Forms W-2c are a fact of life for anyone dealing with employees on foreign assignment. Tax equalization settlements, relocation, and home/host country obligations are a few of the pieces in the large moving puzzle known as your U.S. payroll. Some or all of these may result in the need to issue W-2c’s.
Third parties such as CPAs or consulting firms that handle your tax equalizations; relocation companies that handle inpatriate and expatriate relocation programs; foreign office payroll departments; or third-party accounting firms based in foreign locations can assist in the reduction of W-2c’s. Data from all of these sources are a necessary part of the data flow that makes its way to payroll for reporting on the W-2.
W-2c’s will always exist when you have workers who are on a foreign assignment and tax equalization occurs. Many of the W-2c’s are created through the settlement process. On completion of the assignee’s annual tax returns, the actual hypothetical tax returns typically are recalculated by an independent tax consultant or an in-house tax specialist based on actual facts and circumstances.
The difference between the actual hypothetical tax amount and the estimated hypothetical tax amount withheld during the year, plus any actual income taxes paid by the assignee, is determined, and the difference—if any—settled between the assignee and the company within a pre-agreed period of time. A settlement statement is created but is generally not finalized until the individual tax obligations have been handled. Generally, the statements are in process as all of the year-end data is gathered from external and internal payment sources. In many instances, this final settlement may not occur until after the deadline for filing the employees’ W-2 or even after the individual tax filing deadline of April 15, or October 15 if a filing extension has been requested. Therefore, a W-2c will be necessary.
Can the Number of W-2c’s Be Minimized?
One area where you have a little more control involves individuals who become “substantially present” in the United States, such as F1 visa holders. A typical issue that F1 visa holders face is recognizing the point in time they become substantially present in the United States and are no longer eligible for the FICA exemption.
According to the U.S. Internal Revenue Service (IRS): You will be considered a United States resident for tax purposes if you meet the substantial presence test for the calendar year. To meet this test, you must be physically present in the United States on at least:
- 31 days during the current year
- 183 days during the three-year period that includes the current year and the two years immediately before that, counting:
- All the days you were present in the current year
- One-third of the days you were present in the first year before the current year
- One-sixth of the days you were present in the second year before the current year
You were physically present in the United States for 120 days in each of the years 2012, 2013, and 2014. To determine if you meet the substantial presence test for 2014, count the full 120 days of presence in 2014, 40 days in 2013 (1/3 of 120), and 20 days in 2012 (1/6 of 120). Since the total for the three-year period is 180 days, you are not considered a resident under the substantial presence test for 2014.
Days of Presence in the United States and Exceptions
You are treated as present in the United States on any day you are physically present in the country, at any time during the day. However, there are exceptions to this rule. Do not count the following as days of presence in the United States for the substantial presence test:
- Days you commute to work in the United States from a residence in Canada or Mexico, if you regularly commute from Canada or Mexico
- Days you are in the United States for less than 24 hours when you are in transit between two places outside the United States
- Days you are in the United States as a crew member of a foreign vessel
- Days you are unable to leave the United States because of a medical condition that develops while you are in the United States
- Days you are an exempt individual
When that occurs, an employer should be withholding FICA taxes (social security and Medicare taxes) as well as paying the employer’s matching portion.
In many instances, human resources (HR) is responsible for the tracking of the foreign workers and may miss the point in time that the individual becomes substantially present. Unfortunately, it is not noted until the employee requests a W-2c to have their FICA reported correctly. In addition to the W-2c, the employer must prepare amended 941 returns (Forms 941-X) and remit both the employer and employee portions of taxes. One way to avoid a W-2c in this instance is for payroll to track the employee’s dates of service in the United States and when they will become substantially present and subject to FICA taxes.
Additionally, a program of tax protection is a potential way to avoid W-2c’s in contrast to tax equalization.
Tax protection seeks to reimburse an employee the excess taxes above the taxes they normally incur while on an international assignment. The employee is responsible for the payment of all actual home and host country taxes. This allows the annual W-2 issuance to occur through the normal creation process. The employee then files their personal returns, basically settling up with their home and host countries, not requiring the settlement statements that occur as part of the tax equalization process.
The annual tax protection calculation then compares the stay-at-home hypothetical tax to the actual worldwide taxes paid by the employee. If the actual worldwide taxes exceed the stay-at-home tax amount (as determined under the company’s policy), the company reimburses the excess to the employee. If the actual worldwide taxes are less than the stay-at-home tax, the employee retains the tax benefit (and accordingly, receives no reimbursement from the company). The burden of filing home- and host-country personal taxes is generally placed on the employee. The number of W-2c’s under tax protection are potentially fewer than those created under tax equalization.
It is not recommended that a company rush out to utilize tax protection to avoid W-2c’s. Leaving the filing responsibility for both home and host taxes to an employee can be costly to a company in the long run. Compliance with the host- and home-country tax laws is oftentimes complex and frequently overlooked since the assignee is solely responsible for filing and paying his home- and host-country taxes.
Unfortunately, W-2c’s are a fact of life when dealing with inpatriates and expatriates. The only hope is to minimize the number and hopefully the length of time between W-2 issuance and W-2c creation.
Mindy Harada Mayo, CPP, is Director, Human Capital Tax Services, Ryan. She specializes in leading and advising organizations in the areas of human capital taxation, including financial and operational risk management, process improvement, and strategic management. She is skilled at representing clients before state and federal agencies during employment tax audits or controversy. Mayo assists clients utilizing both inpatriate and expatriate employees, guiding them through the myriad of regulations surrounding payroll for employees on foreign assignments. Her previous experience includes serving as a Director of the Employment Tax Practice with a national accounting firm.