Tax Guide for Remote Workers - Digital Nomads Blog

Amidst the COVID-19 pandemic, numerous US expatriates have reevaluated their life priorities. The limitations on travel and social isolation have led some expats to recognize that being near their loved ones and friends at home holds utmost importance to them.

Chara Richterberg, a Louisiana native, had been living on four different continents until March 2020 owing to her husband’s career in the oil and gas industry, as reported by Richterberg in an article for the Financial Times.

Richterberg states that as we age, it becomes increasingly vital to stay near home, and they did not wish to be stranded far away from their elderly parents or deal with the uncertainty surrounding air travel. Although relocating to Houston, Texas, has been a lonely experience due to their partner’s job, Richterberg mentions that they always manage to find companions wherever they are.

The increase in remote work has simplified the process for American expats working for a foreign company to come back to the United States without quitting their job. However, there is a condition: even though they can remain employed by their foreign employer, spending excessive time in the US could result in them owing money to the IRS.

Even if your employer is withholding foreign taxes, you are now subject to the tax rules of the US because of your presence there.

Working Remotely for a Foreign Company: What About Taxes?

If you return to the US while working remotely for your company based overseas, they will still deduct your foreign taxes. However, a central dilemma arises as you are now in the US again, and are also responsible for paying taxes to the IRS.

As an individual taxpayer, the source of your wages is determined by your physical location. Therefore, if you choose to stay in the US for a specific duration, the IRS will have the authority to tax your income earned in the US. This information can be found on the official IRS website.

When considering wages and other compensation earned within the United States, it is typically regarded as originating from within the country. The source of personal service income is typically determined by the location where the services are rendered, regardless of the location of the contract, the place of payment, or the payer’s residence.

Returning to the US, Americans who still work remotely for a foreign company might find themselves owing a significant amount of money to the IRS, thus negating any expectation of a warm homecoming.

Learn how to navigate the tax consequences of cross-border work arrangements by following the step-by-step process provided below.

Determine If There’s Risk of Establishing a Taxable Presence

When an employee works in another country, it is important for the employer to assess whether the employee’s work leads to the organization having a permanent establishment in that country, thus making them liable to pay taxes in that country. Many countries determine the location for taxing income based on where the services were rendered.

The company is usually liable for income tax in the country if it has a permanent establishment, which is determined by the following criteria.

Types of activities being conducted by the employee
Profit attributable to that activity
Income tax treaties
Additional US tax reporting obligations

Recommendations

Mitigate exposure to foreign tax systems. Understand the specifics of when a taxable presence is triggered in the country where the employee is working.
Make sure you understand the employee’s activities. You should also consider the level of authority exercised by the employee on behalf of your organization.
Evaluate your company’s organizational structure. When a large number of employees work in a particular jurisdiction, determine if an offshore employee holding company could avoid taxable income in a jurisdiction.

Understand the Country’s Employee Versus Contractor Distinctions

A frequently asked tax question pertains to whether a company has employees, contractors, or consultants. This differentiation holds great importance as it can lead to the establishment of a taxable presence for the employer in a location other than their own, as mentioned earlier.

Inadvertently, the company may establish a tax presence in certain foreign jurisdictions if contractors are perceived as employees by certain countries.

Recommendations

Establish a framework. Obtain a complete understanding of how all cross-border employees are compensated and what duties they perform. A framework looks at job duties for personnel abroad and helps align them with how the activities are viewed locally. Specifically limiting functions for employees or contractors can be the difference between creating a taxable presence for the company or not.
Learn the definitions. Remember that the definition of an employee, contractor, or consultant in the United States may differ from those in the country where the person is working remotely.
Manage risk up-front with due diligence. If the United States has a treaty with a country where the organization has employees, income tax issues may be covered. However, treaties don’t necessarily cover local employment law issues, and there’s always the possibility of a new foreign government assuming power and changing the law. To mitigate complications, research local country law and continue to assess these laws periodically because they may change.
Outsource your administration. To manage global payroll risk, some companies use professional employment organizations (PEOs) or administrative services organizations (ASOs) to handle the daily administration as well as payroll tax and returns for team members working abroad. Outsourcing can reduce risk because employees are contracted with the PEO rather than the company. However, but outsourcing doesn’t necessarily prevent a contracted employee from creating an international tax presence for a company.

Consider Withholding Taxes

A payer has an obligation to withhold tax from a payment made to a nonresident recipient, and remit that amount to the taxing authority on behalf of the nonresident recipient. This represents a withholding tax.

The purpose of withholding tax is to collect tax payment on particular types of income given to nonresident recipients. Such income includes payments for management fees and technical services, which are usually carried out by employees or contractors.

The payment of income to nonresident recipients in most countries is subject to a domestic or standard rate of withholding tax. These rates differ across jurisdictions and can be reduced or eliminated if there is an applicable income tax treaty between the payer and recipient home countries.

Recommendations

Evaluate the activities of remote employees. Determine whether the employee is working part-time remotely in a nonresident country and occasionally in the company’s home country.
Establish procedures to continually evaluate withholding tax risk. Even if your organization has established an arrangement with the employee that mitigates cross-border tax implications for an employee working remotely, your organization’s needs may change, resulting in the employee working part-time from a different location.

Determine Transfer Pricing Implications

The issue of transfer pricing has become more relevant as an increasing number of countries now have regulations in place for it. Tax authorities worldwide have also ramped up their attention on this matter.

Transfer pricing comes into play in a cross-border remote work situation if the employee’s work benefits multiple companies within a controlled group. If the employer establishes an offshore employee holding company, transfer pricing is involved.

Recommendations

Document the activities of the employee. Be sure to include how these activities impact the entire organization.
Evaluate the need for intercompany contracts. These may be needed to compensate the company that pays the employee for the benefit provided to other controlled companies in group.
Apply benchmarking. This is useful to determine the range of prices or profit levels.

For transactions between related parties to earn the respect of tax authorities, the following requirements may be necessary.