US Expat Taxation: Employee & Employer Insights

We often talk about digital nomads – the type of American who decides to move overseas for a new adventure and has the ability to work from anywhere they choose to live at the moment. But what about the large group of US expats who may be employed by a domestic US business and are given the opportunity to take on an overseas assignment? (Check out some of the ways moving abroad for work can help you grow professionally.) If you’ve found yourself in this scenario or may be considering it, there are some expatriate payroll taxation considerations you should be aware of. Likewise, the company sending their employees abroad will have some tax implications as well. Whether you’re the employee or the employer, get the facts you need about American expat taxes, terms and expat payroll.

Foreign Earned Income Exclusion for Relocating Employees Abroad

As a domestic US employer, taking the time to educate your employee on the implications of American expat taxes prior to relocating employees abroad is a smart idea. Setting up the assignment in a way that allows the employee to take advantage of the Foreign Earned Income Exclusion (FEIE) is very important, as it will allow the employee to exclude $108,700 of foreign earned income from their 2021 expat taxes. To use the FEIE, the employee must:

• Have a foreign assignment that places them in a “tax home” abroad for a period greater than one year.
• Pass one of two residency test options:
  • Physical Presence Test – Must live abroad for 330 days out of a 365-day period, which can be any time period prior to the filing date of his or her expat taxes.
  • Bona Fide Residence Test – Must live abroad for at least a full calendar year with no intention or plans to return to the US.

You can learn more about the FEIE in this article. Typically, most employees of domestic US businesses will qualify for the FEIE using the Physical Presence Test. Also, check out our tax guide for Americans working overseas for other ways to save on expat taxes.

Foreign Housing Exclusion or Deduction

If an employee qualifies for the FEIE, he or she will also be eligible to claim an exclusion or deduction for foreign housing expenses. If your housing was paid using employer-provided dollars, you’ll claim this on Form 2555 as a housing exclusion. On the contrary, if you went overseas as an independent contractor and paid your housing expenses with self-employment earnings, you’ll take a deduction directly on your American expat taxes. Expenses that are eligible for the exclusion or deduction include:

• Rent
• Repairs
• Utilities (excluding telephone)
• Property insurance
• Furniture rental
• Residential parking expenses

Occasionally, a domestic US business will choose to reimburse the employee for foreign living expenses. These are included as taxable income, but the foreign housing exclusion or deduction will be taken on your US Tax Return.

Foreign Tax Credit

Often, employees will be subject to taxation in their host country. Fortunately, though, US taxpayers who must pay taxes to a foreign country will be eligible to use a Foreign Tax Credit to offset their American expat taxes. This credit will reduce the employee’s taxes dollar for dollar, but note it cannot be used on income that has already been excluded by the FEIE or Foreign Housing Exclusion.

Employer Benefits

Providing additional benefits to employees during expat payroll in the form of reimbursement will create additional taxable income for the employee. Types of reimbursements include:

• Relocation costs
• Education expenses
• Spousal allowance
• Automobile allowance
• Home leave

Any expenses reimbursed to the employee for direct business expenses or deductible moving expenses will not increase taxable income. Moving expenses can be deducted if they meet all of the following criteria:

• The move must be related to the start of work at a new job location.
• The new job location must be more than 50 miles from the previous location.
• The employee must remain employed full-time for at least 39 weeks following the move.

Deductible expenses consist of actual expenses to move household goods from the old location to the new (including temporary storage and travel expenses). Things like temporary living costs, meals and travel related to house-hunting are not deductible – so any reimbursements made for these expenses made by the employer will be taxable for the employee during expat payroll.

Expat Employee Taxes: Other Considerations for Employers and Employees

Payroll Taxes

Domestic US businesses must withhold payroll taxes for US employees, even if they’re working abroad, unless it says otherwise in the tax treaty (based on totalization agreement for example). However, if the employee’s federal withholding is eliminated because they qualify for the FEIE, they can request an exemption from federal withholding by completing Form 673 and submitting it to their employer.

Equalization Package

In some cases of expat employee taxes, moving an employee abroad can come with excessive cost on behalf of the employee, so an employer may want to offer an equalization package to help offset the cost increase. This essentially ensures the employee’s out-of-pocket tax expense is no more or less than if they were in the US. It includes consideration for foreign employer benefits like housing, cost of living adjustments or school tuition, foreign taxes and other taxable factors related to their assignment. With this package, the employer would reimburse the employee for the additional burden on their US expat tax associated with their foreign assignment.

Host Country Regulations

Every country differs when it comes to laws, tax rates and treaties, and those differences will have an impact on the employee’s US expat taxes. Likewise, choosing to have employees establish a permanent location abroad could create corporate tax obligations for the employer. It’s a good idea to consult with an expatriate tax professional when an employee is planning a move overseas, to ensure both parties are fully prepared for the potential expat tax implications.

Working Abroad and Need Help with Your American Expat Taxes?

Our expat-expert accountants are here to help by offering the expat tax expertise you’re looking for so you can cross US expatriate payroll taxation off your to-do list well ahead of the deadline. Get started with us today!