Author: Lynn Carbo
As the borders between states and countries are opening back up, tax jurisdictions are becoming increasingly savvy as to the movement of talent and are ramping up efforts to collect tax revenue from corporate and individual taxpayers. This means that organizations, now more than ever, need to implement tracking capabilities for their workforce, understand the potential risks in new tax jurisdictions, and set up internal policies and processes to cope with an increase in global movement.
In a recent panel hosted by GTN, Hudson McKenzie, and Smith & Williamson, our presenters weighed in on employer and employee considerations for both inbound and outbound scenarios involving the US and the UK. Topics included immigration, tax, and employee benefits. Here, we provide a recap of the key US tax discussion points, as well as additional insights to provide context for more complex topics.
Inbound Scenarios to the US – Employer Considerations
US payroll may be processed monthly, semi-monthly, weekly, or bi-weekly. and employers have payroll tax withholding and remittance obligations to various jurisdictions. It is important to note that a foreign employer would also be responsible for US withholding for services provided by an employee in the US. A foreign entity would either need to register and comply with the US payroll requirements or could designate an authorized agent to assist.
Income Taxes (Federal, State, Local)
Federal and state withholding forms should be completed to set appropriate withholdings based on the employee’s personal situation (i.e., use of Form W-4 to determine the appropriate withholding, often handled online via HR portal).
- In the US, an employee may want to have taxes withheld per pay period to account for tax due on unearned income.
- In the US, many companies withhold federal tax on bonuses, commissions, and equity at fixed statutory rates of withholding (22% for supplemental wages up to $1 million). For executives with higher levels of salary and supplemental compensation, this 22% withholding rate may not be sufficient to satisfy the actual tax due on the income, leaving a tax balance due when the tax return is completed.
- Review for appropriate state and local jurisdictions for work-in/live-in locations to apply the appropriate tax withholdings.
Social Security (OASDI, Medicare)
If the employee is not covered under a totalization agreement with a certificate of coverage, social security withholdings are applied. Social security is comprised of two components:
- Old-Age, Survivors, and Disability Insurance (OASDI): The rate of tax is 6.2% for the employer and employee, currently capped on wages of $142,800.
- Medicare: The rate of tax is 1.45% for the employer and employee, with no income cap. An additional surtax of 0.9% applies to higher income employees only for income over defined thresholds that are based on the taxpayers filing status (e.g., married couples filing jointly pay the surcharge on income exceeding $250,000, single taxpayers pay on income exceeding $200,000).
Annual Reporting for Compensation and Taxes
Employers must capture all compensation items and report on the annual Form W-2 for each employee. In the year of the move to the US, there may be items, such as relocation items paid by third party vendors, that will need to be processed through payroll. US taxable wages include:
- Salary, bonuses, commissions
- Cash allowances
- Benefits in kind (any non-cash benefit of monetary value that an employer provides to an employee)
- Equity (stock options, restricted stock units, restricted stock)
- This can be especially challenging for mobile employees who were awarded equity before their move to the US. Taxation is subject to US tax on the full compensation element, even if attributable to services before the move to the US (RSU at vest, stock options at exercise). Federal tax withheld may be reduced for UK PAYE on the allocated UK source component.
Employers may process US year-end adjustments for compensation and, if applicable, federal, state, and social security tax gross ups by the December 31 payroll for the current calendar year. If adjustments are identified in the subsequent year, wage corrections can be made with a Form W-2 C, but only social security tax gross ups can be processed via payroll for the change in taxable wages.
If your employees have equity compensation or bonuses that cover multiple years, be aware of the rules for reporting in the year of the move and subsequent years when reporting and withholding for multiple jurisdictions are required.
It is also important to manage the employee experience. If withholdings are too much in one jurisdiction but not enough in another, there can be a significant outlay needed to fund the tax return balance due before the refund is available. This timing mismatch may result in cash flow concerns for the employee. This is especially important when dealing with US and UK scenarios as the different US and UK tax year-ends can result in timing issues in utilizing foreign tax credits to address double taxation.
