Magazine article The CPA Journal

Tax Equalization for U.S. Expatriates

Magazine article The CPA Journal

Tax Equalization for U.S. Expatriates

Article excerpt

A U.S. expatriate is a citizen or resident who lives outside of the United States and Puerto Rico for more than one year. U.S. citizens and residents must report 100% of their worldwide income on their U.S. individual income tax return, regardless of where they hve or where the income is paid. In addition to tins U.S. tax filing, the tax filing in the country of assignment is required of a U.S. expatriate; these requirements can be quite complex when the U.S. and host country filings are considered. Tins article helps CPAs identify income tax filing requirements for U.S. individuals living abroad, including instances in winch the relocation is for work purposes.

Tax Equalization

Overseas assignments can bring about increased tax obligations for U.S. expatriates. In response to tins, many employers have tax equalization policies in place that ensure expatriates aie made tax-neutral (i.e., the U.S. expatriate pays taxes as if the overseas assignment had not taken place). Tax equalization policies aie created by the employer, as they will determine what should be factored into the stay-at-home calculation; this is defined as the tax a U.S. expatriate would pay had an overseas assignment not been undertaken. The practice of tax equalization was developed alongside a concept known as "hypothetical tax," used within the mechanics of tax equalization. The hypothetical tax is the tax an employee would have had to pay if the assignment had not occurred. An overseas assignment often comes with additional benefits, such as housing reimbursement, education reimbursement, and cost of living adjustments, all of which create additional tax liability. Tax equalization is the process of calculating the tax due, exclusive of these benefits so as not to penalize the U.S. expatriate for taking the assignment. With tax equalization, the employer will withhold the hypothetical tax, rather than the normal withholding via the U.S. payroll. Hypothetical tax is calculated on an expatriate's earned and nonearned income and deductions (excluding assignment-related income). Hypothetical tax approximates federal, state, and (typically) Social Security taxes.

Hypothetical tax is not an actual tax that is remitted to a tax authority, but held by title employa' and used in the tax equalization summary and final calculation. As the hypothetical tax is withheld from tiie U.S. expatiate, it reduces earned income as reported on an expatnate's actual U. …

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