Many companies just beginning to go global face the same questions: What do we do with our inpatriate and/or expatriate employees? How do we handle the administration of payroll? Do we need to provide tax equalization? Who is subject to U.S. tax? What is a shadow payroll?
When a company decides to utilize a global workforce, there are many implications. Expatriates (the employees you send from the United States into another country, and inpatriates (the employees who come into the United States) have different tax consequences to the company and different pain points of which companies starting out their global journey should be aware.
Taxation of Expatriates
When a company decides to go global, it must understand the employment tax implications.
To remain at a competitive advantage, a company should implement a global employment tax policy for its mobile workforce. Many of today’s workers are savvy about the perks and pitfalls of international assignments. Providing your employees with a tax-neutral or favorable global tax package becomes a marketing tool when hiring, or a retention tool to maintain your global workforce.
It is imperative that small companies beginning to hire global employees understand the basics of tax equalization and have policies and procedures in place as soon as possible. Procrastination tends to result in many foreign workers ending up with different benefits and disparate tax treatment, with non-uniform paperwork governing the entire process.
Tax equalization, or the potential need for it, begins when a company decides to send a worker from his home location to another location. This may be done in the United States from state to state, or globally from country to country.
The principle around tax equalization is for the employee to remain in a tax-neutral position as a result of the assignment. The employees pay no more or no less tax than if they had remained in their home countries. The company pays all worldwide actual taxes, and the employees only pay their usual home country taxes. This results in the company withholding a hypothetical tax (“hypo tax”) from the assignee when the assignment begins that mirrors the employee’s home tax obligation. Many companies employ third parties specializing in global taxation or CPA firms to assist them in determining the hypo tax amounts and the company’s obligation in the foreign jurisdiction.
Tax equalization policies differ from company to company and even by industry. The expenses the company is willing to bear also differ, as does the compensation policy. Your first expatriate will force you to make decisions regarding your global workforce that will lay the groundwork for future expatriates.
Your first foreign assignment will then create the question of how to establish a shadow payroll. Shadow payroll is a process in which a U.S. employee working overseas, for example, receives compensation and benefits in the host country that are shadowed, or mirrored, in the United States for calculating, reporting, and remitting taxes. This concept is confusing to a U.S. payroll person starting with an international employee for the first time but becomes second nature with time.
An inpatriate is a multinational company employee working in the United States after coming from a foreign country. This employee’s payroll tax treatment is largely driven by the type of visa the employee holds. Certain visas allow workers to be employed in the United States, while others do not. All companies, large or small, must be aware of the visa types that exist and their related payroll consequences. Common visas individuals may hold that will allow them to work in the United States are F-1, H-1b, J-1, L-1, and TN.
Payroll Tax Consequences
U.S. income tax is computed on foreign source income, translated to U.S. dollars at the time of receipt. Blocked currency, or foreign income that is not readily convertible into U.S. dollars, does not constitute taxable income and may be deferred until, generally, the currency is convertible into U.S. dollars or is used for nondeductible personal expenses. Withholding of U.S. income tax is not required if the employer is required to withhold the host country’s income tax.
A Foreign Earned Income Exclusion may be claimed when an expatriate files Form 1040, Individual Income Tax Return. The amount of income exclusion is currently $102,100. The amount adjusts annually.
For expatriates, income is subject to the Federal Unemployment Tax Act (FUTA) if the services are performed for an American employer. Social security tax is mandatory if services are performed by a U.S. citizen or resident, and if the employment is for a U.S. employer. Totalization agreements may eliminate dual taxation. If the U.S. has a totalization agreement with another country, the employee may be covered under the home country’s social security equivalent, thereby exempting the employee from U.S. social security.
The federal income and employment tax consequences for foreign citizens working in the United States depend on:
Whether the individual is classified as a “resident” or “nonresident alien” as defined under the U.S. tax laws; and,
Whether a tax treaty or agreement exists between the United States and the foreign citizen’s home country.
Resident aliens are subject to the same federal income tax laws as citizens of the United States (i.e., they are subject to tax on all income earned in the United States and abroad). Resident aliens are subject to social security and Medicare taxes on wages (FICA taxes) and on self-employment income (SECA taxes) in the same manner as U.S. citizens.
Nonresident aliens are taxed on income from sources within the United States but generally not on income from foreign sources. Nonresident aliens are subject to FICA taxes on compensation from work within the United States under the rules applicable to U.S. citizens and resident aliens.
As you place an employee in a country where you have not had payroll previously, questions abound. How do I pay the employee? What benefits are mandatory? What is the social tax system? Can I pay the employee from the United States? What about stock options?
These are just a few of the questions you may encounter. The internet is great for some basic answers—but you definitely do not want to base your tax treatment of an employee on what you can gather from a quick search.
At this point it may be advantageous to begin networking. Find peers in other companies who have employees in the same jurisdiction. If your payroll service can run a payroll in that country, does your accounting firm have a presence there? You will need to gather as much data as possible prior to processing so that you are comfortable with all of the new requirements that you will have to meet in order to be in compliance in the other country.
Communication Is Key
The hiring of your first expatriate or inpatriate can be a daunting task. Communication is key, as is knowledge of the basics:
- What the company is willing to do for the employee (tax equalization)
- The type of visa the worker has
- The tax consequences to the company and the employee of this worker accepting the assignment in both the host and home countries
- How you intend to manage the process
- Policy implementation, whether third-party assistance or internal
In addition, Table 1 reflects the different types of visas you may encounter when utilizing foreign workers in the United States.