Employment Of US Nationals Aboard, Compensation And Tax Issues

In this era of globalization, many US nationals find suitable job opportunities around the world.  From both employer and employee’s perspective, it is very important to understand the tax ramifications and requirements. The requirements vary depending upon whether employed by an American employer or foreign employer and the employer-employee relationship.

Compensation paid to US Nationals by an American Employer

Compensation paid to employees are subject to federal withholding , social security and Medicare tax if employed by an American employer for primarily most of the services performed. There are certain services that are exempt from such requirements which includes the following :

  1. Compensation paid to agricultural workers
  2. Compensation paid to students employed by university or college where they are enrolled full time
  3. Compensation paid to a duly ordained, commissioned or licensed minister of a church.
  4. Services of a house keeper performed in a private home of an employer, or in clubrooms or a house of a local college club
  5. Services performed within or outside the United States by an employee or officer ( regardless of citizenship or residence) of an international organization designated under the International Organizational Immunities Act
  6. Certain services performed outside the course of employer’s trade or business for which cash payment is less than $50 for the calendar quarter

There are certain situations, where the foreign country will impose social security on the compensation paid to US nationals employed by an American employer. This could create a situation where the US national is double taxed on the income.  In order to avoid this, US has entered into Totalization Agreements with some countries in order to avoid double taxation. US citizens and resident aliens who wishes to claim an exemption from US social security and Medicare taxes because of Totalization agreement must obtain a certificate of coverage from social security agency of his or her home country and present such certificate to the American employer, according to the procedures set forth in Revenue Procedure 80-56, 84-54 ,and Revenue Ruling 92-9  An alternate procedure is provided in these revenue procedures for an alien who is unable to secure a Certificate of Coverage from his home country

Compensation paid to US Nationals by Foreign Employer

On the other hand, wages paid to US citizens and resident aliens residing abroad by a foreign employer are exempt from federal tax withholding if either eligible for the earned income exclusion or subject to foreign withholding. Also, the wages are not subject to social security tax unless a binational social security tax agreement applies,  a section 3121 (i) agreement is entered into or in the case of certain services rendered to a domestically controlled foreign person.

The foreign withholding must result from a law or statute of the national government of the foreign country or US possession , a mere contractual agreement between the employer and employee is a not sufficient withholding requirement. Also, at the time of payment, if it is reasonable to believe that the income would be excluded from the recipient’s US gross income under either the foreign earned income exclusion or the housing costs exclusion, then an evidence to support reasonable belief may be based on statements submitted by the employee to the employer indicating he or she will qualify for the income exclusion under the bonafide  residence or physical presence test , even if the tests have not been met at the time wages are paid . The employer may rely on the employee’s statement unless the employer has the knowledge that the statement is incorrect . Also, Form FO-673 may be used.

Compensation in excess of the expected excludable amount is subject to federal withholding unless it is subject to foreign withholding.. The determination subject to withholding is made by applying the excludable amount on a pro-rata basis to each payment of remuneration to the employee.

We also need to understand that US nationals who work for foreign governments and International organizations are subject to certain different set of tax rules.  If he or she is a US citizen working in the US, they must report self-employment income under the Self employment Contribution Act(SECA). US citizens working in the US must pay self employment tax because the foreign government or organization is not liable for the employer’s portion of the contribution to the US system. However, you are not self-employed for any other federal tax purposes and cannot claim any deductions on Schedule C and also not allowed to establish a Simplified Employee Pension Plan (SEP). Previously, he or she was allowed to claim any unreimbursed employee expenses on Line 21 as Itemized deductions on Form 1040, which has been repealed from 2018 tax year per TCJA( Tax Cuts and Job Act).

On the other hand, when US nationals work for foreign government outside of the US, they are not subject to Self-employment tax rules.  In either case, if the US national expects a tax due at the end of the tax year , they must pay estimated payments as the compensation is not subject to withholding.

In summary, it is very important for both  the employers and employees to understand that there are US tax laws and foreign tax laws that are applicable irrespective of whether being employed by an American or foreign employer and ensure that they are in compliance with the laws.