Four tax reform changes that will impact global mobility programs
On Dec. 22, 2017, President Donald Trump signed the Tax Cuts and Jobs Act (TCJA) into law. The TCJA is the most comprehensive tax overhaul in more than 30 years which moved through Congress at breakneck speed, and took effect on Jan. 1, 2018.
It is clear that the TCJA will have an immediate effect on employers and international assignments, however, long term implications and the shifting landscape of multinational corporations with globally mobile employees is still developing.
We expect the IRS and Treasury to issue additional guidance and regulations in the near to mid-term to clear up uncertainty, address technical issues, and mitigate unintended consequences. In the interim, employers will have a tight window to address changes to compensation and benefits, payroll compliance, and international assignment management. Below, we’ve highlighted the most important changes for employers with globally mobile employees, impacts and action items for employers to consider as they begin the New Year with a new tax code.
Payroll compliance – new federal income tax rates, withholding, supplemental wages, and backup withholding
Employers are required to withhold federal income tax from wages paid to employees under IRC Sec. 3402. Every year, the IRS updates the applicable withholding tables in Publication 15 and published Form W-4 for an employee to furnish the employer.
Effective for tax years 2018–2025, the individual income tax rate structure has been changed to the following marginal rates:
|2017 individual income tax rates||2018 individual income tax rates|
|10 percent||10 percent|
|15 percent||12 percent|
|25 percent||22 percent|
|28 percent||24 percent|
|33 percent||32 percent|
|35 percent||35 percent|
|39.6 percent||37 percent
What this means
Withholding requirements of employers are tied to the income tax rates imposed on individual taxpayers. Whether the wage withholding rules for personal exemptions (which are also eliminated for tax years 2018–2025) remain unchanged for 2018 is at the discretion of the Treasury and IRS. On Jan. 11, 2018, the IRS released Notice 1036, which updates the income-tax withholding tables for 2018.
Additionally, there are changes in supplemental wage withholding and backup withholding:
- Supplemental withholding:
- If an employee’s supplemental wages year-to-date are in excess of $1 million, employers are required to withhold at the highest marginal rate, 37 percent (down from 39.6 percent previously).
- If an employee’s supplemental wages year-to-date are not in excess of $1 million, employers are required to withhold at 22 percent (down from 25 percent previously).
- Backup withholding through the end of 2025 is tied to the fourth tax bracket of 24 percent (down from 28 percent).
- Applicability to nonresident aliens–previously the withholding for nonresident aliens allowed a nonresident to claim one personal exemption; with the suspension of all personal exemptions, withholding rates will need to be adjusted.
Notice 1036 will be incorporated into Publication 15 which will be published later in January, but the withholding tables have been released in advance so that employers may begin to incorporate them into their systems. The IRS has stated that employers should implement the new tables as soon as possible but no later than Feb.15, 2018.
Until the supplemental wage withholding rate for situations where year-to-date wages are not in excess of $1 million is clarified by IRS, employers should continue to withhold at the 2017 flat-rate supplemental rate of 25 percent.
Employers with global mobility programs should also revisit cost projections with the new rates to determine the cost impact to their mobility program. Additionally, hypothetical tax calculations should be updated for the new hypothetical marginal rates and elimination of the personal exemption so that employees on international assignment covered by an employer’s tax policy will also receive the same cash flow treatment of the new rates.
Equity compensation and restricted stock units (RSUs) – election to defer income tax
Under IRC Sec. 83, the value of property transferred in connection with the performance of services in excess of the amount paid for the property is included in an employee’s gross income when the property is no longer subject to a substantial risk of forfeiture. For stock options, gross income is the value of the vested transferred shares on the option exercise date over the amount paid as the exercise price. For RSUs, gross income is the value of the shares that are transferred upon settlement of the awards fully vesting.
The TCJA adds to Sec. 83 subsection (i) which allows a qualified employee to elect to defer the inclusion in income of the amount of income attributable to qualified stock transferred to the employee by the employer. An election under Sec. 83(i) must be made no later than 30 days after the date the employee’s rights in the qualified stock aren’t transferable or aren’t subject to a substantial risk of forfeiture, and cannot be made if a prior Sec. 83(b) election was made.
If such an election is made, the federal tax is deferred to the earliest of five years following the date that the vested shares were transferred and when the stock becomes transferable or becomes publicly traded. The amount is also included in the employees taxable income as of the date the employee becomes excluded (i.e. an individual who is a 1 percent owner during the current calendar year or prior 10 years, or who is the CEO, CFO or one of the four highest-paid officers of the corporation), or the date the employee revokes the election.
What this means
The deferral of income tax can be a welcome relief as employees who receive stock options and RSU awards often recognize taxable income when the options are exercised or the RSU is vested, which can create a significant tax liability, but no cash to pay withholding taxes on the income unless the employer offers an option to sell back shares to pay the withholding taxes owed.
It should also be noted that this election only applies for federal income tax purposes, therefore it has no effect on social security, Medicare and unemployment taxes. State treatment may also vary unless state legislation is passed to conform to federal law.
In the instance of a deferral, the employer is not entitled to a business expense deduction until the income is included in the employee’s taxable income. Additionally, employees who elect to defer could realize a capital gain if the share value increases over the deferral period, however, if the share value decreases, the employee would still owe tax based on the original value of the transfer.
