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The growth of our global economy has created an international marketplace for employees. Much like the rapid global capital flows that characterize our current economic environment, skilled employees are viewed as vital assets that must be redeployed as the need arises, regardless of national borders.

In recent years, several factors have been leading American businesses to reach that conclusion and make use of foreign employees in the United States.

An obvious prod has been the relative shortage of skilled workers in many job categories. Perhaps more important, employees brought in from a company's office abroad usually are familiar with its industry, its systems and its practices, which makes these workers more productive in the short term than new hires might be. In a business environment that emphasizes immediate results, plugging an experienced employee from abroad into an existing job opening is an appealing alternative.

So despite a softening U.S. economy, foreign employees continue arriving in the United States from the overseas offices or affiliates of American businesses for assignments that may last a few months or a few years. However, in making the decision to rely on assistance from abroad, U.S. employers often fail to consider the tax implications, and that can complicate the situation for the company and the foreign employee.

This can be a costly mistake - for the employer and employee. For example, a Japanese national arriving in the United States on a temporary work assignment could be subject to a combination of U.S. and Japanese payroll taxes (exclusive of income taxes) equal to almost 40 percent of the employee's gross salary.

Employers should have three objectives when considering tax issues in such situations:

• Meet the company's own tax reporting and contribution obligations at the state and federal levels in the United States, as well as in the employee's home country.
• Protect the employee, making sure that he or she is not financially penalized for taking a job in the United States.
• Minimize the employer's tax liabilities and those of the employee.

In pursuit of those objectives, employers must consider that there are distinct obligations for income taxes, and for health-and pension- related taxes (Social Security and Medicare contributions). Even while working in the United States, employees from abroad may owe both types of taxes in their home countries. In fact, compliance issues in this area aren't necessarily straightforward and can vary substantially depending on an employee's home country.

Contribution obligations to national retirement and health programs, such as Social Security and Medicare, often are the source of double taxation issues. While working here, many employees from abroad will
be responsible for making contribution both to the U.S. Social Security system and the retirement program in their home country. As the earlier example of the Japanese employee makes clear, this can create a significant added burden for the employer and potentially for the employee, because many payroll tax obligations involve employee and employer contributions.

To resolve this issue, the United States now has signed treaties with 17 nations, primarily in Europe, that eliminate dual taxation by retirement programs. Under treaty terms, contributions made by or for an employee go to the employee's home country if the employee is expected to stay in the United States for less than five years. If, however, the employee is here for a longer period (or anticipates becoming a permanent U.S. resident), the contributions go to the U.S. system.

Yet, because only 17 countries have reached a treaty with the United States on this issue, the potential for double contributions remains common. This, in turn, has the effect of discouraging the practice of transfer- ring foreign employees to the United States, which limits the flexibility of U.S. businesses in meeting their employment needs.

Nonetheless, the use of foreign employees continues to expand. Where double contributions are inescapable, employers often accept their own added liability and provide increased compensation so that the employee's take-home pay remains equal to what it would have been without the double contribution requirement.

When contributing to foreign retirement and health programs on behalf of employees working here, u.s. employers find the most efficient method is to have their branch office or affiliate in the employee's home country make the payments. The debt created to the foreign operation is then repaid through an internal inter-company transaction. This strategy reduces the need for frequent and costly currency transactions and makes it unnecessary for human resources professionals in the United States to master another nation's payroll tax procedures.

When it comes to income taxes due on the u.s. earnings of foreign nationals, the issues often are less confusing than in the case of retirement and health contributions. For example, many nations offer a tax credit that lets their citizens offset U.S. income taxes paid on income earned here. However, that treatment can vary from nation to nation, so some research is essential.

Meanwhile, the tax liability to the U.S. government incurred by a foreign employee working in the United States is governed by reason- ably clear rules. First, the employee is classified as either a resident alien or non-resident alien, and it is generally preferable to be the former.

If a resident alien earns income in the United States and pays taxes on that income in another country, he or she usually can claim a foreign tax credit as a dollar-for-dollar offset against u.s. income taxes. Non-resident aliens do not receive such credits.

Fortunately, most aliens who live in the United States for only a portion of the year in which they first arrived can choose resident alien status for the entire year in order to claim the benefit of the tax credit. Even if a husband and wife don't arrive in the United States simultaneously, both can choose resident status for tax purposes as soon as one of them meets the minimum requirements.

Those requirements involve either having permanent resident status (a green card) or meeting what is called the "substantial presence test." There are two ways to meet that test. Either an employee must have worked in the United States for at least 31 days in the present year and 183 days during the prior three years, or the employee will have worked 31 days in the United States during the year of arrival and 183 days during the following year.

New arrivals found the second approach preferable. For example, an employee who begins working in the United States in November, 2001 could qualify for resident alien treatment of2001 taxes as soon as July 1, 2002, by accumulating 183 days of residence. However, to file 2001 income taxes as a resident alien, the employee would have to request an automatic extension of the normal April 15 income tax filing deadline until the 183-day "substantial presence" period was complete. To avoid potential penalties, the employee should pay the IRS, by April 15, an amount sufficient to cover the anticipated income tax liability even if the tax return is filed months later.

Clearly, employers should get a handle on these tax issues even before the decision is made to move an employee here from abroad. That way, both parties can understand the tax implications of the move and evaluate its pros and cons objectively.

DAVID DIAMOND IS A CPA AND PARTNER IN THE FIRM OF
KUTCHINS ROBBINS & DIAMOND, AND HAS HELPED CORPORATIONS DEAL WITH THE TAX ISSUES RELATED TO THE USE OF FOREIGN EMPLOYEES. HE CAN BE REACHED VIA E-MAIL AT DLD@KRDCPAS.COM.

OCTOBER/NOVEMBER 2001 Reprinted from ALA News with permission from the Association of Legal Administrators