Withholding Rules for U.S. Citizens and Resident Aliens Working for a U.S. Employer in a Foreign Country

Editor: Valrie Chambers, Ph.D., CPA

Foreign Income & Taxpayers

For income tax withholding purposes, the wages of U.S. citizens and resident aliens include all remuneration for services performed as an employee for an employer, regardless of whether the services are performed in the United States.

There are statutory exemptions from federal income tax (FIT) withholding for foreign earned wages. Sec. 3401(a)(8)(A)(i) provides that the term “wages” does not include remuneration that is excludable from the employee’s income under Sec. 911, the foreign earned income exclusion. A U.S. citizen may qualify for the foreign earned income exclusion if the employee has a foreign tax home, foreign earned income, and is either (1) a U.S. citizen who was a bona fide resident of a foreign country for an entire tax year, (2) a resident alien who is a citizen or national of a country with an income tax treaty with the United States who was a bona fide resident of a foreign country for an entire tax year, or (3) a U.S. citizen or resident alien who was physically present in a foreign country for at least 330 full days. It is important to note that while both U.S. citizens and resident aliens may qualify for the foreign earned income exclusion, only U.S. citizens are allowed to exempt this amount from withholding under Sec. 3401(a)(8)(A)(i).

The other statutory exemption from FIT withholding is when foreign wages are subject to mandatory withholding in the foreign host country under Sec. 3401(a)(8)(A)(ii). Again this exception from withholding is available only to U.S. citizens. Also, the employer cannot implement voluntary foreign income tax withholding to avoid FIT withholding.

For 2013, the maximum foreign earned income exclusion is $97,600. A resident alien is not exempt from foreign earned wage withholding, but he or she may provide a Form W-4, Employee’s Withholding Allowance Certificate, claiming additional allowances in anticipation of the Sec. 911 exclusion or a foreign tax credit.

FICA Liability and Withholding

Generally, Social Security and Medicare (or Federal Insurance Contributions Act (FICA)) tax withholding, and the employer’s share of FICA, apply when wages are paid to U.S. citizens and resident aliens for services rendered outside the United States. Unlike with FIT withholding (which requires any employer of a U.S. citizen or resident alien to withhold), the employer must be an American employer for FICA taxation and withholding to apply to foreign-source services.

Sec. 3121(b) provides that employment for FICA purposes includes any service performed outside the United States by a U.S. citizen or resident alien if those services are provided to an American employer. Sec. 3121(h) provides that an “American employer” includes a corporation organized under the laws of any state or the United States, a U.S. resident, or a partnership where two-thirds or more of the partners are U.S. residents.

A U.S. citizen or resident alien working in a foreign country may also be subject to social security-type taxes of the foreign government for the same work, resulting in dual coverage and dual taxes. To limit double taxation, the U.S. government has entered into totalization agreements with other countries. These agreements usually provide that the foreign wages are subject to the local, foreign social security taxes.

However, under totalization agreements, if a U.S. citizen or resident alien is sent by the American employer on a temporary assignment (less than five years) to the foreign country that has entered into a totalization agreement with the United States, the U.S. citizen or resident alien is usually required to remain covered only by U.S. Social Security and Medicare. To exempt the wages from the foreign (host) country’s social security tax, the American employer must secure a Certificate of Coverage (CoC) from the U.S. Social Security Administration. The CoC serves as proof of entitlement to the foreign exemption for the U.S. employee and the employer.

FUTA Liability

The wages paid to a U.S. citizen (but not a resident alien) are subject to the Federal Unemployment Tax Act (FUTA) taxes if paid by an American employer, even if the services are provided in a foreign country. Totalization agreements do not cover FUTA taxes. An “American employer” is defined for FUTA purposes in Sec. 3306(j)(3) and mirrors the American employer definition for FICA under Sec. 3121(h).

SUTA Liability

In general, wages paid to a U.S. citizen (but not a resident alien) are subject to State Unemployment Tax Act (SUTA) taxes if paid by an American employer, even if the services are provided in a foreign country. SUTA statutes define “American employer” similarly to Sec. 3121(h) and Sec. 3306(j). The American employer reports the wages subject to SUTA to the state where the American employer’s headquarters are located, not the expatriate’s former worksite or resident state.

The views expressed are those of the author and do not necessarily reflect the views of Ernst & Young LLP.

EditorNotes

Valrie Chambers is a professor of accounting at Texas A&M University–Corpus Christi in Corpus Christi, Texas. Mary Gorman is a senior manager in the Ernst & Young LLP Employment Tax Advisory Services advising on domestic and foreign employment tax matters. For more information about this column, contact Prof. Chambers at valrie.chambers@tamucc.edu.