To inform and serve US expatriates working abroad and foreign nationals in the U.S. on a rotational assignment program of a multi-national company minimizing their US income taxes and professional fees.
Office in Chicago, Illinois
We are specialized US income tax return preparation and related consulting services for foreign nationals in the U.S. and US citizens and resident aliens who work abroad.Also, Japanese income tax services are provided by a Japanese business partner.
Experience and service
With 17 years of tax experience with a Big 4 accounting firm, we provide income tax and related consulting services including tax equalization and payroll processing with a highest quality, hands-on service and reasonable service fee.
Certificate of Coverage Extension - exemption from the U.S. Social Security System
Certificate of Coverage Extension - exemption from the U.S. Social Security System
It has been five years since U.S. Japan Totalization agreement was implemented in October 2005. Because the maximum length of the certificate of the coverage is five years, it will expire in September 2010, if one started it in October 2005. To continue to be exempt from the U.S. social security system beyond the five years, the extension for the certificate of the coverage must be approved. For more information, please contact Social Insurance Agency.
Court decision for the employment discrimination lawsuit against a Japanese Company
Court decision for the employment discrimination lawsuit against a Japanese Company
On September 30, 2009, the District Court for the Southern district of New York issued a critical decision for the case with Japanese corporations doing business through U.S. subsidiaries, which defended against charges of employment discrimination in favor of Japanese expatriates. The dispute was between local employees and the U.S. subsidiary, and Judge McMahon ruled that a foreign corporation posts its expatriate employees to managerial jobs at its U.S. subsidiary does not violate federal, state, or local laws that prohibit racial discriminations.
The plaintiff, who was hired as a chief internal auditor of the U.S. subsidiary, claimed that non-Japanese had been less promoted and less compensated for the equivalent position. He insisted that it is a violation of the U.S. Civil Rights Act and New York state and city human rights law.
The plaintiff targeted directly to the expatriate program that the parent company send and rotate Japanese employees to managerial positions at its U.S. subsidiary every 3 to 5 years, and he claimed that the Japanese expatriates are receiving unfairly attractive compensation and benefits compared to local hired employees.
For the result of the case, the judge dismissed the claim of racial discrimination for the following reasons.
- Different treatment allegedly favoring Japanese expatriates is permitted by the Treaty of Friendship, Commerce and Navigation between Japan and the United States, which states that corporations of each nations doing business in the other country may place their own nationals in executive positions at foreign subsidiaries to manage the business and protect their investment.
- Japanese local hired, non-expatriate, workers were receiving the same treatment as non-Japanese employees. The different compensation and benefit between the expatriates and local hired are not based on their race, but citizenship or status as employees of the parent company.
The court concluded that the expatriate employee's benefits and local hired ones cannot simply be compared. That is because the expatriate employees are temporarily hired by the U.S. subsidiary, but they had been employed by the parent company prior to their U.S. assignment.
This court ruling is a favorite result to U.S. subsidiaries of foreign corporations. There were similar cases in 1991 and 1998, and both were favor to the U.S. subsidiaries against local hired employees. It means that the Treaty of Friendship, Commerce and Navigation between Japan and the United States still protects the U.S. subsidiaries against discrimination suits.
Because of this court decision, a number of discrimination lawsuits related to expatriates may decrease in the future. However, it is still a good idea for employers to keep expatriate benefit information confidential, and their payroll should be handled carefully to avoid a possible discrimination lawsuits. It is better to avoid costly attorney's fee. Besides, disclosing expatriate benefits to local employees might lower their motivations to work hard, and also it will even cause a company performance negatively.
Like many other companies, clients of East Accounting try to lower the inherent risks of the discrimination lawsuits. They handle their expatriate payroll very carefully. One of the reasons they outsource their payroll to East Accounting is that processing the payroll in-house brings more exposure to the eyes of local employees.
