An Introduction to the U.S. Tax System for International Employers

With the increasing volume of international assignments, it is essential that employers understand the various tax systems, obligations, and costs involved when sending an employee on an assignment to a different country.

U.S. tax implications for international employees

In this blog, I want to focus on the U.S. and will provide a summary of the US tax system from the international worker’s perspective. There are 2 main income tax obligations that are triggered with each international assignment:

• Employer tax reporting
• Employee tax reporting.

In general, an employee receiving compensation for services performed in the U.S. must file a U.S. tax return and pay U.S. tax unless an exception applies. This tax liability is determined primarily by the individual residency status for tax purposes. For U.S. federal income taxes an individual can be

• Resident Alien,
• Non-resident Alien, or
• Dual Resident in the same tax year.

Resident Alien for Tax Purposes

An individual who is a U.S. citizen or a foreign national who meets either the “green card” or “substantial presence” test is considered a resident alien for income tax purposes.

Green Card Test

Per the IRS, an individual is considered a lawful permanent resident of the United States, at any time, if they have been given the privilege, according to the immigration laws, of residing permanently in the U.S. as an immigrant. An individual would have this status if the U.S. Citizenship and Immigration Services (USCIS) issued them a Permanent Resident Card, Form I-551, also known as a “green card.”

Substantial Presence Test

An individual is considered a U.S. resident for tax purposes if they meet the substantial presence test for the calendar year. To meet this test, the individual must be physically present in the U.S. on at least:

• 31 days during the current year, and
• 183 days during the 3-year period that includes the current year and the 2 years immediately before that, counting:
• All the days the taxpayer was present in the current year, and
• 1/3 of the days the taxpayer was present in the first year before the current year, and
• 1/6 of the days the taxpayer was present in the second year before the current year.

Exempt Individual

Specific individuals are exempt from counting their U.S. presence days. The term “exempt individual” does not refer to someone exempt from U.S. tax but to those exempt from counting the days of presence in the U.S. for purposes of the substantial presence test. For instance, a J-1 professor or researcher who is complying with the visa requirements does not count days for the first 2 calendar years. Also, an F-1 or J-1 student, who is complying with the requirements of their visa, does not count days for the first 5 calendar years.

In general, resident aliens for income tax purposes must file Federal form 1040, U.S. Individual Income Tax Return, by April 15 of the following year and report their worldwide income.

U.S. Resident aliens for income tax purposes are generally taxed on their worldwide income regardless of where the income is derived – IRC Sec §1.61. This includes all compensation irrespective of where or for whom the services are performed or whether the compensation consists of cash, property, or services received – IRC § 61(a)(1).

FBAR and Form 8939 Requirements

In addition, U.S. resident aliens for income tax purposes are required to report certain foreign financial accounts, such as bank accounts, brokerage accounts, and mutual funds, to the Treasury Department and keep certain records of those accounts.

Foreign Bank and Financial Accounts (FBAR) – FinCEN Form 114

Per the IRS, a U.S. person, including a citizen, resident, corporation, partnership, limited liability company, trust, and estate, must file an FBAR to report a financial interest in or signature or other authority over at least 1 financial account located outside the United States if the aggregate value of those foreign financial accounts exceeded $10,000 at any time during the calendar year reported.

Form 8938, Statement of Specified Foreign Financial Assets

Form 8938 is used to report specified foreign financial assets if the total value of all the specified foreign financial assets in which an individual has an interest is more than the appropriate reporting threshold. There are different reporting thresholds for taxpayers living in the U.S. versus those living outside the U.S.

For instance, if you live in the U.S., are married, and you and your spouse file a joint income tax return, you satisfy the reporting threshold only if the total value of your specified foreign financial assets is more than $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year.

However, if you live outside the U.S., are married, and you and your spouse file a joint income tax return, you satisfy the reporting threshold only if the total value of your specified foreign financial assets is more than $400,000 on the last day of the tax year or more than $600,000 at any time during the tax year.

Non-resident Alien for Income Tax Purposes

An individual who is not a U.S. citizen and who does not meet the “green card”, or the “substantial presence” tests is considered a non-resident alien for income tax purposes.

In general, a non-resident alien for income tax purposes must file Federal form 1040-NR, U.S. Nonresident Alien Income Tax Return, by April 15 of the following year and report their U.S. Source Income.

U.S. non-resident aliens for income tax purposes are generally subject to U.S. tax on income from U.S. sources – IRC Section § 872.

Non-resident aliens are exempt from filing Foreign Bank and Financial Accounts (FBAR), FinCEN Form 114 and Form 8938, Statement of Specified Foreign Financial Assets.

U.S. Source Income

In general, all wages and compensation for services performed in the U.S. are considered to be U.S sourced. The place where the personal services are performed generally determines the source of the personal service income, regardless of where the contract was made, or the place of payment, or the residence of the payer.

Please read IRS Publication 515, Withholding of Tax on Non-resident Aliens and Foreign Entities, and Publication 519, U.S. Tax Guide for Aliens, for more information and examples.

Dual Resident Status for Tax Purposes

An individual is a Dual Status resident for income tax purposes if they are both a U.S. resident alien and a non-resident alien in the same tax year. This is most common for the arrival and departure years.

Individuals who are considered Dual Status resident aliens for income tax purposes must file both, Federal form 1040, U.S. Individual Income Tax Return, and Federal form 1040-NR U.S. Nonresident Alien Income Tax Return. If the dual-status alien is a U.S. resident at the end of the tax year, they must file a 1040, U.S. Individual Income Tax Return with a 1040-NR, U.S. Nonresident Alien Income Tax Return as an attachment. If the dual-status alien is a non-resident at the end of the tax year, they must file a 1040-NR with a 1040 as an attachment.

In general, an individual with a dual status is subject to tax on worldwide income for the period of residence, but only on U.S. source income for the period of non-residence. Treas. Reg. § 1.871-13(a)(1).

State Residency

State residency and filing requirements are determined separately from federal residency. In other words, an individual can be a U.S. resident alien for income tax purposes on a federal level and a non-resident alien for income tax purposes on a state level.

Some states follow the federal government rules when determining an alien residency for tax purposes, and some have their own rules. It’s imperative to review the state rules and regulations when determining your employee’s state residency.

Treaty Tax Positions

The U.S. has double tax treaties with several countries. Under these treaties, residents of foreign countries may be eligible to be taxed at a reduced rate or exempt from U.S. income taxes on certain items of income they receive from sources within the U.S.

Tax treaties generally reduce the U.S. taxes of residents of foreign countries as determined under the applicable treaties. They generally do not reduce the U.S. taxes of U.S. citizens or U.S. treaty residents. U.S. citizens and U.S. treaty residents are subject to U.S. income tax on their worldwide income. It’s important to note that some states honor the provisions of U.S. tax treaties and some states do not.

Tax treaties need to be carefully reviewed to optimize the tax savings for your assignees. Form 8833, Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b), is used to make a treaty-based return position disclosure when filing a tax return.