International Tax Issues Impacting Nonprofits Part 2: Foreign Income Tax for Employees

In the first installment of our international series, we provided guidance for nonprofits awarding grants abroad. Now, we turn our attention to nonprofits that have employees temporarily working or based on foreign soil. If your organization employs anyone working outside of their home country, a variety of complex tax issues come into play for those individuals. With individual income tax rates exceeding 50 percent in some nations, it is vital that nonprofit leaders are fully aware of the international income taxes that employees may be subject to, so they can educate their employees accordingly.

To aid in this process, we’ve outlined five key international income tax issues to address as one or more of your nonprofit’s US employees transition overseas:

1. Identify what obligations your employee may have in the foreign jurisdiction.
Potential obligations to the foreign jurisdiction range from adhering to documentation procedures to tax compliance. Employees may need to obtain the proper work authorization forms to work in their host country. To comply with income taxation in some foreign countries, employees may need to file for and pay the tax themselves. Alternatively, organizations may arrange or be required to pay or deposit the tax on their employees’ behalf. The employee may be required to file a tax return to determine their actual foreign tax liability. In addition, they will need a foreign country return or other adequate documentation to claim a US tax credit for the foreign taxes that they have paid.
2. Determine whether your employee will be subject to or exempt from income tax in the host country.
The U.S. has entered into income tax treaties with many countries (approximately 75) that may offer exemptions or reduced rates to many US individuals working abroad. However, not all treaties function in the exact same way. The treaties are truly negotiated between countries and each country has different goals and objectives. As a first step, you and your employees should identify whether the nation they will be based in has established a tax treaty with the U.S., and then familiarize yourselves with its specific terms. Most tax treaties have specific terms for income tax exemption, such as the length of time an individual can spend in the foreign country and/or the amount of money they can earn for services working in the foreign country.
While it is best practice to review each treaty carefully, typically keeping the length of assignment under 183 days might enable employees to avoid taxation in the host country altogether. For employees exceeding that threshold, the length of the assignment will often have a direct impact on the type and amount of taxation the individual may become subject to. If at the beginning of a foreign assignment, an employee is reasonably expected to be working abroad for less than one year, the organization may cover many travel expenses, like housing, cars and per diems, without any additional U.S. income to the US employee. Similar rules allowing for the exclusion of certain company-provided benefits, based on time and intent, typically exist in other countries as well. It is imperative you engage local tax counsel for in-country tax compliance. Beyond tax treaties, bilateral or status of forces agreements may offer additional exemptions.
3. Assess compensation and benefit options for employees based abroad.
Even if payroll reporting is required in the host country, an internationally-based US employee must also remain on U.S. payroll to receive a Form W-2 to report to the IRS their total income (both US or Foreign Sourced). You may wish to also treat them as a US employee for fringe benefits. This course of action will allow the employee to maintain the ability to participate in certain benefit programs, such as a 403(b) or pension plans. From a procedural perspective, it’s important to obtain new payroll documentation, including a new Form W-4 and Form 673, from the individual before departure. It’s likely that more payroll or other registration documentation will need to be gathered in the host country location. Both of these documents allow the nonprofit employer to reduce or eliminate the U.S. tax withholding while the US individual is abroad.
4. Review the host country’s Social Security system to understand employees’ obligations.
If the host location has a social security system, the individual may be required to contribute to it in addition to the U.S. Social Security system. In some countries, the employee’s required contribution rate to social security can be higher than the income tax rate. The U.S. has worked to mitigate this by entering into Totalization Agreements with a total of twenty-five different countries. Prior to an employee moving overseas, nonprofits should determine whether the host country has entered a Totalization Agreement with the U.S., which serves to eliminate double liability for social security taxes.

5. Do research early to avoid costly penalties for noncompliance.
Managing international employees is important on several levels. Unpaid tax obligations are generally compounded by interest and penalties to effectively double or triple by the time they are noted by the taxing authority. To avoid costly surprises down the line, it is critical to proactively educate your employees about their income tax obligations when based abroad. It is best practice to establish a written policy regarding international income tax obligations to advise employees of their responsibilities to minimize risk and the cost of noncompliance. Individuals subject to unexpected foreign taxes will look to their employer for assistance should the above issues not be addressed prior to sending them overseas.

For nonprofits planning to transfer employees abroad on an ongoing basis, establishing a defined relocation policy and developing educational resources on an employee’s international income tax obligations is best practice to help ensure a smoother process in the future.

Interested in more tips for nonprofits navigating the international tax landscape? Keep an eye out for part three of our series to learn more about tax considerations for nonprofits with more expansive operations based overseas.

For a comprehensive discussion on the top ten financial and legal risks nonprofits face when operating internationally, tune into our webinar, cohosted by Venable LLP, on December 12th. You can view the full program for the webinar and sign up here