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Americans Abroad: IRS to Crack Down on Improper Claims of Exemption from Social Security & Medicare Taxes

A recent report by the Treasury Inspector General for Tax Administration (TIGTA) has shown significant noncompliance with payment of Social Security and Medicare Taxes by Americans working abroad.  The report, more fully discussed below, has prompted the IRS to agree to coordinate very closely with the Social Security Administration to halt the noncompliance and recoup millions of dollars in unpaid Social Security and Medicare Taxes.  Everyone knows that the Social Security system is in dire need of funds and so, this measure may help rake in the much-needed cash.

Totalization Agreements

In an effort to eliminate dual taxation with respect to social security taxes, the United States entered into international agreements, called Totalization Agreements, with 24 foreign countries.  See the list here.   These agreements coordinate the social security coverage and taxation of American citizens and resident aliens who are employed in those foreign countries, as well as resident aliens in the United States that may be subject to U.S. Social Security and Medicare taxes.

If an American citizen or resident alien received wages for employment from an “American employer”, regardless of whether the services are performed in the United States or in a foreign country, they are generally required to pay into the U.S. Social Security and Medicare system. Additionally, many foreign affiliates of American companies provide U.S. Social Security and Medicare coverage for American citizens and resident aliens they employ. However, many foreign countries also require workers who perform services within their geographical territory to pay a social security tax. Dual social security tax liabilities result when American citizens or resident aliens working in a foreign country are expected to pay into both the United States’ and the foreign country’s social security systems.

If an American employer sends an American citizen or resident alien to work in a foreign country that does not have a Totalization Agreement with the United States, the American employer and the employee are generally liable to pay social security taxes to both countries. However, when an American employer sends an American citizen or resident alien to work in a foreign country with which the United States has a Totalization Agreement, relief from dual social security taxes is provided.

How Do Totalization Agreements Generally Work?

In general, Totalization Agreements state:

1. If an American citizen or resident alien is sent to a foreign country for less than five years to work for the same American-based employer, he or she would generally remain covered by the U.S. Social Security system.

2. If the same taxpayer was sent abroad for longer than five years, he or she would pay social security taxes to the foreign country.

3. If the taxpayer is employed by a foreign employer or was hired by an American-based employer while living overseas, he or she would pay social security taxes to the foreign country.

Conversely, if a resident alien is working in the United States the same principles would generally apply.

1. If the resident alien is sent by a foreign employer to work in the United States for less than five years, he or she would generally remain covered by the foreign country’s social security system.

2. If the resident alien worked for an American-based employer or was hired by a foreign employer while living in the United States, he or she would pay U.S. Social Security taxes.

Certificate of Coverage

A “Certificate of Coverage” issued by one country serves as proof of exemption from Social Security taxes on the same earnings in the other country. To substantiate one’s exemption from the Social Security and Medicare taxes, under the terms of a Totalization Agreement, the American citizen or resident alien or his or her employer generally requests a “Certificate of Coverage” from either the country in which the employee is employed or the country of residence.  This Certificate serves as proof of the exemption from the payment of Social Security taxes to the U.S.

To establish the exemption from coverage under the US Social Security system, the employer in the foreign country must request a certificate of coverage from the local social insurance agency that collects workers’ Social Security taxes in that country.  Some countries may have a special form for this purpose, but others may not.  Listed below is the type of information generally required to obtain a certificate of coverage:

  • Full name of worker;
  • Date and place of birth;
  • Citizenship;
  • Country of worker’s permanent residence;
  • U.S. Social Security number;
  • Date of hire;
  • Country of hire;
  • Name and address of the employer in the foreign country;
  • Date of transfer and anticipated date of return.

The Treasury Inspector General for Tax Administration Report on Noncompliance

TIGTA performed a review to evaluate the IRS’s efforts to identify taxpayers affected by Totalization Agreements and ensure that their U.S. Social Security taxes are properly paid in accordance with the Totalization agreements.  In its published report dated July 17, 2015,  TIGTA found that the IRS cannot readily identify American citizens and resident aliens working in a foreign country, as well as resident aliens working in the United States, who may have improperly claimed exemption from U.S. Social Security taxes under a Totalization Agreement. 

The sample of taxpayers included (i) American citizens or resident aliens who worked overseas during Tax Year 2012, but did not appear to have met the five-year period for coverage by a foreign country’s social security system; and resident aliens who worked in the United States during Tax Year 2012, but appeared to have exceeded the five-year period for coverage by a foreign country’s social security system and (ii) resident aliens who appeared to either work for an American-based employer or were hired by a foreign employer while living in the United States.

TIGTA believes that when its sample of taxpayers in groups (i) and (ii) is projected to the general population, $21.2 million dollars was potentially owed in U.S. Social Security and Medicare taxes for the 2012 tax year alone. 

TIGTA determined that the Social Security Administration receives Certificates of Coverage from foreign countries, but the IRS does not have formalized procedures to obtain these certificates to identify noncompliant taxpayers.

TIGTA Recommendations and Future IRS Action to Battle Noncompliance

TIGTA recommended that the IRS coordinate with the Social Security Administration to periodically acquire Certificate of Coverage data, as well as request data related to foreign social security taxes paid.  It also recommended that the IRS use the data obtained to identify noncompliance with payment of U.S. Social Security and Medicare taxes.  IRS officials agreed with TIGTA’s recommendations and the IRS plans to work with the Social Security Administration to periodically obtain Certificate of Coverage data and to request data from countries with Totalization Agreements. The IRS plans to explore the use of the data obtained to identify noncompliance with payment of U.S. Social Security and Medicare taxes.

Read more about Americans overseas and Social Security.

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