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International social security agreements increase income for overseas employers.

American companies that do business abroad save hundreds of millions of dollars in foreign social security taxes each year under agreements negotiated by the U.S. Social Security Administration (SSA). However, some U.S. employers that could benefit from these agreements are unaware of the substantial savings they offer. Anyone who deals with international compensation and tax matters should have a working knowledge of these agreements.

International social security agreements, often called totalization agreements, have two main purposes. First, they eliminate dual social security taxation, which occurs when a worker from one country is employed in another country and is required to pay social security taxes to both countries on the same earnings. Second, the agreements help fill gaps in benefit protection for the worker who has divided his or her career between the United States and another country.

Although the United States has engaged in this type of international cooperation only since 1978, agreements to coordinate social security protection across national boundaries have been common in Western Europe for decades. By August 1989, the United States had concluded agreements with Belgium, Canada, France, the Federal Republic of Germany, Italy, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom. Agreements with Austria and the Netherlands are expected in 2990 or 1991.



Without some way to coordinate social security coverage and taxes, someone who works outside his native country may find himself covered under the systems of both countries simultaneously. Thus, he pays social security taxes on his earnings to both countries. Dual tax liability can affect U.S. citizens and residents working for American companies, as well as those working for foreign affiliates of American companies. This is likely to be the case when a U.S. company has followed the common practice of entering into an agreement with the Treasury Department (under Internal Revenue Code section 3121(l) to provide social security coverage for U.S. citizens and residents employed by the affiliate. In addition, U.S. citizens and residents who are self-employed outside the United States usually are subject to dual social security tax liability because they remain covered under the U.S. program even though they maintain no business operations in this country.

Paying dual social security contributions is particularly costly for companies that offer tax equalization arrangements for their expatriate employees. In this type of arrangement, a company that sends an employee to work in another country guarantees the assignment will not result in a reduction of the employee's aftertax income. The employer usually accomplishes this by paying both the employer and employee share of the host country social security taxes for transferred employees. Since the tax laws of many countries provide that an employer's payment of an employee's share of a social security contribution is taxable compensation to the employee, the employee's social security and income tax liability is thereby increased. So, the employer also must pay additional social security and income tax, which in turn further increases the employee's taxable income and tax liability.

Thus, the employee's foreign social security coverage results in a substantially greater tax burden for the employer than the social security tax alone. Depending on the second country's tax rates, this pyramid effect has been known to increase an employer's foreign social security costs in some countries to as much as 65% to 70% of the employee's salary.



All U.S. totalization agreements attempt to eliminate dual social security coverage and taxation while maintaining the coverage of as many workers as possible under the system of the country where they are likely to have the greatest attachment. Each agreement seeks to achieve this goal through a set of objective rules. Workers or employers may not elect the system to which they wish to contribute. The authority for social security taxes exemptions provided by agreements is contained in IRC sections 1401(d), 3101(c) and 3111(c).

The territorial rule. The provisions that eliminate dual coverage for employed persons are similar in all U.S. agreements. Each one establishes a basic rule that looks to the location of a worker's employment. Under this basic territorial rule, an employee who otherwise would be covered by both the U.S. and a foreign system remains subject exclusively to the social security coverage laws of the country in which he is working.

Detached-worker rule. Most agreements include a territorial rule exception, so that a person temporarily transferred to work for the same employer in another country remains covered only by the country from which he has been sent. The detached-worker rule in U.S. agreements generally applies to employees whose assignments in the host country are expected to last five years or less.

The detached-worker rule can apply whether the U.S. employer transfers an employee to work in a branch office in a foreign country or in one of its foreign affiliates. However, for U.S. coverage to continue when a transferred employee works for a foreign affiliate, the U.S. employer must have entered into a section 3121(1) agreement with the Treasury Department with respect to the foreign affiliate. The rule also can apply when the transfer from the United States is through a third country, instead of directly to the second country.

Self-employment rule. Most U.S. agreements eliminate dual coverage of self-employed workers by assigning coverage to the worker's country of residence. Although some agreements do not use the residence rule as the primary determinant of self-employment coverage, each of them includes a provision to ensure workers are covered and taxed in only one country. You can obtain more details on any of these agreements by writing to the SSA at the address on page 114.

Special exceptions. Each agreement includes a provision that permits authorities in either country to grant exceptions to the normal rules if both sides agree. However, the exception provision is invoked infrequently and only in compelling cases. It is not intended to give workers or employers the freedom to elect coverage routinely that is in conflict with normal agreement rules.



Workers who are exempt from U.S. or foreign social security taxes under an agreement must document their exemption by obtaining a certificate of coverage from the country that will continue to cover them. During 1988-89, the SSA issued an annual average of about 8,000 certificates for U.S. workers on temporary assignment abroad. It is estimated that American employers and their U.S.-based employees abroad are saving about $200 million annually in foreign social security contributions. By contrast, the 11 existing agreements have made it possible for foreign-based workers and employers to save an estimated $60 million a year in U.S. contributions.

When a foreign country certifies that an employee is covered by its system, the employer can stop withholding and paying U.S. social security (FICA) taxes on the employee's earnings. The certificate should be kept in the employer's files in case the Internal Revenue Service questions why no FICA taxes are being paid for the employee. A self-employed U.S. citizen or resident must attach a photocopy of the foreign certificate to his U.S. tax return each year, as proof of his exemption from self-employment taxes.

Employers generally are required to request certificates on behalf of employees they have transferred abroad; self-employed persons must request their own certificates. Certificates of U.S. coverage may be obtained by writing the Social Security Administration, Office of International Policy, P.O. Box 17741, Baltimore, Maryland 21235. Pamphlets about particular agreements listing the information that must be furnished to obtain a certificate also can be obtained from this address.

Because totalization agreements eliminate the possibility of dual social security tax liability, U.S. law provides that an individual may not take an income tax deduction or credit for social security taxes paid to a foreign country with which an agreement is in force. This prohibition can be found in section 317(b)(4) of PL95-216 of the Social Security Amendments of 1977, shown as a note to 26 USC 1401--IRC section 1401.



The agreements also help assure continuity of benefit protection for workers who have divided their careers between the United States and a foreign country. Persons who accrue social security work credits in two countries sometimes fail to qualify for benefits from either country because they have not worked long enough or recently enough to meet minimum eligibility requirements. Under an agreement, such workers may qualify for partial U.S. or foreign benefits based on combined, or "totalized," coverage credits from both countries.



International social security agreements favorably affect the profitability and competitive position of U.S. companies with foreign operations by reducing their cost of doing business abroad. American companies with personnel stationed abroad are encouraged to take advantage of these agreements to reduce their foreign tax burden.

For more information about the United States social security totalization agreements program--including details about specific agreements that are in force--write to the SSA at the address shown on page 114. Also write to that address if you would like to suggest the negotiation of new agreements with specific countries. In developing its negotiating plans, the SSA gives considerable weight to the interest of workers and employers who will be affected by potential agreements.
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Author:Powell, Barry L.
Publication:Journal of Accountancy
Date:Jul 1, 1990
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