.


InpatriatesReporting 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)


Totalization Agreements


U.S. Social Security Totalization Agreements

• 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 24 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).


Totalization AgreementsList of U.S. agreements

Australia Poland

Austria Italy

Belgium Japan

Canada Luxembourg

Chile Netherlands

Czech Republic Norway

Denmark Portugal

Finland South Korea

France Spain

Germany Sweden

Greece Switzerland

Ireland United Kingdom


Questions?

apa section 14: payroll for u.s. employees abroad and aliens in the u.s. kathy holmes

Documents

tax protectionu

tax withholding

expatriates payroll

host country housing

compensation reporting

permanent residents

individuals assignment

nonresident aliens