Report of Foreign Bank and Financial Accounts (FBAR)
Report of Foreign Bank and Financial Accounts (FBAR)
TD F 90-22.1
Report of Foreign Bank and Financial Accounts (FBAR), which is Form TD F 90-22.1, should be used to report foreign financial accounts to U.S. Department of the Treasury if the aggregate value of foreign accounts exceeded $10,000 during the tax year. The requirement of FBAR is originated with "Bank Secrecy Act" enacted in 1970, and it is classified into following two circumstances.
# 1. If a business entity receives $10,000 or more of cash, it will be required to file Form 8300
# 2. If taxpayer owns banking or investing accounts outside the U.S., and the aggregate value of them exceed $10,000, s/he is required to file FBAR by the filing due date. This requirement probably applies to most of the Japanese expatriate taxpayers, so let's take a close look at the #2.
In 1970, "Bank Secrecy Act" was originally enacted to crack down on money launderings. Today, this law is enforced for the purpose of purging drug dealers, terrorists, tax evaders, and other criminal organizations. Currently, approximately 500 of IRS agents are intensively monitoring the violators. In the era of globalize economy, more businesses today involve with international transactions. Compared to domestic transactions, U.S. tax laws are not thoroughly enforced outside. The U.S. government sees that it is necessary to regulate the rule for the international transactions, and tighten the requirements of income reporting and disclosures. In the budget from Economy Recovery Act, the 30 percent will be allocated to the segment that enhances U.S. tax laws for the international transactions, and the government is targeting to 200 billion dollar of tax revenue delivered in next 10 years.
Who must file the FBAR.
U.S. Citizen or resident, and nonresident doing business in the United States are required to file the FBAR, which is Form TD F 90.22-1. For Japanese expatriates, the resident status is determined by either substantial presence test (183 days rule), or green card test. If you fall into the U.S. resident, and aggregate value of foreign financial accounts at any time during the calendar year exceeds $10,000, you would be required to file the form, although you may not have any taxable income from the accounts. The foreign financial accounts that we are discussing here include banks, securities, mutual funds, trust funds or other type of financial accounts. They also includes financial accounts used by other but registered under your name, and accounts that you have signature authority.
Disclosing foreign financial accounts is mandatory. Civil and criminal penalties are imposed for failure to file a report, or file a false or fraudulent report. Please see List of the penalties.
Extension of filing due date
Normal filing due date of the Form TD F 90-22.1 is on June 30, but this year (for tax year 2008) is different. The due date can be extended by September 23, 2009 without the penalties described in above list. The extension would be granted only if taxpayer has filed his/her income tax return, completed the tax payments, not realized that the filing due date was on June 30, and not filed the form TD F 90-22.1 yet.
The U.S. government is currently struggling along with deficit. The government is under the process of penalizing violators of FBAR rule with anonymous accounts at Union Bank of Switzerland. Although there are some pending issues, the U.S. government will eventually catch the tax evaders and punish to those who neglect the disclosure requirement. Furthermore, the U.S. government is eager to stretch a hand of the investigation to HSBC and Credit Suisse.
Since 2004, U.S., U. K., Australia, Canada, and Japan have been helping each other to seize international tax evaders, and they established a united office at IRS headquarter in Washington D.C.
In conclusion, the compliance of the FBAR rule is critically important.
Who pays taxes during expatriate assignment?
In Today's globalize economy, more Japanese companies are sending their employees to foreign locations than ever, so the number of their expatriate assignees is increasing all over the world. While constantly changing tax laws in various assignment locations, Global HR departments should have a good tax settlement policy to cover the international assignments and related tax issues. It is quite essential to keep fairness and impartiality, in terms of tax burdens, among expatriate assignees and with non-expatriate employees.
In the U.S., most Japanese companies reimburse income taxes to their expatriate assignees. Unfortunately, it is a fact that HR professionals are often overwhelmed with tax compliance, and they tend to overlook their tax costs on employees' personal incomes, which include, but not limited to, interests, dividends, capital gains, and spouse wages etc. They are not allocating the liabilities between employer and employee. As a result, their assignees with higher personal incomes receive more compensation in the name of tax reimbursement than other employees who have less personal incomes.
