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.
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.
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.
Non-US Mutual Funds and Non-US Stock
Non-US mutual funds and non-US stock can create complex filings that can lead to disadvantageous tax consequences. Under US tax law, once you become a US tax resident, non-US mutual funds are generally considered Passive Foreign Investment Companies (PFICs). The PFIC rules are often punitive, with certain distributions taxed at the highest marginal federal tax rate (currently at 37%) regardless of whether your other income is taxed at that same rate. State income tax may also apply. Any sale of these types of investments are reported under the PFIC rules and are not taxed under the qualified capital gains tax rates. Ownership of PFICs may result in considerable administrative work in collecting the appropriate information needed to properly report the funds.
In comparison, direct investments in stock of a foreign entity (with limited ownership percentage) and foreign bonds typically do not fall under the PFIC rules and would be taxable like a US investment. Any investments would need to be reviewed in greater detail to determine the appropriate US tax treatment. These types of complexities and intricacies could apply to any foreign holdings, and for this reason, it is imperative to have professional tax guidance with pre-arrival planning and for the subsequent filings of your US tax returns.
Employees with non-US pensions or retirement accounts may enjoy beneficial tax treatment in their Home countries relative to plan contributions, earnings, and even distributions. It is important however, to not assume the US will provide the same beneficial tax treatment. Fortunately, the US and UK have an income tax treaty, but it is important to review and understand the tax treatment for ongoing participation in or distributions from the plan prior to arrival in the US. For example, the UK provides tax-free treatment for certain “lump-sum” withdrawals as long as the distribution is less than 25% of the total pension pot, with any further withdrawals then being subject to UK tax. The US would not view this partial distribution as a “lump sum” and would seek to tax the distribution, potentially reducing or eliminating the beneficial tax treatment normally provided under UK domestic rules.
Outbound Scenarios to the UK - Employer Considerations
Corporate Tax and Payroll Implications
Make sure corporate tax implications and permanent establishment risks are reviewed as a US employer relocating an employee to the UK.
Will the employee be permanently transferred to UK payroll? A UK Modified PAYE can be set up for non-domiciled employees sent to the UK who are covered under the company’s tax equalization program. The UK modified PAYE allows for reporting on an estimated, rather than real-time, basis which can be particularly helpful for employees who remain on their Home country payroll, facilitate ongoing Home country social security, and company benefits.
From a social security perspective, the US and the UK have entered into a totalization agreement for international social security purposes to address cross-border complexities and to help fill gaps in benefit protection for workers who have split their careers in the US and the UK. Under the agreement:
- US employees sent on temporary assignments to the UK (generally up to five years) should obtain a certificate of coverage to maintain participation in US social security and exemption from UK National Insurance (NIC).
- US employees who are sent to the UK on a permanent or indefinite basis would generally be subject to UK NIC and other deductions.
It is important to remember that US social security is not a voluntary scheme. In addition, US employers may have ongoing obligations to report compensation for employees who depart from the US.
- For non-US citizens, compensation should generally be allocated based on time in the US. Don’t forget to source income that may relate to prior years such as bonuses, commissions, and equity compensation.
- Worldwide income will need to be reported for employees who are US citizens and green card holders. There may be exceptions available that allow for the elimination or reduction of US federal and/or state income tax withholding. Proper documentation should be obtained and retained in case of an audit.
- The IRS has ruled that a foreign employer is responsible for income tax withholding on wages paid for services outside the US to a US citizen and green card holder (though exceptions to withholding can apply).
Outbound Scenarios to the UK - Employee Considerations
A US citizen or green card holder is required to continue to report worldwide compensation and unearned income and file a US tax return even though residing outside of the US. US federal tax relief is available in the form of foreign tax credits and, potentially, a foreign earned income and housing exclusion for qualified taxpayers.
- Employees should plan to make estimated tax payments for income (including non-employment income) that may not have a corresponding foreign tax credit or exclusion.
In addition to US federal tax considerations, outbound employees should review their state tax position upon departure. States have different criteria to determine residency for state tax purposes, with domicile (i.e., permanent home, where someone intends to live or return to), and physical presence tests commonly applied. Examples of complexity in this area include:
- States have become increasingly aggressive in their audits of non-resident taxpayers. Therefore, it is important that the appropriate state tax residency is determined and reported on state tax filings.
- Temporary absences, such as short-term assignments or extended business travels outside of an employee’s resident state, may not allow for a break in state residency, and taxpayers are deemed to maintain state domicile until permanent domicile elsewhere has been established. Some states may not consider a foreign move to meet the change in domicile requirements.
- Exceptions to a domicile test can sometimes apply if certain conditions or tests are met.
- If state residency cannot be broken, consideration should be given to the availability of exclusions or foreign tax credits to address potential double taxation.
US citizens and green card holders are subject to the same onerous reporting as discussed for the inbound to US taxpayers holding non-US investments.
In the end, whether your employee is moving to the US from UK or vice versa, planning is the key to avoiding tax surprises. Be sure to implement tracking capabilities for your workforce, understand the risk potential in all locations you have employees, and set up internal policies and processes to cope with an increase in global movement.
With offices throughout the US and expertise in the UK, GTN is well positioned to support employers and employees with the complexities that arise from a mobile workforce. GTN’s tax experts help clients track and manage the tax risks and compliance requirements related to their entire workforce. Schedule a call with our team to see how we can help.
Author: Lynn Carbo
Lynn is a Director in GTN’s Atlantic region. She has over 20 years of experience in expatriate and individual taxation. In addition to consulting with companies on equity compensation issues, she works with clients and their employees to accomplish a variety of solutions to their global challenges. +1.484.885.2438 | firstname.lastname@example.org