Foreign employers’ FICA obligations: Key challenges and compliance strategies

Editor: Jeffrey N. Bilsky, CPA

For non–U.S. employers whose employees have nexus to the United States, compliance with U.S. Social Security obligations under the Federal Insurance Contributions Act (FICA) can pose unexpected challenges. While the FICA rules are generally applied — with few exceptions — on a territorial basis, employees working outside the United States may be subject to FICA tax if both the employer and the employee have a connection to the United States. Determining an employer’s and employee’s FICA obligations can be nuanced and often requires an examination of the employee’s visa type, the location where the employee is performing services, applicable in–force totalization agreements (if any), and statutes and regulations that are sometimes unclear.

A foreign employer’s obligation to comply with U.S. FICA rules can be administratively burdensome and generally requires the establishment of a U.S. payroll system. This, in turn, can lead to the foreign employer needing to comply with other obligations, such as wage withholding, unemployment tax, corporate income tax, and other federal and state requirements.

General FICA rules

With only a few specific exceptions, FICA applies to all employees providing services for an employer within the United States, regardless of whether the employee is a U.S. citizen, resident alien, or nonresident alien and regardless of whether the employer is a U.S. entity or has any other connection to the United States beyond the employee’s presence. However, FICA rules are not strictly territorial, as FICA tax may also apply to U.S. citizens and resident aliens working outside the United States in certain circumstances. Specifically, FICA tax is imposed on U.S. citizens and resident aliens working abroad if their employer is an “American employer” (see Sec. 3121(h)) or a foreign affiliate for which an American employer has made a “FICA election” (Sec. 3121(l)).

If a U.S. citizen works abroad for an employer that is neither an American employer nor a foreign affiliate covered by a FICA election, they are typically exempt from FICA tax under the Code. Moreover, such individuals cannot choose to be subject to FICA tax to maintain FICA coverage.

FICA rules for nonresident aliens

Under the FICA territorial rule in Sec. 3121(b), an employee who performs services within the United States is subject to FICA tax on the portion of their salary attributable to U.S. business days, regardless of the citizenship or residence of either the employee or the employer. With limited exceptions for certain nonimmigrant visa holders, FICA taxes generally apply to all nonresident aliens employed in the United States. Because U.S. income tax treaties generally do not provide exemptions from Social Security tax, a nonresident alien whose income is otherwise exempt from federal income tax under the relevant article of a U.S. income tax treaty will nevertheless be subject to FICA on these wages.

Except for certain nonresident aliens working on U.S.-flag vessels or aircraft, a nonresident alien is exempt from FICA tax on all work done outside the United States.

FICA applies to wages exempt under Sec. 861(a)(3)

If certain conditions are met, the de minimis exception of Sec. 861(a)(3) exempts from federal income tax certain compensation for services performed in the United States. In general, this exemption applies if:

• The nonresident alien is present in the United States during the tax year for fewer than 90 days in the aggregate;
• The total compensation earned for services performed in the United States does not exceed $3,000 in the aggregate; and
• The compensation is paid by a foreign employer or a U.S. employer that maintains an office in a foreign country or U.S. possession.

This exemption, while not frequently used because of the low dollar threshold, typically applies to nonresident alien employees of foreign employers who make short business trips to the United States. However, even if an individual can exempt this income from income tax under Sec. 861(a)(3), it is not necessarily exempt from FICA tax. This position was confirmed in Rev. Rul. 92–106, which examined the FICA and income tax obligations of nonresident aliens who performed employment services within the United States.

FICA exemptions for certain visa categories

Certain nonimmigrant visa holders (primarily those with A, F, G, J, M, and Q visas) are exempt from FICA tax on wages for services performed to carry out the purposes for which such visas were issued to them. In the case of nonresident alien students holding F, J, M, or Q visas and nonresident alien professors, researchers, teachers, trainees, and other nonstudents holding J or Q visas, a broad FICA exemption is applied under Sec. 3121(b)(19).

