Change, Change, and More Change for International Assignment Program Managers
by Joan Smyth, KPMG LLP’s Washington National Tax practice, Washington, D.C.
(KPMG LLP in the United States is a KPMG International member firm)
This year has seen significant changes to U.S. tax law, many of which affect workers on international assignment and their employers. Beginning with the Hiring Incentives to Restore Employment (“HIRE”) Act of 2010. 1 followed closely by health care reform legislation, international program managers have a number of issues to consider in the years ahead including information reporting, withholding taxes, assignment cost accrual updates, and policy review.
In August, KPMG’s International Executive Services (IES) practice sponsored a KPMG TaxWatch program highlighting key issues resulting from the new tax legislation. 2 The program afforded tax professionals and international assignment program managers the opportunity to discuss what impact the new laws may have on a globally mobile workforce, and how a company’s international assignment policies, processes, and costs may be affected. As discussed below, responses to survey questions posed during the program shed some light on how companies are approaching these issues.
This article highlights the enacted legislation and its effects on international assignment programs. (This article highlights legislation enacted in the U.S. up to November 30, 2010.) 3
Health Care Reform Legislation
The health care reform legislation, a product of two bills, 4 made extensive changes to the current health care system. Tax law changes were enacted to offset some of the health care reform costs. While the legislation has implications for many companies, two changes in particular that were discussed during the KPMG TaxWatch program can impact international assignees and their employers: a 0.9-percent increase in the Medicare tax on wage income, and a new 3.8-percent health insurance tax on passive investment income.
Additional 0.9-Percent Hospital Insurance Tax on High-Income Taxpayers
Beginning in 2013, the employee 5 portion of the Medicare hospital insurance (“HI”) tax (currently equal to 1.45 percent of wages) is increased by an additional 0.9 percent on wages received in excess of a threshold amount; $250,000 for married couples filing a joint return (“MFJ”) or a surviving spouse (the $250,000 is applied to the combined wages of both spouses); $125,000 for married individuals filing separately (“MFS”); and $200,000 for single filers. The employer must withhold the additional HI tax on wages in excess of $200,000, regardless of the employee’s filing status or the amount of wages received by the employee’s spouse. (This increase to the Medicare tax is assessed only to the employee; there is no corresponding employer contribution.)
As a result, international assignment program costs will increase by the additional 0.9-percent tax, plus the gross-up costs, if an assignee is subject to the 0.9-percent HI tax due to the inclusion of assignment-related allowances in income. Also, host country tax costs for employees working outside the United States (assuming U.S. Social Security tax continues to apply) may increase if the HI tax and gross-up costs paid by the employer are considered taxable income in the host location.
For individuals on assignment to the United States and who remain subject to their home country social security tax system (i.e., the employer has applied for and received a Certificate of Coverage for the employee), the additional 0.9-percent HI tax will be covered under the social security totalization agreements to which the United States is a party. Thus, when a Certificate of Coverage is in place, the assignee will not be subject to U.S. Social Security tax, including the additional 0.9-percent HI tax.
In the current economic environment, when companies are keeping a close watch on expenses, program administrators may want to consider updating their assignment cost accruals for the additional 0.9-percent tax. Of the KPMG TaxWatch participants who have made the decision to update their cost accruals, 8 percent had already started (as of the August program date), and 24 percent indicated that they plan to do so within the next three to 12 months. (See Figure 1.)
Unearned Income Medicare Contribution
Currently, the HI tax is imposed only on earned income (employee wages or self-employment income). The HIRE Act imposes a new tax on net investment income of high-income individuals or couples, including interest, dividends, capital gains, and annuity and rental income. The tax is 3.8 percent of the lesser of (i) net investment income or (ii) the taxpayer’s modified adjusted gross (“MAGI”) income that exceeds a threshold amount of $250,000 for MFJ or a surviving spouse; $125,000 for MFS; and $200,000 for single filers. Unlike the additional 0.9-percent HI tax, the tax on unearned income is not withheld by the employer, and should be considered when determining whether an individual must make estimated tax payments.
For U.S. citizens and residents, when applying the formula to determine the tax, any foreign earned income excluded (less deductions disallowed) under Internal Revenue Code section 911 must be added back to arrive at MAGI. Similar to the additional 0.9-percent HI tax, the tax on unearned income may increase international assignment costs if the assignee is subject to tax due to the inclusion of assignment-related allowances in income. Also, any host country tax costs for employees working outside the U.S. should be considered when the tax and gross-up costs are considered taxable income to the assignee in the host country.
