Foreign Assignments & US Expat Taxes
International employees are becoming much more common as businesses expand internationally; and it’s vital for US business owners to be familiar with the many US expat tax liabilities which may arise for both the employer and the employee. The cost of sending an employee abroad to complete an international assignment can add up quickly. With detailed plans and advice from a tax professional in place, however, some of the high costs of foreign assignments can be eliminated or greatly reduced.
The employer is not the only entity which needs to be well-versed on every aspect of US expat taxes; it should also educate its employees fully before asking them to accept a foreign assignment. Let’s examine the most important aspects of international operations in regard to US expat taxes.
FEIE (Foreign Earned Income Exclusion)
The FEIE is an option available to your employees which would allow them to exclude a specific amount (up to $92,900 in 2011) of their earned income from their US expat tax liability. In order for this to take place the employer must assign the employee to an area which is classified as a “tax home” overseas for a time period of at least one year.
It’s important to remember, also, that just because an international employee qualifies for FEIE they are not automatically going to receive it; they need to file Form 2555 with their US expat taxes in order to receive exclusion. Aside from the need to be placed in a tax home, an employee on a foreign assignment must also meet at least one of the following conditions:
- Physical Presence The employees international assignment must require their his/her presence in assigned country for a minimum of 330 days out of 365, which can be any time before the deadline filing date of US expat taxes.
- Bona Fide Residence The employee’s foreign assignment is set to last for an indefinite period of time which exceeds one full year abroad.
Foreign Housing Exclusion and Deduction
A qualification for FEIE is a default qualification to claim deductions for foreign housing costs. If the employer is covering the cost of foreign housing for an employee or employees, this housing exclusion amount will be claimed on Form 2555. If the employee is responsible for his/her own housing out of regular payroll, he/she can deduct the amount from Form 1040. The deductible amount is different in each host country, and specific allowable deductions and amounts can be found on Form 2555 Instructions. Generally deductible items include: Furnishings, insurance on property, rent, repairs, residential parking fees, and utilities excluding phone.
There are cases in which a US employer will compensate an international employee for living expenses. In this situation these reimbursements are viewed as taxable income to the employee, but the amount can still be claimed as a deduction on the employee’s US expat taxes. If the reimbursement amount from the employer exceeds the allowable amount by the hosting country the employee’s expat tax liability will be increased.
Foreign Tax Credit
Depending on the country hosting the international employee, there may be foreign taxes due in that country. In this situation a US taxpayer can use this amount to earn a foreign tax credit on US expat taxes, which will reduce their US expat tax liability by the dollar amount equal to that of their liability to the host country. An employee can only claim foreign tax credit if the income has not already been deducted by foreign housing exclusion or FEIE.
If the international employee does not qualify for FEIE the employer must withhold payroll taxes. If the employee does qualify for FEIE, an exemption request must be submitted on Form 673 to the employer.
Benefits to Employee by Employer
Personal expense reimbursements to an international employee by a stateside employer will be viewed as taxable income by the IRS. Among these reimbursements are:
- Moving expenses
- Continued education
- Spouse allowance
- Automobile reimbursements
- Family/Home medical leave
Business related expenses are a different story, however; any businesses expenses for which the employee is compensated will not affect taxable income. Even moving expenses are deductible if they meet the following qualifications:
- The relocation must be relevant to the job – either starting a new job or performing the same job in a new location.
- The job’s new location must be more than 50 miles from the employee’s previous location.
- The employee must retain employment for a minimum of 39 weeks after moving.
The aforementioned qualifications are very specific and only include the actual cost of moving and/or storing household goods. Temporary living arrangements, meals, and travel seeking a new home are not included in deductible reimbursements and will be viewed as taxable income. Any non-reimbursable employer compensation amounts must be included on the employee’s W-2 to be reported on US expat taxes.
Many employers are attracted to the equalization program which would ensure foreign employees that their tax liability would not be any different than if they had continued working in the states. Through an equalization package expenses of both the employee and employer are minimized. The tax equalization program considers employee benefits such as cost of living, housing, travel, and school tuitions. It also takes into account the amount of foreign tax due and other taxable factors of the overseas assignment. Through the equalization package an employer agrees to reimburse its employee for excessive US expat tax liability.
Every host country has unique tax laws and rates and is governed by a different treaty with the US. For example, some countries hosting US employees will result in hefty corporate tax liability. If you are a United States based company who is making use of international employees, you may want to seek advice from a well-informed tax professional that has experience dealing with the tax laws and regulations of each hosting country.
There are numerous facets of working overseas as a United States citizen, and they all should be considered before an agreement is established between the stateside employer and the employee being considered for a foreign assignment. You may be wise to seek advice not only from a professional in the United States, but also from a tax professional from the country to which you intend to send employees.
I.J. Zemelman, EA is the founder of Taxes for Expats