1. APA Section 14: Payroll for U.S. Employees Abroad and Aliens in the U.S. Beata Meyers Cheresa Stoll Deloitte Tax LLP March 19, 2016

2. Today’s overview Session Agenda Expatriates: US Citizens or Resident Aliens Working Abroad −Expatriate Payroll −Tax Equalization and Tax Protection −U.S. Foreign Earned Income Exclusion/Credits −Income Tax Treaty Agreements −U.S. Reporting and Withholding Requirements: Federal, State, Social Security and Medicare −Earnings Adjustments and Tax Gross-Up/Tax Gross-Down Deloitte Tax LLP © 20162

3. Today’s overview Session Agenda Inpatriates: Residents or Non-Resident Aliens Working in the U.S. −Tax Equalization and Tax Protection −U.S. Resident/Nonresident Alien Status −Visas −Payroll Documentation and U.S. Reporting/Withholding −U.S. Resident Aliens −U.S. Nonresident Aliens −Earnings Adjustments and Shadow Payroll U.S. Social Security / Totalization Agreements Deloitte Tax LLP © 20163

4. Expatriates 4

5. Reporting Rules Expatriate Payroll Rules regarding U.S. compensation reporting and tax withholding for U.S. citizens, permanent residents and employees working outside of the U.S. are more complex and require coordination among various departments within an organization. U.S. companies who employ U.S. citizens or permanent residents abroad must report their compensation on a U.S. Form W-2. U.S. companies sending employees to work abroad may have an international assignment policy in place to ensure that the employee receives total compensation that will provide for a standard of living comparable to what he/she would have had if he/she remained living and working in the U.S. This policy may provide for regularly paid allowances and/or reimbursements for the cost of various benefits to ensure that the employees do not suffer or benefit financially in comparison to his/her U.S. counterparts. Depending on the reason or need for the assignment, additional incentives may also be included in an individual’s assignment package. Deloitte Tax LLP © 20165

6. Allowances / Reimbursements Expatriate Payroll Examples of allowances and reimbursements include: −Host country housing and utilities allowance/differential −Goods and services differential (also referred to as a cost of living allowance) −Auto allowance or lease payments −Education allowance or reimbursement for children’s education expenses −Transportation expenses to/from the host location −Shipment and/or storage of household goods −Periodic home leave travel expenses −Location/hardship premiums −International assignment premiums −Host country taxes −Professional fees (i.e., tax preparation services) Deloitte Tax LLP © 20166

7. Sources of Payment Expatriate Payroll How are these allowances/reimbursements paid? Assignment related allowances/reimbursements may be paid from various sources: Additional payroll codes or “buckets” may be necessary to deliver allowances or reimbursements via payroll. Deloitte Tax LLP © 20167 Home Country PayrollHost Country Payroll TreasuryAccounts Payable (Home) Third-party VendorsAccounts Payable (Host) Imputed Income

8. Allowances / Reimbursements Expatriate Payroll Why is it necessary to know about these payments? Any allowances or reimbursements that an expatriate receives (either in cash or in kind) from his/her employer may be considered compensatory and/or taxable in the U.S. −This would not apply to most items of compensation received by individuals on temporary or short-term international assignments (i.e., assignments under 12 months) These allowances and/or reimbursements may need to be added to the employee’s total compensation and reported on a Form W-2. Assignment related allowances and/or reimbursements included in compensation often result in Form W-2 wages of 2-3 times the employee’s pre-assignment reportable wages. The additional compensation often triggers additional tax obligations. In most cases, the incremental tax obligations are borne by the employer. Deloitte Tax LLP © 20168

9. Tax Equalization / Tax Protection Expatriate Payroll Many employers follow a policy of Tax Equalization Tax Equalization is designed to ensure that the tax impact to an employee of taking an international assignment is neutral – the employee will pay no more or no less tax than they would have if they had remained in their home country. Some employers follow a policy of Tax Protection Tax protection is designed to ensure that the employee pays no more tax than they would had they remained in their home country; however, if the actual tax liability is less than what the employee would have paid had he/she remained in their home country, the employee retains the benefit. Deloitte Tax LLP © 20169

