Expat Tax Focus: Sending a US Employee to Germany, Part 2 of 2
The following is part two of a two-part Radius series on sending US expats to Germany. Read part one
By Luigi Nicoletta, Senior Manager, Tax and Global Mobility
In my last post, I described a typical scenario involving a US company sending a US national to Germany on an assignment lasting between one and two years. I also gave an overview of German tax-residency laws under the US-Germany double tax treaty. In part two of this two-part series, I’ll discuss drafting an expat assignment letter and how to ensure that your company fulfills both its US and German tax obligations during your expat’s stay in Germany.
The Assignment Letter
Before sending an employee to Germany, your company should set out all the terms and conditions of the assignment in writing. This document is commonly known as an assignment letter, and it should include:
- The period of the assignment.
- The names and addresses of all parties to the contract.
- The annual gross salary and benefits of the expat, along with any housing allowance, relocation costs, and travel costs.
- The period of notice of the assignment agreement (in case either party wishes to terminate the assignment before the scheduled/initially agreed completion date).
- Annual vacation allowance.
- Work schedule.
- Place of work.
- Any applicable collective labor agreements.
- Assistance with tax forms (if your company intends to provide it).
- Confirmation that health coverage in Germany will be provided (or not).
The above list is by no means exhaustive. For example, other provisions of an assignment letter might include terms and conditions related to: payments to a foreign bank account; salary paid in a foreign currency; and the taxation of bonuses paid in one country for services performed while in another country.
A reminder that in part one of this series, I listed the assumptions of our expat scenario. Those included following a tax-equalization policy, so your company will be on the hook for compensating the expat for any tax losses he or she incurs while on assignment (relative to what the expat would have paid in taxes had he or she stayed home). Given this, your company should carefully review the tax effectiveness of the expat’s remuneration package when drafting the assignment letter. In addition to the expat’s base salary, the following items may influence the tax burden of the package:
- Fringe benefits.
- A bonus and/or premium (e.g., foreign service premium).
- Allowances (e.g., for cost of living or housing).
- Reimbursements (e.g., for language training or home leave).
US Federal, State and Hypo Taxes
When your expat is on assignment in Germany, you may stop remitting federal taxes to US authorities for those amounts regarded as “foreign-earned income,” provided our initial assumptions are met and the expat is considered to have established a “tax home” in Germany. In such cases, the employee will be required to provide the company with a completed IRS Form 673.
To determine if your company may stop remitting taxes to US state (as opposed to federal) authorities for your expat’s foreign-earned income, you’ll need to consult applicable state law, as each state has its own related rules. In some cases, state remittance (like federal) may cease for the duration of the assignment.
US employers should note that though federal and state tax remittances may be stopped in some scenarios for the duration of the expat’s assignment in Germany, this does not mean that tax withholding on the expat’s pay will also stop. The tax-equalized expat in our scenario will continue to have his or her state and federal taxes withheld at source, and your company will use these tax withholdings to cover the liabilities arising in Germany. This process is also known as hypothetical tax withholdings — or more simply as “hypo taxes” — since the taxes are not actually being remitted to US authorities but are used instead to pay for taxes due in the host location (Germany). Finally, it’s a virtual certainty that the hypo taxes collected will not equal the amounts actually due in Germany. As a result, when following a tax-equalization policy, your company will likely have to make up for tax burdens incurred by the expat employee, as tax rates in Germany are typically higher than those in the US.
Taxes for FICA (Social Security and Medicare) and 401(k) Plans
In addition to the tax treaty in place between the US and Germany (mentioned in part one), the US and Germany have also entered into a social security treaty (known as a “Totalization Agreement”). As long as the expat abides by the provisions of the agreement and obtains a Certificate of Coverage, he or she will not be liable for paying German social security taxes to German authorities. The expat will continue to make US FICA and 401(k) contributions while on assignment. Your company can place the FICA and 401(k) contributions in US accounts, while simultaneously paying the expat’s salary in German currency to a German bank.
In our scenario, your expat employee will likely need to file a German tax return and go on a payroll run by your German entity. This kind of payroll is usually called a “shadow” payroll. That is, the US expat will remain on the US payroll, and an additional “shadow” payroll will be established in the host country to track the expat’s compensation and make tax payments to local authorities. In some situations, a shadow payroll may not be necessary and the liabilities due in Germany can be settled via quarterly prepayments (which may also turn out to be a most cost-effective solution than running a “shadow” payroll).
It should be clear by now that there are myriad expat taxation scenarios, whether you’re sending an employee to Germany or to virtually any other country. And almost any company, regardless of size or industry, will benefit from consulting with an expert prior to sending an employee abroad. An expert on global mobility issues will not only ensure you minimize compliance risks and maximize company tax benefits, they’ll also help you protect your valuable employees from potential tax penalties and provide them with a competitive compensation package. This in turn will help you retain and attract top talent in an increasingly competitive global marketplace.
Read part one of this series.