1. California Payroll Conference
September 11 and 12, 2014
Overview of tax reimbursement plans and related payroll reporting requirements
Rajiv Thadani
Principal, Tax
KPMG LLP
(408)

2. ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.
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3. Agenda What is a tax reimbursement plan and why is it necessary
Types of tax reimbursement plans
Tax protection and examples
Tax equalization and examples
Tax Equalization – Payroll reporting requirements
Tax Equalization – Payroll reporting for repayments and examples
Tax reimbursement plans – Administrative matters

4. Tax Reimbursement Plans

5. Tax reimbursement plans
Why is a tax reimbursement plan necessary?
Tax on allowances
Host country (foreign) income taxes
Complexities created by two tax systems (home & host country)
Ease of relocation of international assignees
Generally removes tax as a criteria to consider for cross-border transfers
Competitive advantage
Employee goodwill

6. Tax reimbursement plans – key attributes
Scope
Specify who is covered under the plan and the employer’s intent
Differentiate between assignment types
Differentiate assignments based on period of length due to varying tax factors
Determine the taxes covered under the plan
Clearly define employee and employer responsibilities
Ensure definitions and key language are consistent with the plan’s intent
Examine areas of operation and specifically country combinations of employees on assignment to determine suitable plan

7. Types of Tax Reimbursement Plans

8. Types of tax reimbursement plans
Tax protection
Tax equalization

9. Tax protection

10. Tax protection – Key characteristics
Employee pays all home and host country income and social taxes if applicable
Employer continues to pay ER social taxes only
If the taxes the employee pays exceed the home country tax obligation the employee would have incurred had he/she not accepted the assignment, the company will reimburse the excess taxes the employee paid.
If the actual taxes the employee pays to the home and host country are less than the tax the employee would have paid in the home country had he/she not accepted the assignment, the employee retains the benefit
Tax protection is most often used by employers having a small work force of expatriates who go to an assignment country for a limited time and do not move from one country to another.

11. Tax protection – Benefits and disadvantages
Administration of a tax protection arrangement is generally straightforward
In comparison to tax equalization, which will be discussed later, it may be less costly to the employer due to compounding effect of company funded tax payments under tax equalization. This depends on the country combinations and comparative tax rates.
Disadvantages:
May restrict employee mobility
Inequality for employees in different home and host countries
May result in employee cash flow issues because of funding
Greater risk of non compliance with tax reporting requirements

12. Tax protection – Example 1 U.S. taxpayer assigned to the U.K.
Employee Compensation
$ ,000
US Federal Income Tax (Net of FTC and Exclusions)
$ - 0 -
Actual U.K. Tax
$ 75,000
Total Actual Tax
“Hypothetical” U.S. Tax Liability
$ (37,500)
Amount Due to Employee for Reimbursement
$ 37,500
US Tax Gross-up on Reimbursement
$ 18,200
Employer Tax Costs
$ 55,700
Employee Tax Costs
In this example, the employee funded the UK taxes for a cash outlay of $75,000 before receiving reimbursement of $37,500. This example illustrates the cash flow concerns that may arise at the employee level.

13. Tax protection – Example 2 U.S. taxpayer assigned to Singapore
Employee Compensation
$ ,000
US Federal Income Tax (Net of FTC and Exclusions)
$ 5,000
Actual Singapore Income Tax
$ 22,500
Total Actual Tax
$ 27,500
“Hypothetical” U.S. Tax Liability
$ (37,500)
Employer Tax Costs
$ 0
Employee Tax Costs
Employee Tax Windfall
$ 10,000
In this example, the employee paid the lesser of the actual taxes paid to the US and Singapore and receives a tax windfall of $10,000 relative to his stay at home hypothetical tax obligation.

14. Tax Equalization

15. Tax equalization – Key characteristics
Intent of tax equalization is for the employee to remain in a tax neutral position
Employer pays all actual taxes (both U.S. and foreign) on all taxable compensation
Employee settles “hypothetical” tax on standard non assignment related compensation items (i.e., bonus, equity, salary) to the employer
Payroll retains hypothetical tax withholding (not payable to the authorities) in place of actual tax withholding
A tax equalization settlement calculation is prepared after finalizing the home and host country tax returns comparing the retained hypothetical tax to the employee’s final.
Payment is made either from the employee to the company or company to the employee based on the employee’s final hypothetical tax position.
Overwhelmingly accepted as the preferred method by global companies for U.S. expatriates

16. Tax equalization – Benefits and disadvantages
Promotes compliance with tax reporting requirements
Provides equal tax treatment for employees
Supports mobility of expatriates to various country locations
May lead to tax cost savings depending on country combinations
Disadvantages:
Administratively time consuming
May be costly due to the compounding effect of company funded tax payments