In contrast to the additional 0.9-percent HI tax, it is unlikely that the tax on unearned income will be covered under a totalization agreement. Thus, an individual on U.S. assignment with a valid Certificate of Coverage is not exempt from the additional unearned income tax.
The new law is effective for tax years beginning January 1, 2013. While it may seem like there’s plenty of time to address the issue, program administrators may want to begin reviewing their companies’ policies and documenting their positions on the responsibility for the additional tax.
During KPMG’s TaxWatch program, participants were asked when they plan to update their tax equalization policies to reflect their companies’ positions on the 3.8-percent tax on unearned income. Thirty-one (31) percent of those who have made an affirmative decision to update their tax equalization policies plan to do so within the next 12 months. (See Figure 2.) This is approximately the same percentage as with the 0.9-percent wage tax, despite the larger potential program cost impact.
Hiring Incentives to Restore Employment Act of 2010
In addition to granting tax incentives for employers that hire and retain unemployed workers, the HIRE Act made a number of changes to the tax law to improve tax compliance with respect to foreign accounts and cross-border transactions. The new rules are designed to ensure that U.S. persons are paying U.S. tax on income earned through foreign accounts or entities, and that proper withholding applies to foreign persons. To that end, new withholding, reporting, and information collection obligations have been imposed on both individual taxpayers and third parties.
Foreign Financial Asset Reporting by Individual Taxpayers
Foreign banks and other financial institutions may not be subject to the same reporting requirements as U.S. financial institutions. Therefore, the U.S. government uses certain information filings to help identify persons who may be using foreign financial accounts to evade U.S. tax, and to identify unreported income maintained or earned abroad.
Introduced by the HIRE Act, a significant tax law change is the requirement for individuals to report their interests in specified foreign financial assets on their U.S. federal income tax returns.
Currently, U.S. persons have an annual obligation to separately report to the U.S. Treasury any interest in any foreign financial accounts aggregating $10,000 or more on any day during the year by filing Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (“FBAR”). The account holder may have this reporting obligation even if the foreign account produces no taxable income. Failure to file the FBAR can result in civil penalties up to a maximum $10,000 per violation.
The FBAR is not a part of, and is not filed with, the individual’s federal income tax return (Form 1040). Since the FBAR is not included with the Form 1040 filing, many international assignment programs do not include FBAR preparation in their tax services engagements. In a survey of the KPMG TaxWatch participants, 68 percent indicated that their companies do not pay for FBAR preparation (see Figure 3). Program administrators often manage this requirement by advising the assignee of the reporting obligation and providing a copy of the form for the assignee to complete and file.
Under the new law, effective for tax year 2011, individuals who hold more than $50,000 (in the aggregate) in “specified foreign financial assets” must report information about the assets on their federal income tax return. The IRS has released a draft of Form 8938 to be included with an individual's personal tax return (no instructions have yet been released for this form). The disclosure must be included with the income tax return or substantial penalties may apply.
This new requirement introduces some challenging issues for both tax service providers and international program managers. First, the broad definition of “specified foreign financial assets” raises a number of questions about what assets must be reported. For example, does the definition include an interest in a foreign retirement plan? An interest in a foreign retirement plan would most likely cause an individual to exceed the $50,000 threshold and trigger the reporting requirement. In that case, in addition to providing assignees with foreign plan earnings information for U.S. income tax purposes (if applicable), it would be necessary for a plan administrator to provide certain foreign plan information to be reported on the assignee’s income tax return and (or) FBAR.
The new reporting rule is effective for 2011 tax returns to be filed in 2012. However, program administrators may want to take this opportunity to review their non-U.S. pension plans to determine the requirements for U.S. income tax and (or) information reporting purposes. Of the KPMG TaxWatch participants who have considered a review for their non-U.S. plans, 38 percent responded that they anticipate a plan review within the next 12 months (see Figure 4).