10. Hypothetical Income Tax Withholding Expatriate Payroll Hypothetical tax represents the home country tax that the employee would have been responsible for on “stay at home income” had he/she not taken the assignment. Hypothetical tax is typically withheld from the employee in lieu of actual taxes paid to the IRS In addition to hypothetical federal tax, the employer may take a hypothetical state tax depending on the terms of the international assignment and tax reimbursement policies. Hypothetical tax is treated as a REDUCTION to earnings and reduces the federal, state and Social Security/Medicare wages reported on an employee’s Form W-2. Deloitte Tax LLP © 201610

11. Foreign Earned Income Exclusion Expatriate Payroll Expatriates may qualify for exclusions to taxable income and tax credits which will reduce the actual tax liability on their U.S. income tax return. To the extent it is believed that the employee will qualify for these reductions and credits, U.S. federal income tax withholding obligations can be reduced Exclusions Foreign Earned Income Exclusion ($100,800 for 2015) – Form 2555 −Bonafide Resident (tax home outside the US for an entire calendar year) −Physical Presence Test (physically present outside the US for 330 days in a 365 day period) Housing Exclusion −Qualified non-US housing expenses above $16,128 for 2015, to a maximum $30,240 −May be higher in specific locations as deemed by the IRS −Expenses like personal telephone, cable, domestic labor are not included Deloitte Tax LLP © 201611

12. Sources of Earned Income Expatriate Payroll Source of earned income is determined by where the employee performed the services that produced the income. The following formula is used to determine the portion allocable to the U.S.: Number of days worked in the US X Total income = U.S. Earned Income Total number of days worked Example Jane, a U.S. citizen, is a bona fide resident of Canada. Jane’s total income is $100,000 and she worked for a total of 240 days after subtracting vacation time. She worked 40 days in the U.S. during the year. What is Jane’s U.S. earned income? 40 days worked in the U.S.X $100,000 = U.S. earned income of $16,666.67 240 total days worked Jane’s foreign earned income = $100,000 - $16,666.67 = $83,333.33 Deloitte Tax LLP © 201612

13. Foreign Housing Exclusion Expatriate Payroll Example: Jane, a U.S. citizen, qualifies for the foreign earned income exclusion for 2015 under the physical presence test During the 2015, year she earned a salary of $75,000 and was present and working in the foreign country for 335 out of 365 days Jane spent $15,000 on reasonable foreign housing expenses What is Jane’s base housing amount for 2015 ? −Annual base housing amount for 2015 = $16,128 −Prorated base housing amount for foreign days in 2015 = $16,128 * (335/365) = $14,802 What is Jane’s foreign housing cost exclusion for 2015 ? −Reasonable housing expenses – Base housing amount = Foreign housing cost exclusion −$15,000 - $14,802 = $198 Deloitte Tax LLP © 201613

14. Foreign Tax Credit Expatriate Payroll Credits −Foreign Tax Credits can be taken if income taxes are paid in a host location −Reported on Form 1116 −Other Normal Credits (i.e., childcare credit, AMT, etc.) Should have Form W-4 updated to document expected Foreign Tax Credits Deloitte Tax LLP © 201614

15. Income tax treaty benefits may include: Credits and deductions to reduce taxes imposed by the foreign country (i.e., to avoid double taxation) Nondiscrimination clauses allowing resident aliens (Green Card holders) to qualify for the foreign earned income and housing cost exclusions under the bona fide residence or physical presence test Partial or total exemption from taxation by the foreign country for an employee’s wages for personal services performed in the treaty country Wages received by a U.S. teacher or professor in a treaty country are exempt from foreign taxes under most treaties for up to 2-3 years Amounts received by U.S. residents for study, research, or business and technical training are generally exempt from foreign taxes Expatriates Income Tax Treaties Deloitte Tax LLP © 201615

16. If the individual is… Subject to mandatory withholding in foreign country => automatically exempt, no documentation required. Will qualify for foreign earned income and/or housing exclusions => can reduce income subject to withholding by the amount of income that will be excluded on income tax return, must have Form 673 completed and on file for first two years individual qualifies for exclusions. Will be able to claim foreign tax credits => can reduce income subject to withholding by amount of income that generates a U.S. income tax liability due to foreign tax credits, must have Form W-4 completed and on file documenting additional withholding exemptions. After all is said and done, there may still be a residual income tax withholding obligation for expatriates! Expatriates Reduction in Federal Income Tax Withholding Deloitte Tax LLP © 201616

