As we approach the end of another year, it is time again to reflect on the past 12 months and take steps to prepare for a successful 2020. If your company has tax equalized assignees, you may have noticed employees with surprise tax bills, uncollected tax equalization settlements, or confusion on how their tax liabilities were calculated. If so, now is the time to revisit the hypothetical tax positions for your assignees, to allow for improved results in the upcoming year.
In this month’s newsletter, we provide answers to the most common questions relating to hypothetical tax and provide recommendations on what you can do now and over the coming months to ensure that your mobility program will truly have a happy and successful New Year.
What is a hypothetical tax calculation and how is it calculated?
In general, employees subject to tax equalization are responsible for contributing income and social tax based on the location they worked in prior to the initiation of the assignment and on income that they would have been eligible to receive without regard to any assignment-related compensation. For example, consider the following scenario:
- Jane Expat lives and works as an employee in California
- Her US income includes base salary and bonus
- She takes a tax equalized assignment to Canada
- During the assignment, she receives base salary, a bonus, and various allowances (e.g., housing, cost of living)
- During the assignment, Jane will need to file US federal and Canadian income tax returns to consider her full assignment compensation package. She may need to file a California state tax return, unless certain criteria are met. She will also continue to be subject to US social security taxation based on her full compensation package.
Under most tax equalization policies, Jane would be held responsible for US federal income tax, California income tax, and US social security tax as if she were still working in California (referred to as her “stay-at-home” tax liability). She would only be held accountable for these taxes as calculated on her base salary and bonus income. The employer would cover the actual global tax liabilities on her worldwide income in excess of Jane’s contribution for tax purposes (i.e., her “hypothetical tax”).
From an IRS perspective, hypothetical tax is considered a reduction to base salary. For this reason, it helps to reduce the overall tax cost for the employer. For the employee, hypothetical tax is akin to the actual payroll withholding that the employee experienced prior to their assignment. They are given credit for this withholding when their hypothetical tax liability is trued-up through an annual tax equalization calculation.
Read more of GTN December News Letter