In addition to consider the fairness among employees, employers may need to lower their tax costs by eliminating unnecessary tax burdens. This is merely an example, but it would likely occur when some employees take advantage of their tax reimbursement benefits. Without a tax settlement policy, they could intentionally bring a large amount of funds from Japan to seek for high yield investments in the United States, and they may think that they are in a "Tax Heaven." On the contrary, the employer would keep paying extra taxes on the employees' personal incomes.
Furthermore, E-visa and L-visa holding spouses are now authorized to work in the U.S., and their wages will be reported together in a joint tax return with expatriate assignees. If there is not enough taxes withheld from the spouse pay checks, what would be the consequence? Regardless of who is supposed to pay the shortfall, the expatriate assignees' employer may end up paying the balance due if they don't settle the tax with the employees.
The solution to the problems is obvious, but I mention it here anyway. The employers should have a tax settlement policy that explicitly states who is liable for taxes on personal incomes, and they should allocate them in accordingly.
How to settle tax liabilities between employee and employer.
Two commonly used tax settlement calculations are Tax Equalization and Tax Allocation.
What is Tax Equalization (TEQ)?
When an expatriate employee works in an assignment country, he/she is subject to a different taxation compared to those in their home country. Tax Equalization offsets such a difference so that working abroad is tax neutral (no loss no gain) for the expatriate employee. The TEQ calculation is a comparison of below described (A) and (B), and employer and employee settle the difference. About 95 percent of U.S. multinational companies use TEQ method to settle tax burdens with their employees. The TEQ calculation sheet is usually prepared together with actual tax return by their tax accountants.
(A). Actual withholding taxes that the expatriate assignees paid through payrolls and estimated hypothetical taxes.
(B). Hypothetical taxes, which assignees pay as if they were staying in home country entire year.
If (A) exceeds (B), the difference is due to the employee from the company. If (B) exceeds (A), the difference is due to company from employee.
Japan taxation is based on Separate Withholding Taxation at Source, which they complete the taxation on each taxable income by withholding. Tax Equalization method is not common for Japanese companies because their taxation is not Aggregate Taxation like the U.S. Tax. However, there is still a way for them to use TEQ method for their tax settlements. They can include TEQ result in hypothetical tax withholdings after calculating employees' aggregate income and deductions, such as salary income, social tax deductions, mortgage loan credit, personal exemptions. The calculation is similar to their year-end-tax-adjustment calculation.
What is Tax Allocation?
Tax Allocation is a method to calculate tax settlement amounts for expatriate employees based on their company policies. It apportions some tax burdens and benefits to the employees. In their assignment countries, non-wage incomes and deduction items are allocated between employer and employee in conformity with their tax allocation rules. For example, interests, dividends, capital gains, spouses' wages are considered personal incomes, therefore, those are allocated to the employee burden. Same as the way to allocate personal incomes, personal deductions such as mortgage interests, real estate taxes, charitable contributions, personal exemptions, foreign tax credits are also allocated to employee in the calculation. Many Japanese companies in the United States use this Tax Allocation method. Some of them return the U.S. tax saving from assignees' mortgage interest in Japan to the assignees.
Which is better Tax Equalization or Tax Allocation?
For Japanese expatriate assignees, combining Tax Equalization and Tax Allocation is the ideal because these combinations makes the calculation simple and clear, which makes their company policies understandable to assignees.
These combinations should include:
- Tax Equalization for income arise in Japan
- Tax Allocation for income arise in the U.S.A.
As discussed in an earlier topic "What is Tax Equalization?," Japanese taxation is based on Separate Withholding at Source. In their taxation, employers should adjust assignees' hypothetical tax amounts in Tax Equalization method. Of course, the hypothetical taxes amount fluctuates with TEQ results. The calculation should be based on assignees' incomes and deductions arise in Japan, and the assignees should be treated as if they were staying in Japan. It would be very complicating if the hypothetical tax calculation includes income and deductions from two countries in different taxation. Therefore, assignees' personal incomes and deductions arise in the U.S. should be settled separately with Tax Allocation method.