17. State compensation reporting and tax withholding requirements will vary based on the state of domicile/residence before the assignment begins. The state of domicile/residence must be determined. Domicile – factors used to determine: −Where the employee intends to return −State issuing the employee’s drivers license −Where the employee votes Residence – factors used to determine: −Where employee is physically present −Where immediate family lives and where children attend school −Where the employee works Expatriates US State Reporting and Withholding Deloitte Tax LLP © 201617

18. Certain states will allow the individual to break residency, resulting in no actual state taxation while on international assignment In situations where state residency may be broken, state wages should not accumulate for the period in which the employee was considered to be in non-resident status; provided the wages are not sourced to a state. In some states it is very difficult to break state residency (e.g., New York) and state wages may need to continue accumulating as an individual typically continues to be taxed as a resident while on international assignment. Rules should be reviewed on a state by state basis. In addition, some states (e.g., North Carolina) will recognize foreign tax credits and if residency cannot be broken, tax withholding may be able to be reduced during an international assignment. Expatriates US State Reporting and Withholding Deloitte Tax LLP © 201618

19. FICA wages include compensatory allowances and/or reimbursements, employer-paid individual taxes, net of hypothetical tax withholding. Assignment related allowances and/or reimbursements included in compensation often result in Form W-2 Social Security and Medicare wages of 2-3 times the employee’s pre- assignment reportable wages. In general, these wages are subject to standard U.S. Social Security and Medicare tax withholding. Exclusions and/or credits allowable for federal income tax purposes do not apply to Social Security and Medicare tax withholding requirements. Expatriates US Social Tax Reporting and Withholding Deloitte Tax LLP © 201619

20. All allowances and/or reimbursements paid outside of the normal payroll process should be collected and reviewed to determine if the amounts are compensatory. Since U.S. citizens and permanent residents are taxed in the U.S. on worldwide income, all elements of company paid compensation should be considered regardless of the source of the payment. Certain reimbursements may be excluded from wages based on IRS rules. Factors to consider include: Intended length of the assignment Nature of the payment Form of the payment Policy provisions Certain relocation expenses may be excludable but reportable in Box 12 Code P of Form W- 2. Expatriates Earnings Adjustment Deloitte Tax LLP © 201620

21. Generally a tax gross-up will be calculated to account for the additional federal, state, local and/or social taxes that may be associated with the assignment related compensation elements that are being added to the employee’s taxable wages. An adjustment should be made to the employee’s wages and withholdings to add the additional compensation elements as well as the tax withholding. The tax gross-up should be paid to the appropriate tax authority as withholding on behalf of the employee and reported on Form W-2. Expatriates Tax Gross-Ups Deloitte Tax LLP © 201621

22. Tax Gross-up - common mistake Net payment = $50,000 Tax rate = 20% $50,000 * 20% = $10,000 … additional tax of $10,000 Company pays tax of $10,000, so gross reportable income is $60,000 Employee should pocket $50,000, but receives $2,000 less than intended $60,000 * 20% = $12,000 $60,000 - $12,000 = $48,000 Calculation doesn’t work! Expatriate Gross-Up: Incorrect Application Deloitte Tax LLP © 201622

23. Net payment = $50,000 / Tax rate = 20% X = $62,500 $62,500 * 20% = $12,500 $62,500 - $12,500 = $50,000 Expatriates Gross-up: Correct Application Deloitte Tax LLP © 201623 Net Payment = Gross Amount 1 – Tax Rate 50,000 = X 1 -.20

24. In some situations earnings may be adjusted by reducing income for assignment related payments that an employee paid back to the company. This may result in the need for a tax gross-down which will reduce the amount of the tax payments reported on the W-2. The application of the reduction and the gross down will depend on the company’s international assignment policy. Expatriates Tax Gross-Down Deloitte Tax LLP © 201624

25. Earnings adjustment for assignment-related compensation: Federal wages = include Medicare wages = include Social Security wages = include to the extent that the employee has not reached the maximum wage base ($118,500 for 2015) State/local wages = include only if the employee is considered a resident of that state/locality Tax gross-ups should be included in the appropriate tax withholding box In general, expatriates will have an earnings adjustment for each year of the assignment and typically for an additional one to three years beyond repatriation. Expatriates Form W-2 Reporting for Earning Adjustments Deloitte Tax LLP © 201625