Even if future guidance brings some clarity to what foreign financial assets must be reported, information collection is another area of potential concern. Since the new report is part of the individual’s U.S. federal income tax return, tax service providers will be required to collect foreign financial asset information from assignees. Individuals may be reluctant to provide this information, especially in situations when their interest in a foreign account or asset does not generate income subject to U.S. tax. As with the FBAR, significant penalties may apply to tax returns that omit the required foreign account disclosure.
Finally, the information required to be reported on the individual’s income tax return may be similar to what must be reported on the FBAR, but it is not the same. Thus, this new reporting obligation is in addition to, and does not replace, the individual’s obligation to separately file an FBAR with the U.S. Treasury. Some assignees may be required to file both the FBAR and the new foreign financial asset disclosure. The similarity between these two disclosures could add to the confusion that already exists when it comes to foreign financial asset reporting. Future IRS guidance may eliminate any overlap or redundancy that results from the application of these rules.
New Withholding Tax on Payments to Foreign Entities
Beginning January 1, 2013, 6 a 30-percent withholding tax is imposed on payments of certain U.S. source income when made to a foreign financial institution (“FFI”) with U.S. customers or certain foreign non-financial entities. Withholding applies unless the foreign entities agree to adhere to certain reporting requirements regarding accounts held by U.S. persons.
At first glance, this new withholding rule clearly has a significant impact on the financial sector, prompting FFIs and other foreign entities to reassess their business models and evaluate their compliance options. But what consequence might this law have for international assignees?
Access to Banking Services
In 2009, prior to the enactment of the HIRE Act, concern was expressed about reports that U.S. citizens living abroad are being denied access to U.S. banks. 7
Further, there were reports that certain foreign banks were refusing to open new accounts for U.S. citizens and residents, and closing accounts for existing U.S. customers (including foreign nationals on temporary assignment in the United States). During KPMG’s TaxWatch program, participants were asked whether members of their mobile workforce reported problems accessing banking services while on international assignment. Twenty-six (26) percent responded affirmatively.
Given this observed shift in banking practices prior to the enactment of the new law, in the future, U.S. citizens abroad and foreign nationals on U.S. assignment may find that certain foreign banks may be unwilling to do business with U.S. clients or investors since they may be reluctant to incur the additional costs associated with compliance. For assignees trying to settle into a host country and who need local access to funds, the inability to open a local bank account is more than a mere inconvenience, and those assignees may look to their assignment program managers and relocation service providers for solutions.
Foreign Retirement Plans
As mentioned above, under the new law the definition of an FFI is broad and therefore, may apply to foreign retirement plans that receive U.S. source income. Thus, U.S. source payments to a foreign retirement plan are subject to the withholding tax unless the plan complies with reporting requirements, or an exception applies. Although a foreign retirement plan may qualify as a financial institution, the IRS has stated that it intends to issue guidance that certain foreign retirement plans pose a low risk of tax evasion and payments beneficially owned by these qualifying foreign plans will be exempt from withholding. 8
Foreign retirement plans that do not qualify for an exemption are subject to the information reporting and withholding rules. Thus, a foreign plan must agree to disclose information regarding U.S. persons or the 30-percent withholding tax is imposed on any U.S. source income paid to the foreign retirement plan.
Some plan administrators may ask whether limiting retirement plan participation to non-U.S. persons only will preclude application of the withholding rule. Since withholding is triggered upon the payment of U.S. source income, denying U.S. citizens or residents the right to participate in a foreign retirement plan will not avoid the potential application of the withholding rule if the plan otherwise holds investments that generate U.S. source income.
The administrative costs of identifying plan participants who are U.S. persons may be an issue for foreign retirement plans subject to the new withholding tax provisions. Financial institutions maintain detailed client information databases and highly sophisticated information systems that can extract the necessary data for information reporting purposes. In contrast, foreign retirement plans may not have this capability and may incur substantial administrative costs identifying U.S. participants.
The legislation enacted from January to November 2010 will require international assignment program managers to re-evaluate their companies' policies, information collection processes, and costs associated with their programs. Some have already started the process of updating assignment cost accruals, and reviewing tax equalization policies and foreign pension plans.
The future promises more change as the president signed new legislation passed by Congress in mid-December that concerns tax rates — and other taxes that were scheduled to sunset — and benefits for individual taxpayers. What direction tax policy will take starting with the new Congress that convenes in January 2011 is unknown. For now, all tax service providers and international program managers can do is wait as 2011 promises to be an interesting year.
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