When your foreign or US domestic business performs work in the US, there may be an unexpected effect on your US taxes–such as being required to report payroll taxes. The IRS requires that every employer who pays wages to an employee performing work in the US report their payroll and withholding taxes. This is the case whether the employee is a US citizen or a foreign national. Furthermore, US citizens performing work abroad as employees of US companies are also subject to US payroll withholding requirements. If you fail to properly report and withhold payroll taxes, the IRS can and will assess some stiff penalties so it is important to fully understand your payroll tax responsibilities.
Who is an Employee?
An employee is a person who performs work for your company and meets several key criteria. An employee will work at a time and place governed by the employer. The employer will generally supply the employee with all of the tools necessary to complete their job. The employer will also provide some direction to the employee regarding how the work is performed. If these criteria are not met, it is possible that the person performing the work is a contractor, rather than an employee. Payroll withholding is not required for contractors. Please see the IRS website for more in-depth discussion regarding employees and contractors.
Am I an Employee of My Own Company?
This depends on how the company is legally structured. If your company is organized in the US, how your work for your own company is compensated and treated will depend largely upon how the company is structured. The following table describes each popular entity and how the work performed by the owner is treated:
|Sole Proprietorship||Owner is not considered an employee. No payroll reporting is required on behalf of the owner. All of the business’ income flows through on the owner’s personal tax return, and is taxed at self-employment rates.|
|General Partnership||General partners are not considered employees. No payroll reporting is required on behalf of the general partners. All of the business’ income flows through to the owners’ personal tax returns, and is taxed at self-employment rates.|
|Limited Liability Company||Managing members are not considered employees. No payroll reporting is required on behalf of the members. All of the business’ income flows through to the members’ personal tax returns, and is taxed at self-employment rates.|
|S Corporation||Managing Shareholders who perform work for the S Corporation must pay themselves a “reasonable salary.” The S Corporation must withhold payroll taxes from this salary, and report and pay the employer portion of the payroll taxes. The S Corporation is allowed a deduction for their payroll expenses. Any remaining profit not paid out as salary must be distributed to the shareholders at the end of the year, and taxed at ordinary rates.|
|C Corporation||Shareholders who perform work for the C Corporation will pay themself a salary. The C Corporation must withhold payroll taxes from this salary, and report and pay the employer portion of the payroll taxes. The C Corporation is allowed a deduction for their payroll expenses. Any remaining profit not paid out as salary will be taxed at the corporate level. It may or may not be distributed to shareholders as a dividend, at which point they will be taxed on the profit again at the individual level.|
Ok, I am required to report and pay payroll taxes. Where do I start?
When you have done the research and arrived at the conclusion that you must be reporting and paying US taxes on your employees, you will want to become familiar with the various agencies to which payment will be required. The payroll reporting requirements for employers are summarized below:
|Types||Payable To||Withholding Rate (Employee Portion)||Employer Portion|
|Federal Withholding||Internal Revenue Service via quarterly Form 941||Dependent upon employee’s gross wages – See IRS Publication 15||None|
|Social Security Tax||Internal Revenue Service via quarterly Form 941||4.2% for 2012, will revert back to 6.2% in 2013 Maximum annual taxable earnings of $110,100||6.2% Maximum annual taxable earnings of $110,100|
|Medicare Tax||Internal Revenue Service via quarterly Form 941||1.45% of gross wages||1.45% of gross wages|
|Federal Unemployment (FUTA)||Internal Revenue Service via annual Form 940||None||0.6% on first $7,000 in gross wages (Adjustments for those paying wages in credit reduction states)1|
|State Unemployment (FUTA)||Varies by State||Varies by State||Varies by State|
The employer should be aware the reporting and deposit requirement frequency can change dependent upon your gross wages paid. It should be noted that Social Security and Medicare taxes combined (also known as Federal Insurance Contributions Act, or FICA, taxes) AND doubled is equal to the self-employment tax rate of 15.3%.
6.2% + 1.45% = 7.65% * 2 = 15.3%
It is the employer’s responsibility to withhold and pay the US taxes as directed by law. Having employees increases the company’s responsibilities considerably as there will now be additional paychecks, reconciliations, withholding, reporting and payroll tax returns. Employers may also have additional state and/or local reporting requirements, such as state unemployment or disability insurance. These should be investigated at the state level.
I am an expat working for a US-based company. How does this affect my US taxes?
As you have probably already discovered, living and working abroad can have a big impact on your US expatriates tax return. If you are a US citizen who works as an employee of a US business, you are still subject to US payroll withholding requirements, even if you are working abroad. If you meet the tests to qualify for the Foreign Earned Income Exclusion, you will still be able to claim this exclusion against your income on your tax return. Furthermore, if you fall below the Foreign Earned Income Exclusion, you can file Form 673 with your employer to request exemption from Federal income tax withholding on your wages. If you are self-employed, it is important to note that the Foreign Earned Income Exclusion cannot be used to offset self-employment taxes, whether you work in the US or abroad.
Want More Information About the US Tax Implications of Employees Working Abroad?
For an overview of all the exclusions, deductions and taxes that affect employers and employees abroad, check out our blog post. If you have additional questions or would like Greenback Expat Tax Services to prepare your expat tax return, please contact us.