Tax Advice
"Tax equalization" is a policy that is followed by many employers of expatriate employees. The underlying theory of tax equalization is to ensure that the expatriate assignment is "tax neutral" to the expatriate employee. In other words, while the expatriate employee is on foreign assignment, the employee will pay approximately the same amount of income and social security taxes (referred to as "stay-at-home" or "hypothetical" tax liability) as they would have paid had they remained in the U.S., or their home country, and only earned the items of compensation that they would normally earn such as base wages and bonuses. The company pays any taxes that exceed the expatriate's hypothetical tax liability. Companies also implement tax equalization policies so that expatriate employees are treated fairly and consistently throughout the world (an expatriate in Saudi Arabia is treated the same as an expatriate in the U.K. although the tax laws in these countries are vastly different). Further, tax equalization policies allow large expatriate employers to standardize and streamline administrative processes.
Expatriate employees are subject to a worldwide tax burden during their foreign assignment that is either higher or lower than what they would have paid had they not left their home country. The reasons for their worldwide tax burden being higher or lower include:- Higher Tax Base Employers typically provide additional compensation to the expatriate to cover increased housing, tax, and cost of living expenses. In many cases, these additional compensation items are subject to tax in the home and host locations.
- Tax Rates - Depending on the host country, foreign tax rates may be significantly higher or sometimes lower than the U.S.
- U.S. Foreign Earned Income Exclusion The foreign earned income and housing exclusions reduce the U.S. tax base (regardless of whether the foreign country taxes the expatriate's income).
- What items of income are subject to tax equalization? Some will tax equalize company compensation only, while others will tax equalize some income from other sources including investment income and spousal income. Also, companies may, or may not, tax equalize stock option income.
- What deductions are allowed when computing the hypothetical income taxes? Companies generally have special methodologies for determining itemized deductions.
- Will the expatriate be tax equalized to their former state of residence or some other state (an expatriate's hypothetical tax liability for the tax year generally includes, when looking at U.S. expatriates, federal and state income taxes, as well as FICA taxes)?
- Tax equalization policies may or may not address items such as the sale of a principal residence or rental properties.
- If you receive a hardship allowance or foreign service premium, are these amounts subject to tax equalization?
About the Author
Tim Lenneman is the managing partner of Global Tax Network and is located in the Denver office where he focuses on providing Expatriate and Foreign National tax services to corporate and individual clients. Tim also has a strong background in corporate international tax matters.
First Published: Jul 15, 2002