Editor: Annette B. Smith, CPA
For FICA tax purposes, “wages” are defined in Sec. 3121(a) as all remuneration for employment. Sec. 3121(b) defines “employment” for purposes of FICA generally to include any service performed by an employee for an employer, irrespective of the citizenship or residence of either, within the United States, or any service performed outside the United States by a U.S. citizen or resident as an employee of an American employer. There are also specific rules (beyond this item’s scope) related to services performed on or in connection with certain American vessels or American aircraft and any service performed under an agreement entered into under Section 233 of the Social Security Act, P.L. 74-271.
Without a specific exception, these broad definitions of wages and employment operate to extend U.S. Social Security to American citizens and U.S. resident aliens employed abroad by American employers without regard to the duration of an employee’s foreign assignment and even if the employee has been hired abroad. Employers may be unaware that nonresident alien employees or foreign employees who have been sent to work within the United States for any length of time generally also are covered under the U.S. program. In addition, many American companies enter into agreements with the Treasury Department under Sec. 3121(l) to provide Social Security coverage for U.S. citizens and residents employed by their foreign affiliates.
These rules, in combination with the fact that most countries impose social taxes on persons performing services in their territory, often result in dual social tax liability. This occurs when a worker from one country works in another country and is required to pay social taxes to both countries on the same earnings.
The statute and regulations include several exceptions from FICA liability. One exception applies to certain wages paid during any period in which there is in effect an International Social Security agreement, often called a “totalization agreement.” Sec. 3101(c) (for the employee portion of FICA) and Sec. 3111(c) (for the employer portion of FICA) provide exemptions for wages received by or paid to an individual during any period in which there is in effect an agreement that those wages are subject exclusively to the laws applicable to the social security system of the foreign country. The following 24 countries have entered into totalization agreements with the United States: Australia, Austria, Belgium, Canada, Chile, the Czech Republic, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan, Luxembourg, the Netherlands, Norway, Poland, Portugal, South Korea, Spain, Sweden, Switzerland, and the United Kingdom.
A totalization agreement is intended to eliminate dual social taxation and to provide additional benefit protection for workers who have worked in both the United States and another country. The provisions eliminating dual coverage for employed persons are similar in all U.S. totalization agreements, each of which establishes a “territoriality” rule that looks to the location of a worker’s employment. Under this rule, a worker who would be eligible for coverage under both the U.S. and a foreign social system will be subject only to the coverage laws of the country where he or she is working.
However, except for the agreement with Italy, there is an exception to the territoriality rule in each agreement for workers sent abroad on temporary assignments. This “detached-worker” exception is designed to minimize coverage disruptions, and under it a person temporarily transferred abroad to work for the same employer remains covered by the country from which he or she was sent. Therefore, a U.S. citizen or resident who is temporarily transferred by an American employer to work in one of the 23 countries that have entered into agreements (excluding Italy) continues to be covered by U.S. Social Security and is exempt from coverage under the host country’s system. In that instance, under the agreement, the employee and employer pay U.S. FICA tax on the employee’s wages and not social security contributions to the host country.
While eliminating dual social taxation in many instances, the detached-worker rule has significant limitations. First, it does not permit dually covered employees or their employers to choose among social tax systems. Rather, the agreements simply exempt workers from coverage under the system of one country when their work otherwise would be covered under both systems. Second, the rule requires that covered employees continue to work for the same employer when on assignment in another country. This means that the common-law analysis of whether an employer is truly an employer applies and that the employer cannot be identified simply by contract or some other means. Employers must actually direct and control their employee. Finally, while the definition of “temporary” may vary, most U.S. agreements apply to employees whose assignments are expected to last five years or less.
Totalization agreements also can assist workers who, because they have split their careers between the United States and a foreign country, do not meet the minimum eligibility requirements to qualify for benefits in one or both countries. A totalization agreement may allow those workers to qualify for partial U.S. or foreign benefits based on combined, or “totalized,” coverage credits from both countries.
To document their exemption from U.S. or foreign social taxes under a totalization agreement, employees must obtain a certificate of coverage from the country that will continue to cover them. When employers transfer employees abroad, they are generally required to request certificates on behalf of those workers. An employer is authorized to stop withholding and paying U.S. Social Security taxes on the employee’s earnings when it receives a certificate establishing that the employee is covered by the foreign system. Employers should retain the certificate in their files to produce in the event of an IRS examination or other inquiry.
In summary, totalization agreements may reduce the costs of an international assignment and protect employees who otherwise would lose social benefits due to international assignments. Employers should ensure the rules under totalization agreements are being applied properly and that the required documentation is acquired and retained.
Annette Smith is a partner with PwC, Washington National Tax Services, in Washington, D.C.
For additional information about these items, contact Ms. Smith at 202-414-1048 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with PricewaterhouseCoopers LLP.