If you have employees working outside the United States who are US citizens or permanent residents (i.e., a green card holder), these individuals will need to continue filing US tax returns to declare all of the income they earn in both the United States and their Host country. This requirement does not change if they are employed or paid from a non-US employer. Additionally, most of the tax rules that apply to taxpayers living in the United States will also apply to US persons operating overseas. The result may be that an overseas employee will be subject to tax in both the US and other jurisdictions.
However, the US income tax owed by US citizens and green card holders working overseas may be significantly reduced, or even eliminated, by taking advantage of the foreign tax credit or foreign earned income exclusions. The foreign tax credit protects US taxpayers earning income overseas from double taxation by allowing a credit for foreign taxes paid on income earned outside the US, up to the amount of US tax that relates to this foreign-sourced income. For example, in simple terms, if a taxpayer paid $30 of foreign tax in the Host Country on $100 of income and the US tax on the income was $20, the US would allow a foreign tax credit of $20. Without the credit, the taxpayer could have been subject to $50 of tax, but with the credit, the individual’s global tax would be $30. Any unused credits ($10 in our example) can be carried back one year or forward ten years to potentially provide additional tax relief.
In addition to the foreign tax credit, US citizens and green card holders may also qualify to claim a foreign earned income and housing exclusion. For 2019, these provisions would allow a qualifying taxpayer to exclude up to $105,900 of foreign earned income and a portion of their foreign housing costs from US taxation. A taxpayer cannot utilize both the exclusion and the foreign tax credit on the same foreign income, but higher income taxpayers may be able to benefit from both the exclusion and foreign tax credit to provide relief from double taxation.
Both exclusions may be claimed on the US income tax return if qualifying tests are met. For example, under a physical presence test, an individual may qualify if he/she is physically present and has a tax home in a foreign country or countries for 330 days in a continuous 12-month period. Taxpayers with a tax home outside the US can also qualify under a second residency-based test.
Understanding the best filing position to mitigate double taxation and the specific requirements to qualify for the exclusions can require professional guidance. A tax advisor can work with the individual to determine the optimal combination of the foreign tax credit and/or exclusions while preparing their income tax returns.
In addition to filing an annual income tax return with the IRS, US citizens and green card holders working outside the US may face other information reporting requirements. Two common examples of these additional obligations relate to the Foreign Account Tax Compliance Act (FATCA) and the Report of Foreign Bank and Financial Accounts (FBAR). There are hefty fines for failing to meet these information reporting requirements.
FATCA requires the disclosure of the overseas taxpayer’s foreign assets exceeding the level specified for their filing status and residency. Additionally, FATCA requires certain overseas financial institutions to report information regarding financial accounts held by US citizens and green card holders directly to the IRS. The reporting obligations of the financial institutions include accounts that are held by entities in which a US taxpayer holds a substantial ownership interest.
An individual with a FATCA filing requirement will file Form 8938 with their US federal tax return. Failure to file a FATCA report may lead to penalties which include a $10,000 penalty for failure to file. The asset holder may face an additional penalty of up to $50,000 for failing to file after receiving notice from the IRS. Finally, there is a 40% penalty on the understatement of tax that may be attributed to undisclosed assets.
The FBAR may be required when a US taxpayer has foreign financial accounts totaling more than US $10,000 at any time during a calendar year. Account holders subject to the reporting requirement must file an annual FBAR (FinCEN Report 114) electronically with the US Department of Treasury. This report is not a part of the US federal tax return. Significant financial penalties and criminal charges can apply for failure to disclose accounts as appropriate.
Another layer of complexity facing US-based mobile employees relocating overseas are issues related to state taxes. Some states may consider mobile employees operating overseas on a temporary basis to remain residents for state income tax purposes. This ongoing tax residency may subject the employee to state taxation on worldwide income, sometimes without the possibility of relief from foreign tax credits or exclusion. In addition, the individual’s employer may continue to have withholding and reporting obligations to the state.
Some states will consider mobile employees to be residents even after they have been working abroad for several years. Failure to comply with the rules of a mobile employee’s Home state may lead to additional assessments, fines, and interest payments. There is no one-size-fits-all solution to the various state tax issues created by the use of mobile employees, and their tax issues must be addressed on a state-by-state / person-by-person basis.
Even if a company which plans to send mobile employees overseas is using a payroll system that is equipped to handle the tax and reporting obligations related to its US workforce, that payroll system may not be equipped to address the added filing obligations and complexities arising from the use of mobile employees. For example, the system may not be able to handle multi-state reporting and withholding for employees who are working in more than one state.
For international workers, professional guidance is usually required to help in navigating the different reporting and withholding rules that can apply for both income and social tax purposes. By obtaining advice in advance, financial, legal, and reputational risks can be appropriately managed, leading to peace of mind for both the employee and your organization.
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.