US Expat Taxes for US Employees on Foreign Assignments
As the trend for sending employees overseas increases, it’s important for domestic US businesses to understand the full assortment of US expat tax issues that arise for both the employee and the employer. The employer cost of sending an employee abroad can be expensive, when you factor in such items as travel, equalization packages, various reimbursements and continued payroll tax reporting responsibilities. However, with advance planning and experienced professional tax advice, a company can minimize these costs and get the most from their employee’s foreign assignment.
Foreign Assignments, US Expat Taxes and the Foreign Earned Income Exclusion
A US domestic employer should educate their employee(s) regarding all of the tax implications of their move abroad prior to the employee’s acceptance of the foreign assignment. The employer will likely want to arrange the foreign assignment in such a manner as to ensure the employee’s qualification of the foreign earned income exclusion (FEIE). To do this, they need to ensure that the employee’s foreign assignment places them in a “tax home” abroad for a period greater than one year. This will allow the employee to exclude up to $105,900 from 2019 US taxes ($107,600 on 2020 US taxes) of their income from their US expat taxes.
In addition, the employee must meet one of the following two tests:
- Physical Presence Test: The employee’s foreign assignment must put them abroad for at least 330 days in a 365 day period. The 365 day period can be any period prior to the filing date of the employee’s US expat taxes. See our blog for more information on meeting the requirements of the Physical Presence Test in our US Expat Taxes Explained Series.
- Bona Fide Residence Test: When an employee moves abroad on foreign assignment for an indefinite period that includes at least a full calendar year, they will qualify for the FEIE under the Bona Fide Residence Test. See our blog for more information on the bona fide residence test in our US Expat Taxes Explained Series.
Despite the employee’s qualification for the FEIE, it can only be claimed by completing Form 2555 and attaching it to their US expat taxes. Most employees of US businesses will qualify for the FEIE using the Physical Presence Test.
Payroll Taxes for Foreign Assignments
As a domestic US business, you will be required to withhold taxes for your US employees, even if they are working abroad. However, if the employee’s federal withholding is eliminated because of their qualification of the FEIE, they can request an exemption from federal withholding by completing Form 673 and submitting to their employer.
Foreign Housing Exclusion and Deduction
When an employee meet the tests to qualify for FEIE, they will also become eligible to claim an exclusion or deduction for foreign housing expenses. Foreign employees whose housing was paid using employer-provided dollars will be claimed on Form 2555 as a housing exclusion. Foreign housing expenses paid with self-employment earnings (independent contractors) will be taken as a deduction directly on Form 1040. The amount excludable varies by location. The appropriate deduction limitation eligible on US expat taxes for each location can be found in the Instructions for Form 2555. Expenses eligible for the exclusion or deduction include rent, repairs, utilities (not telephone), property insurance, furniture rental and residential parking expenses.
In some instances, a US based employer will reimburse an employee for his/her foreign living expenses. While these reimbursements are included as taxable income to the employee, the foreign housing exclusion or deduction will be taken on the employee’s US expat taxes. Any amount reimbursed to the employee in excess of the host country’s allowable limitation will increase the employee’s US expat taxes. However, because a deduction cannot be taken for foreign housing expenses not actually paid, the opposite is not true
Foreign Tax Credit
An employee’s residence in a foreign country will likely subject them to taxation in their host country. A US taxpayer who is required to pay taxes to a foreign country will be eligible to use those taxes to calculate a foreign tax credit on their US expat taxes. This credit will reduce the employee’s US expat taxes dollar for dollar. An employee cannot claim a foreign tax credit on income that has already been excluded by the FEIE or foreign housing exclusion.
Equalization Package for Foreign Assignments
For employers whose advance planning shows them that the foreign assignment would prove to be excessively costly for their employee, they might consider offering a tax equalization package to the employee. A tax equalization program is a voluntary benefit that ensures an employee’s out-of-pocket tax expense is no more or less than if they would’ve stayed stateside. The equalization program includes consideration for any foreign employer benefits (housing, cost of living adjustments or school tuition), foreign taxes and any other taxable factors associated with their foreign assignment. Under an equalization program, the employer will reimburse the employee for any additional burden on their US expat taxes associated with their foreign assignment.
Employer Provided Benefits
Any reimbursement by the US-based employer to the employee for personal expenses will generate additional taxable income to the employee. These reimbursements include:
- Relocation costs
- Education expenses
- Spousal allowance
- Automobile allowance
- Home leave
However, any expenses reimbursed to the employee for direct business expenses or deductible moving expenses will not increase taxable income. Moving expenses are deductible if they meet the following three criteria:
- The move must be related to the start of work at a new job location.
- The new job location must be greater than 50 miles from your previous location.
- The employee must remain employed full-time for at least 39 weeks following the move.
These expenses will only consist of the actual expenses to move household goods from the old location to the new, including temporary storage if necessary and travel expenses. Temporary living expenses, meals, and travel associated with house-hunting are not deductible. Thus, any reimbursements for these expenses made by the employer become taxable to the employee. In addition, any amount paid to the employee as reimbursement for the loss on the sale of their home is a taxable event to the employee. These additional taxable reimbursements should be included on the employee’s W-2 and reported on their US expat taxes.
Other Considerations for Foreign Assignments
US domestic companies sending employees abroad should enlist the help of an experienced expat tax professional who is familiar with the regulations of the host country. Each host country has its own laws, tax rates, and treaties; each has an impact on the resulting US expat taxes. For the US company, simply having employees establish a permanent location abroad could create corporate tax responsibilities in the host country.
More Information About Tax For Foreign Assignments
There are many aspects about an overseas assignment that must be reviewed prior to accepting it, both by the employee and the employer. A good place to start is our blog post on tax-saving opportunities in your US expat taxes. If you have further questions or would like to learn about our expat tax services, please contact us. Or ready to file your taxes? Get started today.
Originally published in 2012; most recently updated March 3, 2020.
