Partner, Managing CPA, and thought leader at Bright!Tax Expat Tax Services, the award-winning US tax provider for Americans living abroad.
The pandemic may have changed working habits forever, as both employers and employees have learned to embrace the practicalities, and the benefits, of remote working. The primary benefit of remote working for businesses is reduced overhead costs due to either reduced need or no need for office space and all its associated costs. For employees, one major benefit is having more time back in their day due to not having to commute.
Not all people and businesses want to continue remote working indefinitely, though, especially in business models that require or benefit from face-to-face team and client interaction. While some firms may conclude that it makes sense to continue 100% remote working after the pandemic, others are expected to embrace a hybrid model, with employees working part time from home and part time in the office. Alternatively, firms may offer their employees flexibility to decide their own mix of home and office working, but a hybrid office-remote working model has the potential to offer the best of both worlds.
Given the widespread transition to remote working, many employees are expected to take the opportunity to become international digital nomads, working remotely from abroad. This lets them explore the world and potentially also save money. In this article, I’ll offer five (and a half) tax tips for U.S. employers managing remote international employees.
1. Remember that international remote employees may have to file U.S. federal, state and foreign taxes.
The U.S. taxes all U.S. citizens on their global income, so Americans working remotely abroad still have to file a U.S. federal tax return.
If they retain ties in the state where they last lived (such as property, dependents or financial accounts) or intend to return to live in the state, they may well have to continue filing state taxes, too, depending on the rules in the particular state. Some Americans who live in high-tax states such as California move to a different state before heading abroad, if they can, to reduce their overall tax bill once they’re overseas.
If they live and work in just one country overseas as opposed to working while traveling between countries (like many digital nomads), then remote employees may also have to pay foreign taxes in their new country of residence, too.
So the first step employers of international remote workers should take, ideally before the move abroad, is to research the applicable state and foreign country tax rules. These can impact not just the employee but the firm, too, as some countries may want to tax firms that have employees residing in that country, for example.
2. Remind employees working abroad that they can claim special credits and exclusions.
American employees working from abroad who do pay foreign taxes on their income in another country can file IRS Form 1116 when they file their federal return to claim the U.S. Foreign Tax Credit. The Foreign Tax Credit provides a $1 U.S. tax credit in lieu of the equivalent value of foreign taxes paid abroad to mitigate double taxation.
Another IRS provision called the Foreign Earned Income Exclusion allows Americans working abroad to exclude the first $107,600 (in 2020; the 2021 figure is $108,700) of their earned income from U.S. taxation, whether they pay foreign income tax or not.
For the majority of Americans working abroad, claiming either the Foreign Tax Credit or the Foreign Earned Income Exclusion will result in owing no U.S. federal income tax. There are other exclusions and credits available for Americans filing from abroad, too, depending on the details of their personal and financial situation.
3. Consider tax equalization.
If an American employee is working solely in, for example, France, they will have to pay French income tax. As French income tax rates are higher than U.S rates, although they can claim the Foreign Tax Credit to eliminate their U.S. tax bill, they will still be paying more income tax overall than if they lived in the States. Some employers agree to compensate the employee for the difference. This is called tax equalization, and it is most often used if an employer wants to incentivize an employee to work abroad so that their overall net income won’t be affected by the move.
4. Be aware of beneficial provisions in tax treaties.
The U.S. has signed tax treaties with around 70 other countries; however, none of these treaties prevent Americans living abroad from having to file U.S. taxes. Some treaties contain provisions that benefit some Americans, though, most often if they work in research and development, the arts, sport or education, or if they have income from dividends or royalties. Beneficial provisions must be claimed on Form 8833 as part of the employee’s annual tax return.
5. Don’t forget about U.S. Social Security tax.
Americans working abroad for an American employer still generally have to pay U.S. Social Security tax. The only exception is if they are living in a country where they must pay a local social security tax, and the country and the U.S. have signed a Totalization agreement.
Totalization agreements are tax treaties that are designed to prevent double Social Security taxation. Additionally, they allow workers to apply credits earned in a foreign social security system back to the U.S. system for purposes of receiving future benefits.
5.5. Seek advice, if needed.
Filing U.S. taxes from abroad is more complex than filing from in the States due to the additional forms that must be filed to reduce U.S. taxes, and often the intersection and interaction with a foreign tax system. As such, it can be beneficial to consult an expat tax specialist rather than use a U.S.-focused accountant or for employees to try to prepare their taxes alone.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