17. Tax equalization – Example 1 U.S. taxpayer assigned to the U.K.
Summary:
Employee
Employer
Salary
150,000
Actual Federal US Income Tax Obligation
UK Taxes
75,000
Employee Hypothetical Taxes
(37,500)
Net Compensation
112,500
197,500
Final Hypothetical Tax Obligation
(42,500)
Tax Equalization Settlement Balance
5,000
(5,000)
Total Tax Costs Including Equalization Settlement Repayment
42,500
32,500
In this example, the employee’s retained hypothetical tax was less than his/her final hypothetical tax obligation and repayment was settled to the employer.

18. Tax equalization – Example 2 U.S. taxpayer assigned to the Singapore
In this example, the employee’s retained hypothetical tax was more than his/her final obligation. The company realizes an overall tax cost savings of $7,500 (net of settlement), primarily driven by lower Singapore taxes. Retained US hypothetical taxes exceeded the actual tax obligations and the company realizes the benefit.
Summary
Employee
Employer
Salary
150,000
Actual Federal US Income Tax Obligation
5,000
Singapore Taxes
22,500
Employee Hypothetical Taxes
(37,500)
Net Compensation
112,500
132,500
Final Hypothetical Tax Obligation
(35,000)
Tax Equalization Settlement Balance
2,500
Total Tax Costs Including Equalization Settlement Repayment
35,000
(7,500)

19. Tax Equalization – Payroll Reporting Requirements

20. Tax equalization – Payroll reporting requirements
Hypothetical taxes withheld from an employee’s salary under an employer tax equalization program reduces the amount of income subject to tax.
Since the hypothetical tax retained is not gross income to the employee, FIT withholding and FICA and FUTA taxes do not apply.
Payroll retains hypothetical taxes during each per pay period and reports a negative adjustment to compensation for taxes retained in each period.
Tax equalization settlement repayments paid to the company from the employee generally do not reduce reportable compensation unless repaid in the same year. Repayment is subject to claim of right reporting under IRC Section 1231 and is not reportable as compensation.
Tax equalization settlement payments owed to the employee should be settled net of taxes and reported in compensation

21. Tax Equalization – Payroll Reporting for Repayments

22. Tax equalization – Payroll reporting for repayments
Example 1.
The employee’s 2013 final hypothetical tax obligation reconciled per his/her tax equalization settlement exceeds his retained hypothetical taxes by $5,000. The employee pays the company $5,000 for settlement in What are the payroll reporting requirements?

23. Tax equalization – Payroll reporting for repayments
Example 2.
The employee’s 2013 final hypothetical tax obligation reconciled per his/her tax equalization settlement exceeds his retained hypothetical taxes by $5,000. The employee pays the company $5,000 for settlement in What are the payroll reporting requirements?

24. Tax equalization – Payroll reporting for repayments
Example 3.
The employee’s 2013 tax equalization settlement balance reflects that the employer owes the employee $5,000 for settlement. The employee is a US tax resident on assignment in the UK. The employer settles payment in The employee is no longer a State tax resident and his/her wages have exceeded the FICA base limit. Should the payment be grossed-up for US taxes?

25. Tax equalization - Payroll reporting for repayments
Example 4.
The employee’s 2013 tax equalization settlement balance reflects that the employer owes the employee $5,000 for settlement. The employee is a US tax resident and completed his/her assignment in The employee is living in California during 2014 and the company arranges settlement of the tax equalization payment during This is the final settlement related to the assignment. What US tax gross-ups should apply to the payment?

26. Tax Reimbursement Plans – Administrative Matters

27. Tax reimbursement plans – Administrative matters
For each tax year of the assignment, payroll should maintain the following forms, with appropriate exemptions and exclusions, when operating both tax protection and tax equalization arrangements
Form 673 Statement for Claiming Exemption From Withholding on Foreign Earned Income and Eligible for the Exclusion(s) Provided by Section 911
Form W-4 updated with “exempt status” if the employee is not subject to US tax withholding because he is subject to foreign tax withholding and is not expected to have residual US Federal tax obligations.

28. Questions

29. Thank you for your attention
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30. Rajiv Thadani, Principal KPMG LLP
Background:
Rajiv is a global engagement lead for various technology clients in KPMG’s Bay Area office. He joined KPMG in 2001 having previously worked with Arthur Andersen. He has more than 17 years of experience providing a vast array of international tax and human resources services. Prior to relocating to the United States, Rajiv has worked in Belgium, United Kingdom, and India, and is familiar with the tax and HR challenges that accompany the international assignments.