Unlike Japanese companies, many U.S. companies use only Tax Equalization method for their expatriates because they can obtain all necessary tax data from their assignees' tax returns. It does not need to hybrid with Tax Allocation method because U.S. taxation is Aggregate Taxation, that they include world-wide income on their tax return.
Tax settlement policies fulfill these purposes.
-Working abroad should make tax neutral for the assignees, which means that the expatriate assignees should have a same tax burden as if he/she stayed at their home country. In other words, the tax settlement makes assignees to keep no less or no more tax benefit or burden. For example, some expense items that are not deductible in a host country may be allowed to deduct on tax return in assignment countries, but the settlement policies prevent refunding the tax saving to assignees.
-Compared to employees who stay in Japan, tax burden for the expatriate assignees should be equivalently calculated. With tax settlement, employers can pay net guaranteed salary amount (after tax amount of salary) without fluctuating in the influence with different taxation at foreign locations.
Scope of Income and Expense subject to TEQ
Many Japanese companies categorize taxable incomes and/or deductible expenses by assignment countries in their books. Most of the time, incomes arise in Japan are already subject to withholding taxes, so they are excluded from TEQ calculations. However, large income items such as stock options are usually subject to the TEQ calculation, and hypothetical national and inhabitant taxes are collected from assignees.
They pay tax benefits from assignees' mortgage loan interests to assignees because they lost opportunity to claim Housing Loan Credit on their Japan tax returns.
Adjusting Hypothetical Tax on Salary in Host Country
Generally, international assignees' tax burdens should be treated impartially in conformity with host country (Japan) taxation and company policy. No Gain or No Loss should be arise with the tax settlement regardless of timing of starting or ending date of assignments. Also, it should apply a same rule to all assignees regardless of assignment locations.
For the fairness to all employees, many companies withhold hypothetical tax from expatriate assignees paychecks in Japan while they are nonresident in Japan. However, many companies incorrectly calculate the hypothetical taxes for the transfer year assignees. For example, in the year that assignees leaving for the U.S. from Japan, the assignees taxable salary income in Japan is smaller than previous year because assignees do not reside in Japan for entire 12 months period. In Japan taxation, just like most other countries', tax rate is higher gradually as income increase. The transfer year assignees get taxed at lower rates compared to full year resident of Japan. Furthermore, they get full amount of employment tax deductions and personal exemptions even though they lived in Japan less than 12 months. More appropriate way to calculate the amount would be that the employer annualizes the transfer year assignees' incomes and deductions.
Bonus earned in Japan prior to the U.S. assignment, but paid later while the one is on U.S. assignment, is subject to nonresident rate of 20% Japan national withholding. Many people believe that the 20% withholding makes the assignees tax burden neutral (No gain No loss). However, it is not correct. Depending on one's taxable income, a different tax rate should apply for actual taxes and hypothetical taxes.
Some companies calculate hypothetical tax only once prior to beginning of an assignment, and they never adjust it for few years. Tax rates are usually changing every year, and annual update is necessary to calculate the tax correctly.
Tax Allocation Calculation in Assignment Country
Many Japanese companies in the U.S. pay Net Guaranteed Salary to Japanese expatriate assignees, and their gross salary include net pay and tax reimbursement. The amount of the tax reimbursement depends on assignees net salary and personal income and deduction amounts. If assignees have more personal incomes, the employers' tax cost increase because they would pay more of tax reimbursement. Before initiating Tax Allocation, employer should let employees understand the concept of company policy and U.S. taxation because assignees usually plan their living cost and budget based on their net take home pay amount.
Tax Rate on Tax Allocation Calculation
Examples of Tax Allocation Rate for assignees on their personal income
1.Taxes on personal incomes are calculated at host country tax rate (Japan Tax Rate).
2. Excluding personal incomes from actual tax return, and taxes on only assignee's wage are calculated. Company pay taxes on assignee's wage only, therefore, the assignee pays the rest at top on the marginal rate.
