It's increasingly common for U.S. companies to ask employees
to work abroad. That usually means dealing with two tax codes. But
companies recognize many employees won't accept foreign
assignments if it means higher taxes. So, most firms that move
U.S.-based employees provide either tax equalization or tax
Equalization: Pay is
adjusted up or down so the employee's after-tax income is no
different than it would have been had she continued working in the
Protection: Same as
equalization, except there's no downward adjustment. This would
only be an issue if tax in the foreign country is lower than the
tax in the home country.
The equalization calculation is often complex because it's
hard to determine hypothetical tax, which is what the
employee's tax would've been at home. Once hypothetical tax
has been determined, it's compared to actual tax; the employer
then pays the employee the difference. But that payment is always
taxable for U.S. purposes, and often for foreign purposes. So that
amount also has to be equalized.
Employers have to decide what income to equalize. Employment
income is standard, but what if the employee has other sources,
such as interest, dividend, rental, and capital gains? If the
employee is American and starts contributing to a foreign plan, it
may not be tax efficient. What if there's no foreign company
plan, but available individual plans (e.g., an equivalent to an
IRA)? What if an employee's spouse also moves? Should the
spouse's income be equalized?
Large, experienced companies typically have robust policies.
But, smaller firms that are new to the employee transfer game can
make expensive mistakes.
LEARNING THE HARD WAY
A typical scenario would be a U.S. company expanding into
Canada. A mid-level or senior employee is moved, but no one
considers the tax issue until Canadian withholding starts. It's
much higher than U.S. withholding, so the employee asks the firm
for help. The employer typically says something like,
"Don't worry, we'll make it the same as it would be if
you were still in the U.S."
The employer consults with us and learns the cost of
equalization is considerably greater than anticipated. There's
the equalization cost itself, and the cost of doing the
calculation. Sometimes the calculation must be done in advance, and
not just after returns are finished. That doubles the cost.
The problem is not the absolute cost level—it's
expensive to move people around the world. Instead, unanticipated
costs can be problematic. For your clients, it's better for
them to know their costs in advance. So, if you have American
business-owner clients expanding abroad, have them work with their
tax teams well in advance to avoid unnecessary costs.
Originally published in Advisor's Edge Report.
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.
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