26. Base Wages (without assignment income) = $205,000 Add company paid benefits: Host Housing$ 60,000 Auto Assistance$ 20,000 Education Assistance$ 30,000 $110,000 Gross Up Rates Federal28.00% State*3.75% Medicare1.45% Additional Medicare.9% Total Additional Compensation = $166,919.58 *Assumes earnings adjustment occurs while the individual is a state tax resident. Expatriates Earnings Adjustment Example Gross-up Calculation Deloitte Tax LLP © 201626 $110,000 = X 1 – (.28+.0375+.0145+.009)

27. EXAMPLE Breakdown of tax gross-up 166,919.58 *.28 = $46,737.48 = Federal Taxes 166,919.58 *.0375 = $6,259.49 = State Taxes 166,919.58 *.0235 = $3,922.61 = Medicare Taxes Total Taxes =$ 56,919.58 Total Allowances=$110,000.00 Total Adjustment=$166,919.58 Expatriates Earnings Adjustment Example Gross-up Breakdown Deloitte Tax LLP © 201627

28. Adding it to Form W-2 wages Box 1 Federal Wages: $ 166,919.58 Box 2 Federal Taxes:$ 46,737.48 new cost Box 3 Social Security Wage *:$ 0 Box 4 Social Security Tax *:$ 0 Box 5 Medicare Wage:$ 166,919.58 Box 6 Medicare Tax:$ 3,922.61 new cost Box 16 State Wage:$ 166,919.58 Box 17 State Tax:$ 6,259.49 new cost * Assumes annual Social Security maximum has already been met. Expatriates Form W-2 Adjustments Deloitte Tax LLP © 201628

29. Hypothetical tax withholding is generally used to help offset incremental assignment related costs. Adjustments to earnings are payments that have already been made and therefore most likely have been accounted/accrued for by the paying party. Tax gross-ups are new payments that have often not been accounted/accrued for by the paying party. Generally tax gross-ups are charged to the cost center bearing the cost of the assignment, while hypothetical taxes are credited to that cost center. Expatriates Treatment of Additional Employer Costs Deloitte Tax LLP © 201629

30. Inpatriates 30

31. Just as with expatriates, inpatriates will generally be covered by a company International Assignment Policy to alleviate any financial or tax burden as a result of accepting the international assignment. Inpatriates may be covered under a policy of tax equalization or tax protection. The inpatriate may be responsible for paying their own U.S. taxes depending on company policy. Inpatriates covered by a certificate of coverage should not be subject to Social Security and Medicare tax. Inpatriates Tax Equalization / Tax Protection Deloitte Tax LLP © 201631

32. Determining U.S. Resident and Nonresident Alien Status U.S. Resident: meets lawful permanent resident test or substantial presence test Lawful permanent resident – “green card” test Substantial presence test −Present in the U.S. for at least 31 days in the current calendar year; and −Total U.S. days of presence meet or exceed 183 days counting: −Total U.S. days in current calendar year, plus −1/3 U.S. days in first preceding calendar year, plus −1/6 of U.S. days in second preceding calendar year Nonresident aliens taxed on U.S. sourced income, with exceptions Inpatriates Tax Residency Status Deloitte Tax LLP © 201632

33. Business Travelers May be exempt from U.S. federal income tax withholding if: Nonresident alien is in the U.S. for 90 days or less during the tax year; and Compensation received for U.S. services does not exceed $3,000 during the tax year; and Nonresident alien is employed by foreign employer, or a U.S. employer in a foreign country Inpatriates Tax Residency Status Deloitte Tax LLP © 201633

34. Immigrant Visa – I-551 / Permanent Resident Card (i.e., green card) Nonimmigrant visas include: B-1: Visitors for business Students, workers, or foreign press being paid by a foreign employer H-1B: Professional and technical workers College-educated or experienced professionals J-1: Exchange visitors Students, trainees, and teachers in the U.S. to participate in an exchange program Federal income tax withholding exemptions available Exempt from social wage reporting and withholding L-1 (A and B): Intracompany transfers Executives or professionals with specialized knowledge F-1: Students Full-time students at an approved U.S. educational institution Federal income tax withholding exemptions available Exempt from social wage reporting and withholding Inpatriates Visas Deloitte Tax LLP © 201634

35. Inpatriates should obtain a U.S. social security number (SSN) or ITIN (Individual Taxpayer Identification Number). ITIN numbers begin with a 9 (no SSNs start with a 9) ITINs expire after 5 years Application process can be arduous because of new rules Inpatriates should complete a Form W-4, Employee’s Withholding Allowance Certificate, and Form I-9, Employment Eligibility Verification. Wages paid to and taxes withheld from inpatriates must be deposited and reported by the employer in the same way it does for all other employees, using Form 941 and Form W-2. Inpatriates US Payroll Documentation and Reporting Deloitte Tax LLP © 201635

