Editor: Mary Van Leuven, J.D., LL.M.
In an increasingly global and competitive work environment, companies frequently turn to business travelers, remote workers, contractors, or short- or long-term assignees to satisfy a particular business need. Along with complex issues such as immigration, the U.S. tax issues associated with compensating these employees can be challenging. With advance planning, however, the potential U.S. tax issues and compensation challenges may be mitigated. This item highlights several key cross-border compensation issues non-U.S. companies need to consider when employing individuals in the United States and U.S. taxpayers overseas.
Equity awards: Sec. 409A
While many U.S. companies design equity awards with the Sec. 409A nonqualified deferred compensation rules in mind, non-U.S. companies often do not realize that punitive U.S. tax consequences exist for awards that fail to satisfy, or fit into an exemption to, Sec. 409A rules. In particular, the employee may be subject to taxation under Sec. 409A at vesting (rather than when the amount is actually paid — a dry income problem) plus an additional 20% tax charge (a premium interest tax charge may also apply).
For example, stock options granted by a non-U.S. company with a discounted exercise price and restricted stock units with discretionary payment terms may be problematic under Sec. 409A if granted to an employee on assignment to the United States or to a U.S. taxpayer working in a non-U.S. jurisdiction. However, non-U.S. companies may take steps to design equity awards that satisfy (or fit into an exemption to) Sec. 409A. (Sec. 457A may also need to be considered but is outside the scope of this discussion.)
Ideally, a review of the non-U.S. equity plan is completed prior to granting an equity award to a U.S. taxpayer or sending an employee on assignment to the United States. A preemptive review allows non-U.S. companies to identify potential problems with plan provisions from a Sec. 409A standpoint and provides the information necessary to decide whether to add specific U.S. terms through the award agreement or a U.S. addendum to mitigate the U.S. tax consequences. For example, the simplest solution for a stock option grant is often to grant the award with an exercise price equal to the stock's fair market value, as determined under Sec. 409A (which itself may differ from foreign valuation rules), and to make sure the grant is over service recipient stock.
If a preemptive review is not done, it is possible that the particular award does not result in taxation under Sec. 409A. Careful review of the specific award and plan may be necessary to conclude that an exemption is available. Even if an exemption is not available, a correction program for plan document and plan operation failures may provide limited relief to Sec. 409A taxation. In these situations, U.S. executive compensation specialists can advise on how to approach existing awards while at the same time considering changes so future awards are not problematic.
Equity awards: Sec. 83
Aside from Sec. 409A issues, restricted stock awards granted by a non-U.S. company may also result in unexpected U.S. tax consequences if prior thought is not given to how the award will be treated in the United States. Under Sec. 83, a restricted stock grant generally results in compensation income when the stock becomes vested. Non-U.S. companies and employees may not realize that a Sec. 83(b) election can be made within 30 days of the restricted stock grant to include compensation in income when granted so that any future appreciation in value is capital. The election is quite useful if timely made because if the restricted stock vests while the employee is working in the United States, no compensation income is subject to U.S. taxation when the stock vests.
Often, non-U.S. companies assist employees in restricted stock purchases by offering loans. The use of a loan to facilitate the restricted stock purchase may be considered the grant of an option rather than the grant of restricted stock. The recharacterization as an option means that the employee cannot make a Sec. 83(b) election. Additionally, if the loan is granted with an interest rate below the applicable federal rate, the employee may be subject to U.S. taxation on the imputed income. If a non-U.S. company facilitates the share purchase with a loan, a review of the award and loan documentation is recommended to determine the potential imputed income tax consequences based on whether the award is treated as the grant of restricted stock (for which a Sec. 83(b) election may be made) or an option (for which a Sec. 83(b) election is unavailable).
Corporate transactions
When a non-U.S. company is exploring how to handle outstanding equity awards in connection with a corporate transaction, consideration should be given to the U.S. tax requirements, such as Secs. 83 and 409A. For example, if target option awards will be rolled over into acquirer option awards, the rollover of options held by employees who are U.S. taxpayers should generally be in accordance with Sec. 409A. (Sec. 424 may also apply if the awards are incentive stock options.)
In some transactions, the merger consideration may include an earnout provision pursuant to which an employee is granted the right to future compensation tied to certain revenue or other performance objectives. To the extent an earnout provision is included as part of the corporate transaction, non-U.S. companies need to consider whether the earnout will be treated as nonqualified deferred compensation and how to design the earnout in compliance with Sec. 409A, such as providing for a permissible distribution event or qualifying it as a short-term deferral. Further, to the extent a compliant nonqualified deferred compensation plan or award requires a distribution on a change in ownership or control, the distribution must be timely made following the change in ownership or control to satisfy Sec. 409A.