Employers should consider whether the federal income tax deferral will be made available to employees and provide education to their employees regarding the option to defer. If the deferral is made available to employees, new earnings codes would need to be set up in the payroll system to accommodate tax withholding and reporting obligations. Federal income tax withholding when an Sec. 83(i) election is made is required at the maximum income tax rate in effect at the time the income is included in gross income, under the new law, 37 percent.
From a global mobility perspective, multi-year equity compensation is one of the most tedious items to track and comply with global payroll and withholding obligations depending on where services were performed over the earning period if an individual worked both in the US and abroad. The option to defer US tax on equity awards could create significant foreign tax liabilities and corresponding US tax credit timing differences between countries, depending on when equity is taxable in a host country.
As a simple example, if a tax equalized assignee fully vests in an 3-year RSU award on Year 3 of a 3 year assignment to Country X (fully taxable in Country X upon vest), and the employee defers US federal income tax for five years, foreign taxes paid by an employer under an equalization policy toward Tax Year 3 could not be recouped until Tax Year 8 with the inclusion of income on the US tax return.
Employers should consider their tax equalization policies closely and make adjustments to mitigate such timing differences where possible, or analyze the costs of continuing to tax equalize the individual long after their assignment has ended.
Moving expense deduction eliminated
Under IRC Sec. 132(g), the TCJA temporarily suspends the exclusion from gross income for any fringe benefit that qualifies as a “qualified moving expense reimbursement” for tax years 2018–2025 for any employer-paid amounts that would be deductible under IRC §217. The TCJA also suspends the individual deduction under Sec.217. The only exception to the suspension of the moving expense deductibility is for members of the US Armed Forces on active duty moving pursuant to military orders and permanent change of station.
What this means
Employers are now required to include in gross income any reimbursements for moving expenses made to employees or paid directly to third parties (such as moving companies) between Jan. 1, 2018 and Dec. 31, 2025, and such amounts are subject to federal, FICA and FUTA tax. State reporting and withholding obligations may vary based on conformity to federal law as of Jan. 1, 2018. Additionally, employees may not deduct any moving expenses for the same period on their individual income tax return.
Employers should be aware of the new rules and ensure payroll systems and expense management/reimbursement tools are set up to accommodate this change. Employers will also need to consider whether they will offer assistance to employees to offset the tax cost of reimbursed amounts, or potentially change the delivery of relocation assistance from receipted or direct billed expenses under an accountable plan to offering a one-time cash allowance through Dec. 31, 2025 to ease administrative burden of maintaining an accountable plan now that these amounts are fully taxable.
Employers who have tax equalization policies and globally mobile employees will need to review cost accruals for international assignments as moving expense can often be a large component of an equalized compensation package. Moving expenses are generally a tax cost that the employer would bear under an equalization policy (and previously such costs were not taxable), which may now require a significant US tax gross up. Additionally, the manner in which such costs are paid can also have host country considerations (i.e. receipted reimbursement vs. cash allowance), thus, it is important to consider the administration and tax impact globally regarding moving expenses.
Wage advances and repayments – miscellaneous itemized deductions subject to 2 percent of AGI floor eliminated
Under the claim of right doctrine, IRC Sec. 1341, a taxpayer that receives gross income in one year and later returns the income to the payor is entitled to claim an itemized deduction not subject to the 2 percent of AGI floor or a reduction of tax (refundable credit) in the year the income is repaid if the repayment is in excess of $3,000. Sec. 1341 does not apply if the repayment is $3,000 or less and that amount previously could be claimed as a miscellaneous itemized deduction subject to the 2 percent floor.
The TCJA has eliminated miscellaneous itemized deductions subject to the 2 percent floor for tax years 2018 through 2025.
What this means
Any repayments of wage advances received in one year but repaid in a future year of $3,000 or less may no longer be claimed as a deduction on the employee’s tax return. If multiple repayments are made during the year, they are aggregated for purposes of determining whether then $3,000 threshold is exceeded.
In the case of any amounts of income that were subject to FICA tax and later those amounts were repaid to an employer, the employer is responsible to amend payroll tax Forms 940/941 to obtain a refund of excess social security and Medicare taxes paid, and return the employee-paid amounts to the employee.
Employers should make employees aware of the tax treatment when receiving repayments for advance wages. A common example of repayments is often under an employer’s tax equalization or protection program. As part of the tax reconciliation process, employees are generally responsible to remit any excess tax reimbursement or under-withheld hypothetical tax to their employer upon completion of the tax settlement. Repayments are not eligible to be deducted on the individual’s tax return if they are $3,000 or less for tax years 2018–2025.
Generally any tax benefit of this deduction under an employer tax equalization program would go to the employer, accordingly, any additional income tax that arises as a result of not being able to claim this deduction would be the employer’s responsibility. Due to the AGI limitation, this may have little to no effect on the overall tax position of the company for an equalized assignment, however, payroll tax forms should still be amended to recoup the employer and employee share of FICA tax on the income repaid.
We’ve outlined four major changes that will require attention from employers with globally mobile employees, but there are other potentially impactful changes that may also require some thought and action as we head into the new year. There are always unintended consequences and planning opportunities that can arise with a sweeping tax law change–so it’s important to understand the issues, potential implications for your business and your employees, to advise your stakeholders and make informed decisions.