Individuals employed by a foreign government (who generally hold A visas) are generally exempt from FICA taxes on wages earned from that employment. This exemption applies to nonresident aliens, resident aliens, and U.S. citizens alike. Similarly, employees of international organizations holding G visas are exempt from FICA taxes on wages earned from their employment. As with foreign government employees, this exemption applies regardless of the individual’s citizenship or residence status.

Outside these visa classifications, FICA exemptions may also apply to other nonimmigrant visa types and statuses. For example, crew members holding D visas may be exempt from FICA taxes if they serve on a foreign vessel with a foreign employer or if their services are performed outside the United States.

Totalization agreements

A totalization agreement — which overrides the FICA rules under the Code — is a bilateral agreement between the United States and another country designed to eliminate dual social security taxation and help cross–border workers qualify for benefits in both countries. In general, the tax provisions of U.S. totalization agreements may apply to any individual who could be subject to double social security taxation, regardless of their citizenship, immigration status, or residence in either country.

For U.S. citizens or residents employed by a foreign employer, the agreement determines which country’s social security system they contribute to, based on factors such as the length and location of their assignment. For nonresident aliens working in the United States for a foreign employer, the agreement similarly prevents double taxation and ensures coverage under only one system.

An individual who is exempt from U.S. Social Security tax under a totalization agreement is exempt from all FICA taxes imposed under Secs. 3101 and 3111, which includes Medicare tax. Thus, an exemption from FICA tax under a totalization agreement exempts individuals and their employers from both the Old–Age, Survivors, and Disability Insurance (OASDI) and Hospital Insurance (HI) tax portions of FICA. Likewise, a high–income individual who is subject to the additional Medicare surcharge is exempt from this tax under a totalization agreement. However, totalization agreements do not apply to Federal Unemployment Tax Act (FUTA) taxes or to state unemployment taxes.

Practical issues for foreign employers

As discussed above, wages paid to resident aliens working in the United States — whether for an American or foreign employer — are subject to Social Security and Medicare taxes under the same rules that apply to U.S. citizens. Similarly, wages paid to nonresident aliens for services performed in the United States are generally subject to Social Security and Medicare taxes, regardless of whether the employer is American or foreign, except in certain cases based on their nonimmigrant visa status, totalization agreement coverage, and other statutory exceptions not based on visa status.

While resident aliens employed in the United States will typically obtain a Social Security number (SSN) — which is typically used by an employer to comply with its FICA obligations — a nonresident alien making a short business trip to the United States is generally not eligible to obtain an SSN. However, an employee’s inability to obtain an SSN does not exempt a foreign employer from complying with its FICA obligations. To meet its FICA compliance requirements, a foreign employer must establish mechanisms to calculate, withhold, and remit both the employee and employer portions of Social Security and Medicare taxes. This often involves establishing a U.S. payroll system and requires the filing of certain quarterly payroll forms, along with issuing an annual wage statement to its employees.

A foreign employer that establishes a U.S. payroll system will also need to comply with wage withholding and FUTA rules, along with any applicable state and local payroll rules. In addition, the establishment of a U.S. payroll system could be seen as evidence that a permanent establishment (PE) has been created and expose the foreign employer to federal corporate income tax. Even if a PE is not created and no federal corporate income tax is required, the foreign employer may still face exposure to state and local corporate income tax obligations.

Enforcement considerations

While foreign employers’ FICA compliance is not currently an active campaign of the IRS’s Large Business and International Division, the enforcement of nonresident alien reporting related to tax treaty exemptions remains an active campaign. In most situations, wages exempt under an income tax treaty remain subject to the FICA rules. When nonresident aliens are required to report treaty–exempt wages on Form 8833, Treaty–Based Return Position Disclosure Under Section 6114 or 7701(b), with the filing of their Form 1040–NR, U.S. Nonresident Alien Income Tax Return, this could serve as a pathway for the IRS to discover a foreign employer’s noncompliance with the FICA rules.

Editor

Jeffrey N. Bilsky, CPA, is managing principal, Washington National Tax, with BDO USA, P.C. in Atlanta.

For additional information about these items, contact Bilsky at jbilsky@bdo.com.

Contributors are members of or associated with BDO USA, P.C.