3 Approaches to Accounting for the Tax Costs of an International Assignment

One of the most unpleasant surprises a global mobility manager may encounter is receiving an unexpected request to pay a large tax payment on behalf of a tax equalized assignee. With the right tax accrual process in place, you can avoid those unpleasant tax payment surprises.

Anticipating the Unexpected

Implementing a plan to properly account for tax payments for assignees can be challenging due to the following factors.

First, tax payments are typically more unpredictable to track than any other kind of assignment benefit (e.g., housing, car rental, home leave). 

Unlike other assignment benefits, the payment of taxes for an assignee often takes place at a later date than when the liability arose. Sometimes, the tax bills even arise after the employee completes the assignment or leaves the company. 

Second, determining the amount of tax costs for an international assignment requires extensive calculations and it is almost impossible to calculate the amount precisely in advance. For example, even if the exact liability is known in advance, the exchange rate can change based on the actual tax payment date.

Finally, the actual payment of taxes for an assignee often occurs in multiple locations using different systems across the globe. For example, an employee could have hypothetical tax deducted from Home country payroll, with Host country tax paid via a shadow payroll in the Host location. Accordingly, it can be a challenge to have all tax payments flow to a single place for analysis.

Combined, these factors can make it difficult to develop an accurate accrual process, but the benefit of avoiding “surprise” requests for tax payments can make the effort worthwhile.

The Tax Cost Options Available to Companies

There are three primary approaches companies can use to account for the tax liabilities associated with their mobility programs. Each approach can produce very different results.

• Full cash method
• Partial tax accrual method
• Full tax accrual method

Under the full cash method, income and expenses are recorded when cash is received or paid out. It is a simple system and, typically, the “default” approach for companies lacking an accrual process. However, it is not likely to be an effective one for accurately anticipating annual costs when there are mismatches in tax years or the timing of tax payments.

With the partial tax accrual method, the amounts collected from the employee via hypothetical withholding are reserved to help pay for some of the final tax costs. The possibility for surprise tax payments remains with this option, but the surprises tend to be less disruptive than under the cash method.

The third approach, the full tax accrual method, involves regularly recording tax liabilities as an expense during the assignment, regardless of when the tax payments are paid or received. Typically, this approach will require the preparation of a tax cost projection, and then the anticipated tax costs are recorded as an expense in a “tax accrual” account. Additionally, it is critical that all types of tax payments (including tax gross-ups, hypothetical withholding, tax equalization payments, etc.) are recorded to the same tax accrual account.

Though each method will ultimately record the same amount of net tax expense, it will happen at different times and in different tax years, depending on the countries involved. For instance, in the case of an employee who traveled in 2019, not accounting for the associated expense until the taxes are due in 2021 could result in significant budgeting issues, which the example below illustrates.

Example of the Effects of Each Tax Accrual Method

Given the basic fact pattern below, we can show the impact of the methods:

• Employee goes on a short-term assignment within calendar year 2019.
• Total actual worldwide taxes during the assignment are projected to be $100,000 (based on the tax cost projection prepared at the time the engagement began).
• Total hypothetical taxes during the assignment are projected at $40,000 (based on the initial tax cost projection). From an assignee's standpoint, the hypothetical tax is similar to a withholding tax; however, usually, it is not paid to federal or state taxing authorities. It approximates the assignee's tax burden at home. For payroll and accounting purposes, it is a reduction to salary and netted against actual tax payments made by the company in determining the total tax costs of an assignment.
• Projected tax cost to the company is expected to be $60,000 (actual taxes of $100,000 less hypothetical taxes of $40,000).
• Final tax costs are determined to be $110,000 in actual taxes and $40,000 for hypothetical taxes, so the final net tax cost is $70,000.
• The hypothetical tax of $40,000 is withheld during the assignment period in 2019.
• Tax liability of $110,000 is paid in 2021.

Comparison of accounting for tax costs:

As can be seen, the full cash method resulted in a potentially large, unexpected result in year three, while the full tax accrual method minimized the final year adjustment.

What to Consider When Choosing an Accounting Method

Ultimately, the accounting method your company selects to budget for the tax costs of international employees on assignment should be based on three critical considerations:

• The number and location of your assignees
• The bandwidth of your accounting and finance teams
• The materiality and importance of budgeting for each of the associated business units 

By understanding how each of these factors impacts your ability to budget, you will have an easier time choosing the accounting method that best aligns with your objectives.

To Improve Accuracy, Consider Turning to an Expert

With so much riding on accurately anticipating the tax costs for your international assignees, consider discussing your situation with a mobility tax expert. These specialists can offer guidance on implementing the best planning practices along with the most appropriate processes for you to use to accurately project and time tax payments across your entire program.

The information provided in this article is for general guidance only and should not be utilized in lieu of obtaining professional tax and/or legal advice.