Additionally, a non-U.S. company may need to consider whether the corporate transaction is a change in ownership or control for purposes of Secs. 280G and 4999 (the golden parachute rules). Generally, Secs. 280G and 4999 may deny a corporate deduction and impose a 20% excise tax on the individual with respect to certain payments made in connection with a change in ownership or control. For example, even if the acquirer and target are non-U.S. corporations to which the Sec. 280G deduction limitation may not apply, if the CEO (or certain other individuals who are considered disqualified individuals) is a U.S. taxpayer who receives significant compensation in connection with the merger, then the CEO may be subject to a 20% excise tax on certain excess parachute payments.
Even though Secs. 280G and 4999 may appear to apply, the exception for certain privately held companies that satisfy the shareholder vote and disclosure requirements often provides a mechanism to mitigate or eliminate the deduction disallowance and excise tax. If this exception is not available, a company may need to explore other mitigation techniques, such as increasing compensation in the years prior to the merger. Nevertheless, unless the company recognizes the potential application of the golden parachute rules and engages in advance planning prior to closing the transaction, it may be unable to mitigate the negative impacts of Secs. 280G and 4999.
Non-U.S. retirement plans
While a non-U.S. employee may be able to defer income into a non-U.S. retirement plan on a tax-efficient basis while working outside the United States, once the employee moves to the United States and performs services, continued participation may no longer be tax-efficient. The U.S. tax consequences of participation in a non-U.S. retirement plan depend on a variety of factors, including whether the plan is funded, how it is funded, if there is a substantial risk of forfeiture attached to benefits under the retirement plan, and the relevant income tax treaty (if any). For example, if the retirement plan is funded with a trust and the employee is considered highly compensated, then the employee is generally taxable on the increase in the vested accrued benefit each year under Sec. 402(b)(4). Taxation may occur each year even if there are no employer contributions to the retirement plan while the employee is working in the United States.
Aside from contributions and accruals to a non-U.S. retirement plan while working in the United States, an employee who is on assignment to the United States may not realize that there may be U.S. tax consequences if the employee takes a distribution or transfers amounts from one retirement plan to another while he or she is a U.S. resident. In some situations, the employee may be subject to U.S. taxation on the distribution or transfer, particularly if the relevant income tax treaty does not protect the distribution or transfer from U.S. taxation.
Employer-reimbursed moving costs
Prior to the enactment of the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, qualified moving reimbursements were excludable from an employee's gross income for federal income tax purposes and from wages for employment tax purposes. Qualified moving expenses generally include amounts paid by the employer that would have been deductible if paid by the employee as a moving expense. Following the enactment of the TCJA, the exclusion for employer-reimbursed moving costs was suspended until 2026 (with an exception for members of the armed forces on active duty who move pursuant to military orders and incident to permanent changes of station).
Realizing that they could no longer move employees tax-free to a new assignment location, many U.S. employers made formal adjustments to payroll processes to reflect the taxability of moving expense reimbursements or provided gross-ups to affected employees, while other employers made ad hoc determinations regarding the treatment of moving expenses. Accordingly, employers may want to review the costs and benefits associated with their choices regarding reimbursement of moving expenses to determine whether additional changes to internal processes, policies, and communications are necessary. As part of that review, employers may want to consider whether a long-term assignment is the most cost-effective choice to satisfy the particular business need, given the changes in how and where employees work.
Compliance challenges
There are many issues, including taxation, to consider in connection with cross-border compensation. This item highlights some issues that may arise for equity compensation, corporate transactions, non-U.S. retirement plans, and moving expenses. In addition to these issues, other U.S. tax issues often arise, including those with respect to:
- Sourcing of compensation;
- Employer and employee information reporting;
- Federal income tax withholding compliance;
- The corporate deduction for compensation expense;
- Compensation paid to nonemployee directors;
- U.S. Social Security and Medicare treatment; and
- State income tax law implications.
Given the increased reporting and communication between taxing authorities and the current emphasis on compliance, non-U.S. companies should carefully consider the U.S. tax consequences associated with cross-border compensation when sending employees to work in the United States or hiring a U.S. taxpayer to work outside the United States.
EditorNotes
Mary Van Leuven, J.D., LL.M., is a director, Washington National Tax, at KPMG LLP in Washington, D.C.
For additional information about these items, contact Ms. Van Leuven at 202-533-4750 or mvanleuven@kpmg.com.
Contributors are members of or associated with KPMG LLP. These articles represent the views of the author(s) only, and do not necessarily represent the views or professional advice of KPMG LLP. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.