3. Taxes on personal incomes are calculated at effective rate at assignment country (U.S. Tax Rate).
4. Tax rate prescribed in company policy is used for Tax Allocation.
|1||Japan tax rate is used, so it is fair for both employees in Japan and U.S.||It is necessary to decide and choose either Resident rate or Nonresident rate. There is a possibility to increase employer's tax cost. (Example, Retirement Bonus)|
|2||Employers pay taxes on wages only.||Assignees pay U.S. taxes at top of their marginal tax rate. Assignees have large US tax burdens.|
|3||Effective rate is average tax rate for the assignees that is calculated from actual tax return. It is fair to both employee and employer.||Employer burden may increase when assignees have large income (Winning Lotto, etc.)|
|4||It is fair because the same tax rate applies to every assignee.||
Employer burden may increase depends on personal income of assignees.
Non-taxable limit in Tax Allocation
For tax allocation calculation, it is not necessary to follow tax laws because it is merely a settlement calculation between employee and employer. Employer should set a certain non-taxable amount for all assignees. For example, a policy may state that $2,000 personal income is exempt from the Tax Allocation calculation, but any amount excess of the $2,000 is subject to the calculation.
When 20% is withheld on interest income in Japan, and taxed at 35% in the U.S., the difference (15%) should not be collected from assignees with tax allocation. It would be unfair to assignees because the assignees would not need to pay the 15% if he/she stayed in Japan without the assignment. Many Japanese companies set their policy that only personal incomes arise in the U.S. are subject for the Tax Allocation calculation.
New Eligibility of Social Security Number for E or L visa spouse
New Eligibility of Social Security Number for E or L visa spouse
Recently, the eligibility rule of social security number for E and L visa holding spouse has been changed, and this may affect eligibility of ITIN applications.
Since Welfare Reform in 1996, E/L visa spouse did not have eligibility to obtain a social security number unless they hold EDAs (Work Permit). Hence, under the old rule, they needed to apply ITIN in order to claim a personal exemption on their tax return. Now, the new rule makes E/L visa spouse eligible to have a social security number without EDAs. They need to submit only a proof of marriage. On the other hand, it does not mean that they are permitted to work without the EDAs. They are still required to obtain EDAs , if they want to work. For ITIN, it is for someone who is not qualified for SSN; therefore, it may change the ITIN eligibility anytime in a future.
How to obtain Social Security Number?
Both spouses go to Social Security Office together with their passports and marriage certificate. There is no application fee.
1. Passports of both spouse (husband and wife)
2. Marriage certificate
3. Form SS-5. You may obtain the form at Social Security Office or on website (www.ssa.gov)
How to apply?
1. Visit a nearby Social Security Office. For the location, please visit (www.ssa.gov). No appointment is necessary.
2. Submit all required documents.
3. A receipt of application will be issued by Social Security Administration upon acceptance of your application. Please review spellings of your name, address, and birth-date. It will be your burden to correct the error once social security card will be issued.
4. Social Security Card will be mailed to you by postal mail.
How to obtain your marriage certificate?
Via notary public
You may use English translated family register after it is notarized.
Via Embassy/Consulate general of Japan
Embassy/Consulate general of Japan issue English version of marriage certificate. They accept the application by mail. However, the application procedure varies depends on locations, so please contact the Embassy/Consulate general in your jurisdiction.
New U.S. Japan Treaty with 183 days rule
New U.S. Japan Treaty with 183 days rule
Under the new US-Japan tax treaty, the way to calculate U.S. days for the 183 days rule has been changed. Under the former treaty rule, U.S. days were counted in a calendar year for their exempt status in U.S. taxation. Under the new rule, it is not within the calendar year, but the 183 days can be fall "in any twelve month period." Therefore, it is necessary to count U.S. days in the prior year, the tax year, and the following year in order to determine the exempt status. It means that your wage during the U.S. business travel may be taxed in U.S., even U.S. days within a calendar year is less than 183 days.
