It is more and more common for an employer to ask a U.S.-based
employee to work in a foreign country. When that employee works in
the foreign country, they are often (but not always) subject to
that country's tax.
Foreign countries have different personal and social security
tax regimes than the United States. They can be more or less
expensive than U.S. tax.
Since the employee is often a U.S. citizen or resident, they are
still subject to U.S. tax, even on their foreign-source income.
This means that both tax regimes apply. The United States has a few
mechanisms to mitigate double taxation, but the total tax can still
be higher than it would be if the employee continued to work in
their home jurisdiction.
Most other advanced nations, including Canada, have higher
personal taxes than the United States does. Employers recognize
that many employees would not accept foreign assignments if it
meant they would have to pay those higher taxes. Consequently, most
employers who move U.S.-based employees provide tax
'equalization' or tax 'protection'.
Tax equalization means that the employee's pay is adjusted
up or down so that their after-tax income is no different than it
would have been had the employee remained working under their
Tax protection is essentially the same thing, except there is no
adjustment downwards. This would be only an issue where the tax in
the foreign jurisdiction is lower than it is at home.
The equalization calculation is a fairly complicated, because it
is sometimes hard to determine what the tax would be at home (this
is called "hypothetical tax"). The hypothetical tax is
compared with the actual tax to determine a difference. The
employer then pays the difference to the employee.
But that's not the end of the story. That difference payment
is itself taxable, always for U.S. purposes and often for foreign
purposes. So that amount has to be equalized – and so
There's more. Employers have to decide things like what
income will be equalized. Equalizing the employee's employment
income is standard. But what if the employee has other sources of
income – interest, dividends, rental, capital gains, etc.?
Sometimes the foreign country taxes these things too. Should they
What if the employee stops contributing to the U.S. retirement
plan, and / or starts contributing to a foreign plan? Sometimes the
foreign plan is not tax efficient for an American. What if there is
no foreign company plan, but there are individual plans available
(say, an equivalent to an IRA)?
What if an employee's spouse moves as well? Should the
spouse's income be equalized?
There are many more questions that an employer has to decide.
Experienced companies have robust policies. But smaller companies
that are new to the employee transfer game can make expensive
An introduction to equalization, the hard way
A typical scenario is one where a company expands from the
United States into Canada. A trusted, up-and-coming, mid-level or
senior employee is transferred to Canada. Nobody considers the tax
issue until Canadian withholding starts. It's much higher than
U.S. withholding, so the employee asks the employer for help. The
employer says something like, "Don't worry, we'll take
care of you and make it the same as it would be if you were still
in the States."
Canadian tax rates are high. The employer then consults with us
and learns the cost of equalization is considerably greater than
was originally anticipated. There's the equalization cost and
the cost of the calculation. Sometimes the calculation needs to be
done in advance, not just after the tax returns are finished.
That's twice the cost.
In order to avoid unanticipated costs, it is strongly
recommended you work with your tax professional up front, so you
know exactly what you're facing as you expand your activities
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
To print this article, all you need is to be registered on Mondaq.com.
Click to Login as an existing user or Register so you can print this article.
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).