Payroll taxes, expatriates and nonresident aliens.

U.S. employers with expatriates must be concerned with the effect of an overseas assignment on social security and other payroll taxes as well as income taxes. Employment taxes also may be a trap for employers of nonresident aliens providing services within the United States. Foreign employers unfamiliar with U.S. law may be particularly unaware of these additional taxes incurred through employment of individuals performing services within the United States.

These rules operate separately from the income tax rules and can be very confusing. To assist in determining who is subject to these taxes, Rev. Rul. 92-106 discussed the treatment of nonresidents and expatriates. The ruling did not alter their treatment; the positions taken have always applied and are required by the Internal Revenue Code.

Social security (FICA) taxes

Sec. 3101 imposes a tax of 6.2% on the wages received by an employee for old-age, survivors and disability insurance (OASDI). An additional tax of 1.45% is imposed for hospital insurance (Medicare). For 1993, the taxes are imposed only on the first $57,600 of wages for OASDI and the first $135,000 of wages for Medicare. An employer must withhold these taxes from an employee's wages under Sec. 3102; a corresponding tax is imposed on the employer under Sec. 3111.

Wages, with certain exceptions, means all remuneration for employment including the cash value of benefits and other non-cash remuneration (Sec. 3121(a)).

Employment is broadly defined as any service of whatever nature performed in the United States by an employee for the employer, without regard to the citizenship or residency of either party. Services performed by a U.S. citizen or resident outside the United States for an "American employer" is also employment. Special rules apply to services provided on or in connection with an American aircraft or vessel (Sec. 3121 (b)).

An "American employer" is a U.S. resident; a partnership, if at least two-thirds of the partners are U.S. residents; a trust, if all trustees are U.S. residents; a corporation organized under the laws of the United States or any state; and the United States or any U.S. instrumentality (Sec. 3121 (h)).

Federal unemployment tax

Employers are also subject to the Federal unemployment tax (FUTA) of 6.2% of the first $7,000 of each covered employee's wages (Sec. 3301). A credit up to 5.4% is allowed for payments made to state unemployment funds. Therefore, the net FUTA tax usually is 0.8% of the first $7,000 of each covered employee's wages.

Although the definitions of wages, employment and "American employer" are similar to those for FICA purposes, differences do exist. For instance, only services performed by a U.S. citizen outside the United States for an American employer are included in employment (Sec. 3306(c)). Also, the United States or any U.S. instrumentality is not considered to be an American employer for FUTA (Sec. 3306(j)(3)).

Expatriates

A U.S. citizen or resident working overseas for an American employer is subject to FICA withholding. The employer also is subject to FICA and FUTA on wages paid to this employee. Wages subject to FICA withholding include any amount excluded from Federal income tax under the Sec. 911 foreign earned income exclusion.

U.S. citizens or residents working overseas for a foreign employer are not subject to FICA withholding and accrue no U.S. social security benefits. Foreign affiliates of an American employer may agree to extend coverage under the U.S. social security system to their U.S. citizen and resident employees. Such an agreement would allow the employees to accrue U.S. social security benefits and would subject the employees and the employer to FICA taxes.

Foreign employers are not subject to FUTA for wages paid for services performed outside the United States.

Nonresident aliens

Nonresident aliens are subject to FICA, and their employers are subject to both FICA and FUTA, on wages for services performed in the United States.

Sec. 861(a)(3) generally exempts a de minimis amount of compensation paid by a foreign employer to a nonresident individual from Federal income tax by excluding this amount from U.S. source income. To qualify for this exemption, the nonresident alien must be temporarily present in the United States for not more than 90 days during the tax year. The compensation cannot exceed $3,000 and must be for services performed for a nonresident alien, foreign corporation, or foreign partnership, not engaged in a U.S. trade or business, or for services performed in an office or place of business maintained in a foreign country by a U.S. citizen or resident, domestic corporation or domestic partnership.

Most treaties expand this de minimis exclusion by altering the definition of U.S.-source income for residents of the treaty partner. The time period for which a nonresident alien may be in the United States is usually increased from 90 days to 183 days a year and the $3,000 limit is usually completely eliminated or substantially increased.

However, treaty and de minimis exclusions do not apply to FICA and FUTA. Foreign employers still are subject to FICA and FUTA on the excluded wages. They also must withhold and remit the employee's FICA taxes imposed on these wages.

Totalization agreements

On retirement, expatriates and nonresident aliens may find that a temporary assignment could affect the amount of social security benefits they obtain. A U.S. citizen or resident working abroad for a foreign employer is not subject to FICA taxes, but also does not accrue benefits.

To eliminate this problem, the United States has entered into totalization agreements with several foreign countries. These agreements determine which system will cover the employee during his employment and which country will provide retirement benefits. These agreements allow the individual to total his service under one system.

Totalization agreements also eliminate double social security taxation. U.S. expatriates and their employers should take advantage of these agreements when possible, because the social security taxes in many countries are substantially higher than the U.S. taxes.

Totalization agreements, like tax treaties, differ from country to country and are usually extremely complex. They generally do not cover unemployment taxes. An individual wishing to take advantage of an agreement must obtain a certificate of coverage to present to the authorities of the country in which he will be temporarily assigned. U.S. individuals going abroad may obtain a certificate of coverage from the Social Security Administration.

Conclusion

While the primary focus on cross-border employment is frequently the income tax problems created, FICA, FUTA and foreign social security taxes cannot be ignored by either employees or employers. Often overlooked, these taxes frequently may represent a substantial cost of doing business.