Updated February 2021
Given the complexity of the U.S. tax code and the myriad of regulations related to ERISA plans, managing benefits for domestic employees is a complicated undertaking. But managing benefits for the employees your U.S. company sends to work overseas—known as expatriates, or expats—adds several layers of complexity.
Even with the halt of global travel during the COVID-19 pandemic, globalization continues to be a defining characteristic of the economy. Many U.S. companies continue to find opportunities to grow abroad. But before their employees ever step on foreign soil, employers need to learn about the various taxes other governments may impose on benefits and compensation, and think through the various questions that go into developing a sound policy for managing benefits for expatriate employees. Employers also need to help their employees understand what the foreign assignment means to them personally with respect to taxes and benefits.
Understand the Basics of Expatriate Taxation
For purposes of this article, an expatriate is a U.S. citizen or green card holder who is sent by their U.S. employer to work at a branch or other linked organization in a foreign country. Assignment duration may vary anywhere from six months to several years. Employees must obtain a work visa, and—depending upon the host country—may be eligible for certain benefits offered by that country while working abroad.
U.S. citizens, green card holders, and their employers should understand that expatriates will still have an income tax return filing obligation and potential tax liability at home, regardless of where they work globally. The United States is unusual in this regard with respect to taxing their citizens and permanent residents (green card holders) who are living and working abroad; many foreign governments allow their citizens to fall under the host country’s tax code when working abroad with home country taxation often suspended until the individual returns.
The United States’ unusual approach, however, doesn’t mean that U.S. expatriates will always face double taxation. The U.S. tax code looks to offset this, at least partially, by allowing certain foreign tax credits and / or the foreign earned income exclusion. Employers take these credits, the foreign earned income exclusion, and the foreign country’s tax policies into consideration when developing the compensation package for the employee.
In addition to understanding how the U.S. will tax the expatriate’s foreign compensation and benefits, employers need to understand how the host country will tax this income. Almost every country requires some kind of tax to be paid by foreign workers. While taxation of salary and bonuses may be relatively straightforward, things can get quite complicated when it comes to how benefits—such as retirement matching contributions or profit sharing—are taxed.
Consider Your Options for Making Expatriates Whole
Employers should be familiar with the foreign countries’ tax laws and be aware of each applicable country’s nuances so a fair, balanced and competitive compensation package is developed. The good news is that employers have flexibility in navigating these issues and developing their policies.
The first option is to do nothing. Sometimes, in this scenario, the expatriate is responsible for the taxes and other costs incurred while working in the host country. A more common strategy is to equalize the tax burden on the employee. This is a tax-neutral policy, often referred to as tax equalization, where the employee is no worse or better off while working abroad. In this case, the goal of the compensation package is to keep employees whole—which means maintaining roughly the same financial standards they would have experienced at home.
Beware Double Taxation of Retirement Benefits
Expatriates are allowed to participate in U.S.-based retirement plans while working abroad. They can contribute pre-tax dollars to their traditional 401(k) plans, and employers can offer a match to the employee deferral. Unfortunately, many foreign countries consider the deferral to be taxable income.
What’s more, the employer contribution may be considered regular income subject to foreign taxes. In this case, the employee is double taxed: first by the host country for the “income” sent to the retirement plan, and then by the United States when it’s time for the participant to withdraw assets. Double taxation may also happen in a Roth situation, where participants pay taxes up front when making the deferral.
In these situations, employers will need to decide whether expatriates should be excluded from the plan and possibly compensated outside of the benefit to avoid the double taxation—or utilize a tax equalization policy where the expatriate is made whole. The latter approach would be in keeping with the U.S. system, in which qualified retirement plan contributions are only taxed once when the employee takes a distribution from the plan at or after retirement.
BDO Insight:
Take a “No Surprises” Approach to Your Expatriate Benefit Policy
The goal of any expatriate compensation package should be to ensure that neither the employee nor the company encounter any surprises. To achieve this, employers need to think through many issues well before sending an employee abroad.
The first issue is to decide whether or how to make employees whole. After that major issue is resolved, employers need to focus on finer points such as evaluating foreign tax policies, reviewing plan documents to determine eligibility and analyzing foreign tax credit structures to maximize value.
It’s also important to have strong communication strategies and resources for employees. A solid two-way communication plan aids expatriates in clearly understanding what they will be receiving and responsible for and offering them access to experts who can help them feel that they are not alone in navigating complex tax structures in host countries.
So while companies may have slowed down the expatriation of their employees, it is important that they keep track of those who continue to be on assignment or have been “displaced” in a remote working situation or home location that was not originally intended. There could be unintended state and country withholding obligations that may now apply. Many companies are also currently looking to include “remote worker” language in their travel and assignment policies to help mitigate these type of compliance surprises.
