With increasing globalization and the expansion of cross-border business activities, U.S. employees are often relocating to work in foreign countries. U.S. expatriate employees typically may work in a foreign country for a U.S. company or for a foreign subsidiary company or foreign affiliate of the U.S. employer. There are certain U.S. federal tax considerations that may impact both the U.S. employee and employer when employees work in a foreign country.
A significant consideration is whether the U.S. employee will remain on the payroll of the U.S. employer. Regular U.S. federal Form W-2 reporting will apply if the employee continues to receive compensation from the payroll of the employer while working in the foreign country. This means that generally the U.S. employee will be subject to U.S. federal income tax, Social Security and Medicare withholding on the compensation earned while working in the foreign country. The employee may qualify for an exemption from U.S. federal income tax withholding on the foreign earned wages if the employee will qualify for the foreign earned income exclusion. There is also an exemption from federal income tax withholding on foreign earned wages if the wages are subject to employment tax withholding in the foreign country. A U.S. employee’s foreign earned wages generally continue to be subject to U.S. Social Security withholding. Some foreign countries have treaties with the United States referred to as Social Security Totalization Agreements, which provide that the employee working in the other country continues to be subject to the Social Security system of the home country unless the presence in the other country is greater than five years.
Alternatively, the U.S. employee could be transferred to the payroll of a foreign subsidiary or affiliate of the U.S. employer. If the employee receives compensation from the payroll of the foreign company, the foreign earned wages generally are not subject to U.S. federal income tax, Social Security or Medicare withholding. However, U.S. federal Social Security withholding is required for U.S. employees who are on the payroll of a foreign company and who are working on a U.S. government contract. Otherwise, the U.S. employee may lose the FICA contributions on the foreign earned wages. The U.S. employee also would lose the ability to participate in the U.S. employer’s benefit plan, including a 401(k) plan with respect to the foreign earned wages. However, there is an irrevocable election on Form 2032 which allows the U.S. employer to pay the FICA contributions with respect to the U.S. employee’s foreign earned wages received from the payroll of a foreign affiliate. The Form 2032 election requires the U.S. employer to have at least 10% direct or indirect ownership of the foreign employer. Another option is for the U.S. employer to enter into a secondment agreement with a controlled foreign subsidiary company. The secondment arrangement allows the employer to continue to report and pay the U.S. federal employment tax withholding on the U.S. employee’s foreign earned wages while the U.S. employee is on loan to the foreign subsidiary company.
Please contact your Aronson LLC tax advisor, Alison N. Dougherty, International Tax Services at 301.231.6290 for more information.