International Payroll for Compensation of U.S. Expatriates and Impatriates

A U.S. company may face international payroll challenges when it sends U.S. employees to work in a foreign country or if it engages foreign individuals to work in the United States. Some U.S. payroll service providers do not have the capability to address the specific U.S. employment tax and payroll reporting issues that often arise in these situations.

The U.S. requirements that apply typically depend on whether the individual workers are employees or independent contractors. The individual worker’s classification as a U.S. citizen, resident or nonresident also will determine how the compensation is reported. Another critical factor is whether the work is performed within or outside the United States. A U.S. company with U.S. or foreign individual workers in a foreign country also should consider whether the activity will create a taxable presence for the U.S. company in the foreign country.

What are the U.S. employment tax and payroll reporting considerations when a U.S. company sends U.S. employees to work overseas?

If a U.S. company sends a U.S. employee who is a U.S. citizen or resident to work in a foreign country, the employer’s employment tax and payroll reporting obligations implicate a broader scope of rules. Questions often arise regarding whether the U.S. employee will qualify for an exemption from U.S. federal income tax withholding (FITW) on the wages earned while working in the foreign country. This exemption depends on whether the U.S. employee will qualify for the foreign earned income exclusion and/or whether the U.S. employee’s wages will be subject to foreign employment tax and payroll reporting in the foreign country.

The FITW exemption may be limited if based on the U.S. employee’s foreign earned income exclusion, depending on the level of compensation. The U.S. employee must provide the Form 673 to the U.S. employer to claim the FITW exemption based on the foreign earned income exclusion. The FITW exemption does not apply to U.S. Social Security and Medicare withholding. There is generally not an exemption from U.S. FICA and Medicare withholding on a U.S. employee’s wages earned while working for a U.S. employer in a foreign country.

A U.S. Social Security Totalization Agreement in effect with the foreign country will insure that the U.S. employee is not subject to double Social Security withholding in the United States and in the foreign country where the work assignment is located. Another issue is the appropriate taxable wage base for these types of withholding. It is important to keep track of foreign housing, relocation, cost of living differential and other foreign assignment benefits which generally are includible in the U.S. employee’s taxable compensation.

What if the U.S. employer hires a foreign person to work as an employee?

The U.S. employer’s employment tax and payroll reporting requirements will depend on whether the foreign individual employee is a U.S. resident or nonresident and whether the work is performed within or outside the United States.

• If the individual employee is a nonresident and works in the United States, then all of the applicable FITW, FICA and Medicare withholding generally are required. The nonresident employee must provide the Form W-4 to the U.S. employer.
• If the individual employee is a nonresident and works only outside the United States, then FITW, FICA and Medicare withholding are not required.
• If the individual employee holds a U.S. green card or meets the substantial presence test, then all of the applicable FITW, FICA and Medicare withholding generally are required unless the employee will qualify for the foreign earned income exclusion as the basis for the FITW exemption.

What if the U.S. company hires a foreign person to work as an independent contractor?

The United States has a federal nonresident withholding tax regime that applies to compensation paid to a nonresident who works in the United States as an independent contractor. The applicable U.S. federal nonresident withholding tax rate is 30% of the gross compensation, unless there is a reduction under a U.S. tax treaty. The nonresident contractor must provide the Form W-8BEN to the U.S. company. The nonresident contractor must provide the Form 8233 to claim a reduced nonresident withholding tax rate or exemption under a treaty. It is important to keep in mind that a Form 1099 cannot be issued to a nonresident contractor. The Forms 1042 and 1042-S are filed to report a nonresident contractor’s compensation for work performed in the United States.

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