Requirements for the exempt status from U.S. taxation
The requirements for the exempt status in U.S. taxation were ruled under the former US-Japan tax treaty Article 18, but the rule has been changed and stated in Article 14 under the new US-Japan tax treaty.
Under the new rule, the requirements of the exempt status are:
1. Days spent in U.S. are less than 183 days in any twelve month.
2. Compensations are paid by nonresident entity outside the U.S.
3. The salary cost is not charged back to a US entity
Under the old rule, about one year salary could be treated exempt when all other requirements are met. For example, s/he is continuously on business trip in the U.S. from 7/3/2004 to 6/30/2005, the salary s/he earned during the period is exempt from US taxation under the old rule. However, under the new rule, the salary would be taxable in both 2004 and 2005. The taxable incomes we are talking here include base salary and bonus paid in Japan, but travel expenses and per diem within the limitation under US tax law are not taxable.
If you plan on starting the U.S. assignment, you should be aware that your salary earned during the US business trip within 6 months before and after the assignment will be taxable in U.S. For example, you start the U.S. assignment on January 1 this year and you had visited the U.S. on business in previous year between July and December, the salary and bonus earned during the US business trip are taxable in the U.S. In this circumstance, the salary and bonus are taxed in both Japan and U.S. On the other hand, you may claim a foreign tax credit on Japan tax return in order to avoid the double taxation from both countries. The foreign tax credit calculation is very complex, though.
U.S. Subsidiaries of Japanese Corporation send expatriate employees to its parent in Japan
TU.S. Subsidiaries of Japanese Corporation send expatriate employees to its parent in Japan
Taxation of U.S. Expatriates in Japan
Recently, there are more numbers of U.S. subsidiaries of Japanese Corporation send its employees to their parent companies in Japan. Today, we will briefly explain about the structure of expatriate payroll and applicable U.S. taxation. When developing an expatriate payroll system, it is necessary to design the structure and policy to be consistent with Japanese dispatch in order to avoid potential employment discriminations. Many Japanese companies calculate compensations for Japanese expatriates under the net guarantee method, which hypothetical amount of Japan taxes are taken from base salaries but actual U.S. taxes are reimbursed. Their U.S. net pay is fixed and guaranteed amount, and it does not fluctuate by withholding taxes.
Surprisingly, most Japanese companies don't adjust hypothetical taxes every year, although expatriates' salary usually increase. Unlike Japanese companies, U.S. companies usually adjust estimated hypothetical taxes annually based on income levels. They execute the tax settlement with their employees for the discrepancies between estimated hypothetical taxes and definitive hypothetical taxes. This settlement is called Tax Equalization. In the settlement, the expatriates' burden of U.S. tax is consistent as if they were staying in host country without foreign assignment. In other words, they get no gain or no loss of tax liabilities. It is fair among all employees.
U.S. Taxation during Japan Assignment
For U.S. citizens and U.S. permanent residents, their world-wide incomes are subject to U.S. tax whereever they live. They must file a tax return every year. Nevertheless, their salaries earned abroad up to $91,400 (in 2009) can be excluded from taxable income (Foreign Earned Income Exclusion). In addition to that, foreign taxes can be claimed on U.S. tax return. Of course, incomes that are already benefited from the foreign earned income exclusion is removed from foreign tax credit calculation, because double benefits are not allowed.
In order to take Foreign Earned Income Exclusion, they are required to stay in Japan for more than one year and pay income taxes in Japan. Also, they need to pass either one of the two tests listed below.
1) Bona-Fide Residence Test - Stay in Japan for more than an entire calendar year (1/1-12/31)
2) Physical Presence Test - Stay in Japan for more than 330 days within a consecutive 12 month period
If qualified, it is possible to take Foreign Earned Income Exclusion, Foreign Tax Credit, Itemized/Standard Deductions, and Personal Exemptions on tax return. Accordingly, the U.S. tax liability during foreign assignment would be significantly smaller if it is compared to the the time of no foreign assignment, unless the expatriate has much personal incomes (non-wage).
Japan Taxation during Japan Assignment
Regarding Japan taxation, U.S. expatriates in Japan are classified into three categories.
