In the current global economy, many employers are faced with difficult questions regarding foreign transfers. U.S. employees frequently are transferred to foreign affiliates to obtain experience and to bring home local knowledge from foreign countries.
Conversely, employees are transferred from foreign affiliates to U.S. headquarters for similar reasons.
When transferring employees, a frequent question is whether or not to treat an individual as a local hire - subject to local compensation, benefits and national programs - or be kept on the initial employer payroll and benefits.
The ultimate decision is based on the length of the transfer and unique factors for each company. Employers also regularly enter into totalization agreements to keep employees "whole" for benefits, cost of living and other expense differentials between countries. That said, several issues warrant consideration when transferring foreign employees to and from the United States.
If a foreign employee is transferred to the United States, past service credits will be considered for eligibility under a U.S. retirement plan.
For example, assume an individual has worked for a foreign-owned company for five years and is transferred to a 100% U.S.-owned subsidiary or affiliate. Even if the U.S. 401(k) plan has a one-year waiting period, the employee immediately will be eligible to enter the plan as a result of prior service.
Service within the United States isn't needed to enter a U.S. retirement plan. Employers should review their retirement plans to confirm that foreign employees are not excluded from participation.
Similar to eligibility, a foreign employee will be given prior service credit regarding vesting under a retirement plan. Thus, if an employee enters a U.S. plan and makes salary deferral contributions entitling them to matching contributions, the individual will have all service aggregated for vesting.
For example, an employer has a graduated vesting schedule entitling employees to 20% vesting for each year of service, with a 100% vesting after five years. A foreign transferee has four years of service abroad and is transferred to the United States for two years.
The employee makes pretax contributions to the U.S. 401(k) plan for two years and receives matching contributions. This individual will be 100% vested in all employer contributions when he or she terminates employment or returns to a foreign affiliate.
The primary difficulty with having foreign employees participate in a U.S. retirement plan involves the payment of benefits when they return to their home country.
In the example above, an employee participated in a 401(k) plan for two years, making employee contributions, receiving matching contributions and possibly receiving profit-sharing contributions. If the employee simply takes a position with a new employer, a normal distribution of benefits may occur.
However, if the employee returns to his or her home country and continues to work within the same controlled group of employers, no separation from service will occur and the employee is not entitled to a distribution of benefits.
Furthermore, if the employee has taken a loan while in the United States, no payroll will exist from which to withhold loan repayments. Therefore, an employee may be in default on a loan when transferred home and not entitled to a distribution.
Unless a plan document or loan policy permits payments outside of a payroll deduction, there is no way to avoid a default. Thus, when the distribution rules are properly explained to foreign transferees, they often elect voluntarily not to participate in a U.S. plan.
Depending on the country and manner in which an employee is transferred, an employee may remain subject to U.S. Social Security and Medicare taxes, and not similar foreign taxes.
Section 3121(l) of the Internal Revenue Code allows an employer to enter into an agreement with the IRS to treat services performed outside the United States with a foreign affiliate as employment within the United States.
If such an agreement is executed, the employer must pay both the employer and the employee portion of Social Security and Medicare taxes.
After an agreement is made with the IRS, it is effective beginning with the first day of the calendar quarter in which the agreement is made or the first day of the succeeding calendar quarter, as provided in the agreement.
Once an agreement is made with respect to any foreign affiliate, the agreement may not be terminated.
For purposes of the above rule, a foreign affiliate is country in which a U.S. employer has a 10% interest or greater. As a result of the clear language of the statute, a transfer to a foreign parent entity is not an affiliate. Therefore, use of a Section 3121(l) agreement (i.e., entered into using IRS Form 2032) is not appropriate.
Under the Social Security detached-worker rule, if an employee is temporarily transferred to the same employer in another country, the individual remains covered by the payroll contributions required from the country in which he or she was transferred. This rule may apply for up to five years.
Since a transfer to a foreign parent is not a foreign affiliate, it may be beneficial to rely on the detached-worker rule without entering into a Section 3121(l) agreement with the IRS.
U.S. employers seeking to retain employees transferred to a foreign entity under the Social Security system may request a Certificate of Coverage from the Social Security Administration.
Employers can go to the SSA Web site, www.ssa.gov/coc, for details. Certificates of Coverage generally are issued in less than 30 days. The advantage of this approach is that an employer only will be required to undertake this policy when it wants a specific employee to remain subject to U.S. Social Security and Medicare taxes, and is not locked in to a permanent agreement with the IRS for all employees.
Employers should always check the applicable treaty with each country before making any decisions regarding foreign transfers and Social Security taxes, or related issues.
All of the above issues can be addressed by establishing a foreign transfer policy and/or in negotiations with each employee.
Contributing Editor Frank Palmieri, CPA, JD, LL.M (Taxation) is a partner with the law firm Palmieri & Eisenberg, with offices in Princeton, N.J. and Alexandria, Va. He is a national speaker and writer on employee benefits issues and is a fellow in the American College of Employee Benefits Counsel. Follow EBN on: Twitter | Facebook | LinkedIn | Podcasts
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