With immigration enforcement in the news, some employers may be wondering what responsibilities they have related to their retirement plans, if an employer discovers that an employee lacks documentation to demonstrate they are authorized to work in the United States legally.
In Part 1 of this series, I addressed the consequences under ERISA of undocumented workers participating in an employer retirement plan. In this second and final part, I will consider the tax reporting and withholding rules as they may apply to workers who are unauthorized to be present in the United States. Similar to ERISA, the Internal Revenue Code ("Code") does not make a distinction between authorized and unauthorized workers, but special attention should be paid to the unique circumstances that unauthorized workers may create.
Factors to Consider Under the Code and for Tax Reporting Purposes
Under the Code, which does consider the concept of "residency" for tax reporting purposes, there is no consequence for legal or illegal immigration status. Although the immigration laws of the United States refer to aliens as immigrants, non-immigrants, and undocumented aliens, the tax laws of the United States refer only to resident and nonresident aliens.
Federal law defines residency for tax purposes in a way that is very different from the immigration laws. Under the Code, all aliens (i.e., non-U.S. citizens) are considered to be nonresident aliens unless they are "Lawful Permanent Residents" under the immigration laws (i.e., they have a "Green Card"), or they pass what is known as the "Substantial Presence Test" (a numerical formula that measures days of presence in the United States.)
For tax reporting purposes, individuals (whether by virtue of being citizens, Green Card holders, or based on the Substantial Presence Test) are considered to be "U.S. Persons." All others are non-U.S. Persons. In many circumstances, even if an unauthorized immigrant entered the country illegally, they will qualify as a "U.S. Person" because they have stayed in the United States long enough to meet the Substantial Presence Test.
Tax Reporting and Withholding for U.S. Persons
The reporting requirements for payments to U.S. Persons are usually familiar to retirement plan sponsors and third party administrators. Distributions are reported on Form 1099-R, and the plan sponsor is required to file Form 945. Proper withholding depends on whether the distribution is an eligible rollover distribution, a periodic distribution (e.g., an annuity), or a nonperiodic distribution (e.g., a corrective or hardship distribution). There are, however, some additional complications if the plan sponsor is missing the participant's Social Security Number ("SSN") or has discovered it is invalid. This is frequently an issue when a sponsor discovers one or more unauthorized worker.
- Eligible rollover distributions are generally subject to 20% federal income tax withholding (unless they are paid as a direct rollover or are less than $200, in which case they are not subject to withholding).
- Periodic distributions generally are withheld the same as wages based on a participant's Form W-4P. If the sponsor does not have a valid SSN or Individual Tax Identification Number ("ITIN") for the participant, it must withhold as if the participant were single claiming no withholding.
- Nonperiodic distributions are subject to 10% withholding, unless a participant claims an exemption from withholding. If the sponsor does not have a valid SSN or ITIN for the participant, it must withhold 10% regardless of the election.
In some cases (particularly in the unauthorized worker context), a plan sponsor may not be aware whether a participant is a U.S. Person. Treasury Regulations allow the sponsor to assume it is making a payment to a U.S. person if the sponsor has a valid SSN for the payee and a valid mailing address either in the U.S. or a foreign mailing address in a country with which the U.S. has an income tax treaty that exempts pension payments from income.
Tax Reporting and Withholding for Non-U.S. Persons
Again, frequently, unauthorized workers will qualify as U.S. Persons merely based on the amount of time (legally or illegally) they have spent in the U.S. With that being said, it is sometimes the case that a deferred vested participant is no longer a U.S. Person after moving to another country for some time.
If the plan sponsor believes it will make a U.S.-sourced retirement payment (i.e., a retirement payment based on service performed in the U.S.) to a person who is not a U.S. Person, a plan sponsor may consider confirming that tax status by providing the participant with Forms W-8BEN, W-9, and W-7.
The Form W-8BEN permits the participant to attest whether they are a U.S. Person and determine whether they will claim benefits under an applicable tax treaty. A Form W-9 gives the sponsor a record of the participant's name, address, ITIN or SSN, which may allow them to be treated as a U.S. Person, pursuant to the assumption rules discussed above. In case the participant is eligible to take advantage of treaty benefits, they will need to complete a Form W-7.
In the absence of a treaty exemption that provides otherwise, the plan sponsor must withhold at the statutory rate of 30% on the entire distribution to a non-U.S. Person.
Missing or Incorrect SSNs
IRS Publication 1586, "Reasonable Cause Regulations and Requirements for Missing and Incorrect Name/TINs," specifies the steps an employer must take to show reasonable cause and the triggers for doing so. This is a helpful reference any time an employer realizes it is missing or has an invalid SSN/ITIN.
Rules for Missing Participants
Sometimes when an employer discovers an unauthorized alien, or when an employer begins asking questions, the worker stops reporting to the jobsite. To the extent that a participant cannot be located, under ERISA and the Code, sponsors of qualified retirement plans have a fiduciary responsibility to make a reasonable effort to find missing or unresponsive participants. Missing participants are an area of focus for the DOL, and having appropriate processes and procedures can limit liability in that regard.
Such processes might include:
- Sending notices to the participant's last known mailing address by certified mail.
- Sending notices by appropriate means to any other contact information, such as email addresses and telephone numbers.
- Checking the records of related plans and employers.
- Checking with the participant's designated plan beneficiary.
- Using free electronic search tools (such as internet searches and public record data sites).
- Using a commercial locator service, a credit reporting agency, or a proprietary internet search tool for locating individuals.
Tax reporting and withholding rules, while usually familiar to plan sponsors, are complex in of themselves. An additional layer of complexity is added when information is missing or invalid, which is frequently the case when an employer discovers that some of its employees are unauthorized workers. In this case, in addition to retaining an experienced immigration attorney, it is helpful for employers to consult with an attorney experienced in payroll tax and benefits issues.
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.