Recently, I have heard from several American employees of a foreign (non-US) international airline. Apparently, for a significant number of years, the airline had been withholding from the wages of its US employee cabin crew certain payroll taxes, including Federal Insurance Contribution Act (FICA) taxes. FICA taxes are commonly called “Social Security” taxes because they relate to entitlement benefits such as Social Security. It seems that such withholding had been initially undertaken by the airline without a full understanding on its part as to its US withholding duties. This is not the first time I have heard of some messy US tax work on the part of a foreign airline.
Now, the airline (presumably based on proper legal advice) has determined that such withholding was not required and it has told the employees that it shall discontinue FICA payments and withholding. At least some of the employees are very upset over this decision since they had hoped to be able to collect Social Security benefits at a later stage in life. Among some of the questions I had been asked included whether such a US employee could make voluntary contributions to Social Security, or, whether the foreign airline could continue to withhold and pay into the Social Security system even though an exception was in place under the law?
Before delving deeper, a little background about FICA may be helpful.
Federal Insurance Contribution Act
The area of FICA taxation is somewhat complex. FICA taxes are paid by both employers and employees, with the employee’s portion being withheld from his wages. Under the FICA rules, if the employer is not a so-called “American employer” and all services are performed outside the US, no FICA taxes are imposed on either the employer or employee.
As an aside, it’s a no-brainer to understand why the foreign airline in question will discontinue making FICA payments to the US Treasury – while half of the tax is paid by the employee, the other half of the FICA taxes must be paid over directly by the airline. I can imagine the airline is thinking along the following lines: Why should the airline lose profits and pay into a system if it does not have to?
When FICA obligations exist, payment of the employer’s share of the tax and withholding on the employee’s share are required. The employer is ultimately responsible for the tax when failing to withhold. Failure to withhold is serious business and has very harsh results for an employer who does not follow the rules.
Who is an “American Employer”?
Until 2008, an “American employer” was defined as (1) the United States itself, (2) an individual who is a resident of the U.S., (3) a partnership, if two-thirds or more of the partners are residents of the U.S., (4) a trust, if all of the trustees are residents of the U.S., or (5) a corporation organized under the laws of the United States.
In 2008, the law was changed with passage of “The Heroes Earnings Assistance and Relief Tax Act of 2008” (The “HEART Act). The HEART Act maintained the same definition of an “American employer”, but expanded the list to include certain foreign employers for FICA purposes.
Under the HEART Act, a foreign employer can be treated as an “American employer” for FICA purposes with respect to an employee who is performing services in connection with a contract between the US government and any member of a domestically controlled group of entities which includes this foreign employer. The term “domestically controlled group of entities” means “a controlled group of entities the common parent of which is a domestic corporation”. The term “controlled group of entities” means a controlled group of corporations as specially defined; it generally includes parent-subsidiary / brother-sister controlled groups, generally with over 50% ownership. Thus, US parent companies having controlled foreign entities that participate in government contracts must carefully review the employee population of those foreign entities to determine whether any US-citizen or US-resident employees are present.
Totalization Agreements Can Change the Result
Exceptions to all of the above rules may apply if a so-called US totalization agreement is in effect (basically, a totalization or social security agreement is similar to a treaty). The United States has entered into totalization agreements with a number of foreign countries to coordinate social security coverage and taxation of workers employed for part or all of their working careers in one of the countries that is a party to the agreement. You can learn more about Social Security and working abroad as well as totalization agreements at my US tax blog posts here and here.
Working for a Foreign Employer? No Social Security?
Let’s take the simple case of a US person working abroad for a foreign employer (say, a US citizen working in Dubai for a UAE corporate-employer). Under the rules just discussed, the employer and employee have no FICA responsibilities whatsoever; there are no FICA taxes to pay. (There is no totalization agreement in place between the US and the UAE; so, no changes will result from such an agreement).
Knowing that old age catches up with all of us, it is very possible that the US employee will want to voluntarily pay into the US social security system. Are voluntary payments into Social Security possible?
Unfortunately, such payments are not possible. This issue has been addressed by both the Social Security Administration and the Internal Revenue Service. You simply cannot make voluntary social security payments if no taxes are due. By way of analogy, it is also doubtful the non-American employer (should it wish to be so generous to its US employees) can simply decide to disregard the law by “voluntarily” making FICA tax payments to the US Treasury and withholding FICA tax for the US employee.
What Can I Do About Retirement Savings as an Employee Working Abroad?
So, what should the typical expatriate do to plan for his golden retirement years? Many are not given a pension plan by their employers and must devise a way to save for retirement. Unfortunately, I see that a number of expatriates make the mistake of investing in foreign mutual funds, life policies, savings plans, portfolio bonds and similar fund arrangements to save money for retirement.
Such investments end up being a big mistake due to US tax rules that make them completely inappropriate investments for the US individual. So-called PFIC rules will eat up this type of foreign investment in punitive taxes and interest charges, leaving the expat in the poorhouse. Given the significant tax complexities, Americans must be well advised before investing in the offshore market.
Given the plight of many expatriates working overseas for a non-American employer, I asked my trusted colleague, Vince Truong, Certified Financial Planner™ what can be done to plan for retirement in a US tax-friendly way since Social Security payments cannot be made in this situation. Vince is the only United States certified Financial Planner in the United Arab Emirates. He provides advice in the areas of pensions, investments, comprehensive financial planning and assurance (life, disability, medical).
Part II of this tax blog post will turn the floor over to Vince who will provide a treasure trove of information on this topic.
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