Inbound Scenarios to the US – Employee Considerations
Taxpayers moving to the US can experience significant tax challenges. Unfortunately, many of those taxpayers find out too late that certain tax planning opportunities are only available prior to establishing residency in the US. The complexity of the US tax system is exacerbated by the multiple levels of US individual taxation: federal, state(s), city/localities, OASDI, Medicare. Please note there are other taxes that could potentially impact an arriving taxpayer to the US, which were beyond the scope of our panel discussion, but are important to be aware of for US tax planning purposes:
- Corporate income tax
- Estate tax
- Gift tax
- Trust taxation
Once an employee joins the US company, they will need to complete Form W-4 to establish the amount of US federal and state (if applicable) withholding that will apply through payroll. Key points to remember:
- If the employee’s full projected income tax liability, including salary and other income (e.g., interest, dividends, capital gains), will not be funded via withholdings, they should plan to make quarterly estimated tax payments.
- Employees should remember to track non-US financial account balances and income earned as it will be required for US tax reporting purposes.
- It is critical to maintain an accurate summary of travel and workdays, especially if the employee has income that relates to employment in multiple tax jurisdictions.
The jurisdiction where income is sourced (where it is earned) typically has the principal right to taxation. So, what happens if the US and UK tax the same piece of income?
- Jane moves to the US (NYC) on October 31, 2020. In March 2021, her 2020 bonus of $1M is paid to her in the US.
- Jane previously worked in the UK.
- Where and how is the bonus taxable?
- $833,333 is UK sourced income (for the ten months—January – October 2020—Jane spent in the UK prior to the US move) and is taxable in the UK.
- Because Jane is a US tax resident on the date of the payment, the $1M is subject to US federal tax with a foreign tax credit available against $833,333 of the income.
- Because Jane is a resident for both New York state and city tax purposes on the date of payment, the $1M bonus is subject to both New York State and City tax.
- No foreign tax credit is available on the New York State and City tax returns. Note that each state has its own rules and regulations pertaining to the allowance of double tax relief for tax paid in foreign jurisdictions.
- Double taxation is occurring. In states where offsetting credits are not applicable, the employee will be subject to double taxation.
- Potential issues surrounding cash flow could arise in both jurisdictions. In this scenario, Jane would have a refund on the US federal tax return in relation to the bonus compensation. However, she will most likely need those funds to pay the associated tax due in the UK during the next fiscal year. If she does not receive a swift refund from the US federal tax return, she may have a large out-of-pocket expense to pay the UK tax, pending her US refund.
The above example illustrates the potential challenges for employees who receive income that was paid while a resident of one or more tax jurisdictions but relating to work performed while a resident or working in other jurisdictions. The challenges are not limited to bonuses but could cover any of the following typical incentive compensations:
- Bonus – typically taxed based on workdays over the earnings period of the bonus.
- RSU – sourced over workdays between the grant and vest dates.
- Stock options – the US typically would source stock options over workdays between the grant and vest dates, but the US-UK treaty would call for sourcing between grant and exercise.
Finally, it is important to note that the US rarely recognizes foreign compensation as being tax effective. For example, UK Enterprise Management Incentives or EMIs allow certain employers to grant share options on a tax-efficient basis to key employees UK purposes. The US would not recognize the same tax treatment, which may result in the reduction or loss of the intended benefit to the employee.
The US Internal Revenue Service (IRS) requires citizens and residents with foreign assets and financial accounts to annually file certain disclosures for such accounts to justify they are not tax evaders. Individuals with non-US holdings, such as ownership in foreign companies, trusts, mutual funds, and rental properties will likely have special filing requirements. It is important to review these investments before a move to the US, so the tax filing obligations are understood, as there are risks of substantial penalties for non-compliance.