36. In general, U.S. resident aliens are subject to the same U.S. federal, state and unemployment tax reporting and withholding obligations as U.S. citizens / permanent residents. Employers must report compensation and withhold federal, state, local and social tax (also state disability and unemployment taxes where required). Employers must also fund the employer portion of Social Security, Medicare, and federal and state unemployment taxes. In general, federal unemployment (FUTA) applies to all wages paid for work performed in the U.S. regardless of the citizenship or residency status of the employee or the employer. Inpatriates Reporting and withholding for US resident aliens Deloitte Tax LLP © 201636

37. In general, U.S. nonresident aliens are subject to the same U.S. federal, state and unemployment tax reporting and withholding obligations as U.S. residents. If an income tax treaty applies, the nonresident alien employee may be exempt from U.S. income tax withholding on wage income Form 8233 must be provided to the employer for the income tax withholding exemption to apply Form 8233 should be mailed by the employer to the IRS within 5 days of receipt A copy must be given to the employee upon submission Inpatriates Reporting and withholding for US non-resident aliens Deloitte Tax LLP © 201637

38. Form 1042 is required for reporting of US sourced non-wage payments and tax withholding made to non resident aliens and not reported on Form W-2 Form 1042 – Payer reporting form − Must be paper filed Form 1042-S - Payer required form to provide to the payee − If payer files 250 or more Forms 1042-S, they are required to be submitted electronically Form 1042-T – Form to be sent with the paper Form 1042-S − Only required if filing a paper form All forms due by March 15 th following the close of the tax year Inpatriates Reporting and withholding for US non-resident aliens Deloitte Tax LLP © 201638

39. Special procedure is required to calculate Federal income tax withholding for nonresident alien employees The income tax to be withheld is determined by applying the withholding tables to the sum of the wages paid for the payroll period plus the additional amount below: Per Publication 15 (2016) Inpatriates Income Tax Withholding Calculation for Nonresident Aliens Deloitte Tax LLP © 201639

40. While the inpatriate may continue to be paid in his/her home country, wages received for work performed in the U.S. should be reported in the U.S. and the appropriate taxes should be paid to the appropriate tax authority on Form W-2. The assignee may also receive other company paid benefits. An earnings adjustment may be required (as with an expatriate) to ensure proper reporting and withholding on Form W-2. Where taxes are paid on behalf of the assignee by the company, a tax gross-up will be added to the individual’s compensation each pay period to result in a neutral net effect to the employee. Inpatriates Earnings adjustments and shadow payroll Deloitte Tax LLP © 201640

41. Monthly Base Pay in UK = GBP 5,000 Converted @ 1.5 = $7,500 Federal Taxes = $1,875 State Taxes = $375 Monthly Pay = $9,750 Less: Federal Taxes Less: State Taxes Less: Pay Received in UK Net Pay in U.S. = $0 (In this example, no Social Security or Medicare taxes are paid due to Totalization Agreement) Inpatriates Reporting Monthly Pay in U.S. Shadow Payroll Example Deloitte Tax LLP © 201641

42. Certificates of Coverage Totalization Agreements 42

43. While living and working outside the US, assignees may become subject to host country social tax. In order to eliminate the burden of double social tax, the US government has entered into bi-lateral social security totalization agreements with 25 countries. Obtaining coverage under a totalization agreement alleviates the need to contribute to host country social system. The employee continues to contribute to the home country social system where they will ultimately obtain a social security benefit. Certificates of coverage under a social security totalization agreement can be applied for via the U.S. social security administration website: http://www.ssa.gov/international In general, certificates of coverage are effective for 5 years (with the exception of Italy (unlimited) and Germany (9 yrs). Global Reporting Certificates of Coverage Deloitte Tax LLP © 201643

44. Global Reporting Countries with enacted Totalization Agreements with the US Deloitte Tax LLP © 201644 Australia Austria Belgium Canada Chile Czech Republic Denmark Finland France Germany Greece Ireland Italy Japan Luxembourg Netherlands Norway Poland Portugal Slovak Republic Spain South Korea Sweden Switzerland United Kingdom

45. Question / Answer Session 45