|Payroll Reporting and Withholding Requirements
for Foreign Nationals Working in the U.S. Part I
by Larry Ghirardo, KPMG LLP, Seattle
(KPMG LLP is the U.S. member firm of KPMG International, a Swiss association)
Note: This article is the first in a series on U.S. payroll issues for foreign nationals that will be published in upcoming editions of The Expatriate Administrator.
Do you have foreign nationals who are performing services in the United States? If so, it is important to be aware of the employee and employer U.S. payroll reporting and withholding requirements for these individuals.
U.S. payroll reporting and withholding on payments made to a foreign national can be affected by many factors such as the determination of who the actual employer is, the individual's U.S. residency status, the sourcing of income, and the application of income tax treaties. This article is a general discussion of some of these concepts as they apply to personal services provided by foreign nationals in the U.S. and can be regarded as a general guide to give international human resources and tax professionals a better understanding of the U.S. payroll reporting and withholding rules. Future articles on this subject area will address other factors in more detail such as exempt income, income tax treaties, social security agreements, and tax requirements for certain visa type holders.
Who is Required to Withhold?
Internal Revenue Code (IRC) section 3402(a)(1) requires that every "employer" making payment of wages shall deduct and withhold from wages a tax at a rate and in a manner prescribed by regulations. Generally, the term "employer" means any person for whom an individual performs or performed any service, of whatever nature, as the employee.
It is not necessary that the services be continuing at the time the payment is made for the status of employer to exist. Thus, a person for whom an individual has performed services in the past for which the individual is still receiving wages is an employer for withholding purposes.
However, section 3401(d) provides that if the person for whom services are rendered does not have legal control of the payment of wages for those services, the term employer means the person having such control.
The term employer also includes any person paying wages on behalf of a nonresident alien individual, foreign partnership, and/or foreign corporation, not engaged in business within the United States.
Wage Withholding for Foreign National Employees
Employers who have foreign national employees working in the U.S. are required to withhold U.S. income and other payroll taxes from the wages of these employees if the wages are not exempt from U.S. taxation under U.S. domestic tax law or treaty.
A foreign employer may be required to establish a formal U.S. payroll system, obtain an IRS employer identification number, make periodic deposits of tax, and file the applicable informational returns. The foreign employer may consider transferring the employee to the payroll of the U.S. affiliate. If it is not possible or desirable to place the employee on the U.S. payroll of a U.S. branch, subsidiary, or parent company, it will be necessary for the foreign employer to make U.S. withholding payments on behalf of the resident alien employee. Alternatively, the foreign employer may appoint its U.S. affiliate as an agent or enlist an outside payroll agent to perform these payroll functions.
A foreign national considered to be a resident for U.S. income tax purposes is taxed in the same manner as a U.S. citizen. Thus, a resident alien is taxed on and must report income from all sources, including sources outside the United States.
A nonresident alien is generally subject to U.S. income tax only on income from U.S. sources. Remuneration paid to a nonresident alien employee for personal services rendered outside the U.S. is not considered U.S. source earned income and is not subject to U.S. taxation. If a nonresident alien receives compensation that covers a period of employment in the U.S., then the portion of the compensation received that is U.S. source income is generally taxable in the U.S.
Determining status as a resident or nonresident is governed under a series of rules that are beyond the scope of this article.
Sourcing of Wages
If income is related to personal services performed partially within the United States and partially without the United States, an allocation to U.S. source income must be made. The allocation is made on the basis of time unless another method is justified (e.g., dual employment contracts).
Rate of WithholdingIncome Tax
Federal Insurance Contributions Act (FICA)
Federal Unemployment Tax Act (FUTA)
Exceptions to Withholdingin General
This exemption does not apply to social security taxes under the FICA or unemployment taxes under the FUTA.
U.S. payroll reporting and withholding rules with respect to payments made to foreign nationals (nonresident and/or resident aliens of the United States) are quite complex. Due to the complexity of the rules and the myriad of possible scenarios, it is highly impractical to cover all possible permutations here and is beyond the scope of this article. This article simply provides a basic understanding of the rules and requirements for foreign nationals and their employers. The information in this article is based upon the relevant provisions of the IRC of 1986, as amended, the regulations thereunder, and the judicial and administrative interpretations thereof. These authorities are subject to change, retroactively and/or prospectively, and any such changes could affect the validity of the information presented in this article.