1. Nonresident (less than one year)
For nonresidents, income from sources in Japan is subject to Japan National Tax at 20% rate, but it is not subject to local inhabitant tax. Their Per Diem, such as lodging and living expense, are not taxable in Japan.
On their U.S. tax return, foreign earned income exclusion is not allowed. However, they can take foreign tax credit on U.S. return, so their Federal tax amount will be lower, but many states do not allow any foreign tax credit.
2. Non-permanent Resident (More than 1 year, but less than 5 years)
U.S. expatriates lived in Japan for less than five years (with no intension of living in Japan permanently) are considered non-permanent residents. Their income including cost of living, education, tax reimbursements etc. from sources in Japan are subject to both national tax and local inhabitant tax at progressive tax rates. After completing the assignment and leaving Japan for U.S., income sources in Japan, such as remaining tax reimbursement, is taxed at nonresident rate at 20%, and it needs to be grossed up because it is reimbursed by company.
On their U.S. tax return, foreign earned income exclusion and foreign tax credit can be taken. Generally, foreign source income for the tax year is calculated based on number of foreign work days and total work days, so more U.S. business travel you have during the assignment, less foreign source income you get, which makes less foreign tax credit in the calculation.
Unlike their wages, their personal incomes in the U.S. such as interest, dividend, and/or rental income are not taxable in Japan.
3. Permanent Resident (more than 5 years)
Taxation for permanent residents is same as taxation for Japanese citizens, and they are required to pay taxes on all income from Japan and outside Japan. They can take foreign tax credit on Japan tax return if they pay taxes outside Japan. In comparison, non-permanent resident pay taxes only on Japan source income, but permanent resident pay taxes on their world-wide income.
On U.S. tax return, they pay taxes on their world-wide income, but they can take foreign earned income exclusions as well as foreign tax credits.
For payroll of U.S. subsidiary employees in the parent company in Japan, estimated hypothetical taxes are calculated and withheld from their pay checks every pay period. The calculation is based on their income and deduction from their prior year's tax return. Every year, the definitive hypothetical tax amount is figured based on actual tax return, and discrepancies between estimated amount and definitive amount are settled between employer and the expatriates. This settlement calculation is called Tax Equalization (TEQ), and it is mostly used by International corporations in U.S. If estimated hypothetical tax is smaller than definitive amount in the TEQ, it results balance due to company from the expatriate. If the estimated amount is larger than definitive amount, the result is vice versa, balance due to expatriate from company.
Regarding expatriates in Japan, Japan source income that company reimbursed need to be grossed up because the reimbursement is considered a benefit to the employee. Withholding tax certificates at year end need to be issued by company, which is an equivalent document to Form W-2. On U.S. payroll, it is necessary to report worldwide income (both Japan and U.S.), and the calculation of the compensation is different compared to local/domestic employees' payroll. Although they are taxed on world-wide income, withholding tax amount on expatriates' payroll is much smaller compared to non-expatriate because foreign earned income exclusions and foreign tax credit help mitigate their annual tax amount.
For expatriate payroll, compensation breakdown including estimated hypothetical tax should be displayed on earning statement in order for expatriates to understand what include in their gross salary. Otherwise, they might misunderstand the contents of their benefits, and it might also lead to a potential conflict with employer.
TAX ADVICE NOTICE:Tax advice, if any, contained in this document does not constitute a "reliance opinion" as defined in IRS Circular 230 and may not be used to establish reasonable reliance on the opinion of counsel for the purpose of avoiding the penalty imposed by Section 6662A of the Internal Revenue Code.The firm provides reliance opinions only in formal opinion letters containing the signature of a partner. The content of EastAccounting.com is for general information purposes only. The information at this website does not in any way constitute legal or professional advice and East Accounting LLC cannot be held liable for actions arising from its use. In addition, East Accounting LLC cannot be held responsible for the contents of any externally linked pages. Without consent of East Accounting LLC, reproducing or copying materials from this website is strictly prohibited.