The pros and cons of foreign management
This week I thought I'd return to that variation on an old theme what happens when someone goes to work abroad from the perspective of what happens when someone from Poland goes to work in the United States.
These kinds of assignments are becoming more frequent. We've looked at the Polish side before, so this week, courtesy of my good friends Abigail Greef and Alex Knight in our U.S. tax group in Brussels, we look at what happens in the U.S., and relate that back to what goes on in Poland. This week we'll look at the tax residency implications, and in two weeks' time we'll look at things like social security.
As companies race to expand across borders, executives are increasingly being assigned to work overseas, whether to share expertise, develop the knowledge of a new workforce, or as a result of their own wish to work in a new environment. With all the excitement of a new challenge and career opportunities, it can be easy to overlook the potential tax complications of an international assignment. For executives assigned to work in the U.S., the tax law can prove to be particularly daunting and complex, especially to the unwary.
There are numerous issues foreign executives (and their employers) need to consider when contemplating a U.S assignment; a seemingly insignificant aspect of a U.S. assignment could have a significant impact on an executive's U.S. tax liability. The myriad issues to consider include: length of assignment, visa type, assignment start and end dates, timing of income recognition, timing of asset sales, social tax implications, type of compensation package, rental or sale of principal residence, and many more.
Each issue has a direct impact on the total tax liability of a foreign executive in the U.S. As with much in life, an ounce of prevention is better than a pound of cure, and so assignment planning is most effective when undertaken before the foreign national arrives in the U.S. good planning can minimize the impact of the above issues and maximize the tax savings available.
Before entering the U.S., immigration issues and the right to work in the U.S. must be considered. To obtain the right to work in the U.S., an individual must generally have a visa; the application procedure may involve the prior submission of a petition to the U.S. Immigration Service by the employer. Several types of visas are available depending on the nature and length of the assignment. Thus, frequently it will be wise to seek advice from a U.S. immigration lawyer before making an application.
Additionally, it is prudent to seek the advice of a tax adviser because certain visa types may impact the U.S. tax rules described below. It's very important to remember that U.S. rules are far stricter than in Poland, and it is generally not advisable to travel prior to obtaining a visa. Trying to convert a "business trip" into an assignment may work coming from the U.S. to Poland, but does not work the other way.
A major consideration for U.S. tax purposes is whether the foreign executive is to be considered a U.S. resident or a non-resident alien (NRA). There are several tests to determine whether an individual qualifies as a U.S. tax resident. Firstly, possession of the famous U.S. green card automatically qualifies the holder as a U.S. tax resident for the entire period that the green card is held, even if the individual returns to the foreign country.
Another test is the substantial presence test. This test looks at the total number of days an individual is physically present in the U.S. over a three-year period. If the individual is present in the U.S. for the requisite number of days, then he is considered a U.S. tax resident.
Therefore, if an individual travels to the U.S. regularly, he may inadvertently meet this test, and be treated as a U.S. tax resident. This test is particularly noteworthy because the rules are different from the 183-day rule contained in most tax treaties (including the U.S.-Poland treaty), and should be analyzed separately.
The importance of the distinction between residency and non residency becomes clear when we consider how each category is taxed. U.S. resident aliens are generally taxable on worldwide income in the same way U.S. citizens are, including, for example, salary, interest, dividends, capital gains and rental income, regardless of the geographical source or payment of the income. The income is all reported on one tax return (form 1040 for federal purposes). The taxpayer can then claim against his income either a standard deduction or itemized deductions for expenses such as mortgage interest payments, state taxes, real property taxes and charitable deductions. He is also entitled to claim exemptions for himself and any dependents (assuming they are U.S. tax residents). The tax rates are graduated, ranging from 15% to 39.6%; the applicable rates and some of the deductions depend upon the taxpayer's filing status.
NRA taxpayers are taxed on U.S. source income only; for salary purposes, a day worked in the U.S. by a NRA generates U.S. source income. The location of the payer does not determine the source of compensation income. For example, salary paid via a non-U.S. payroll is considered U.S. source income if the compensation is for services performed in the U.S. The income is reported on form 1040NR. Earned income, e.g. salary, is taxed at graduated rates; other U.S. source income, such as interest and dividends, may be taxed at fixed rates. In addition to federal taxes, a foreign executive may also be subject to taxation by the state in which he works and/or resides. Most states rely on a subjective determination of residency based on an individual's intent to reside in the state, known as the concept of domicile. Bearing in mind that some states have top tax rates in excess of 10%, planning and advice relating to state issues is often an overlooked, but very significant, pre-assignment consideration.
That's the easy part of the income tax next time, we look at other aspects of the assignment.
Peter Ferrigno is a partner in the Warsaw office of Arthur Andersen. Alex Knight and Abigail Greef are managers in the U.S. tax group in Arthur Andersen's Brussels office, specializing in U.S. taxes for U.S. and non-U.S. individuals working in Poland and Central Europe.
