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Payroll in Practice: 12.2.19

Dec. 2, 2019, 3:04 PM

Practitioners’ questions are answered by a payroll and tax consultant who also is an enrolled agent licensed to practice before the Internal Revenue Service.

Question: We hired a nonresident alien to perform a job in the U.S. The employee was entered into our payroll system using a Social Security number and was paid with all payroll taxes applied. The employment contract stated that the employee was aware that applicable taxes would be withheld. However, the employee disagreed with the withheld taxes and submitted a Form W-8BEN, claiming exemption from tax withholding. How do we handle this?

Answer: Because the company is are treating the nonresident alien as an employee, the withholding situation is going to be the same as for employees who are U.S. citizens. However, there are some modifications to what may be claimed on Form W-4. That means wages will be subject to graduated income tax withholding rather than the general 30% withholding rate for nonresident aliens.

Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Individuals), is used for nonemployees to provide information to a payer of certain types of income, including tax identification information and to establish exemption from backup withholding at 30% for certain types of income.

Form W-8BEN is not used to claim exemption from withholding on compensation for personal services performed in the U.S.

The correct form to claim exemption from income tax withholding on compensation from personal services is Form 8233, Exemption From Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Nonresident Alien Individual. Dependent personal services generally are those performed as an employee.

Form 8233 is used by a nonresident alien to claim a tax treaty exemption from withholding with respect to some or all of the compensation received for dependent personal services.

An employee would have to provide Form W-4, Employee’s Withholding Certificate, if the compensation is not exempt or only partially exempt. There are special instructions for Form W-4 for nonresident aliens. The Internal Revenue Service issued Notice 1392, which has two pages of instructions for nonresident aliens to assist them in filling out Form W-4. For employer withholding instructions, see IRS Publication 15 (Circular E) “Employer’s Tax Guide.” For 2020, the employer withholding instructions are to be available in IRS publication 15-T, “Federal Income Tax Withholding Methods.” Note: The final version of Publication 15-T is expected to be released in December of 2019.

For more information, employers and employees can consult the tax treaty that the U.S has with the country of citizenship for the employee to determine which exemptions may apply. The IRS has several webpages related to tax treaties, including a general information page at https://www.irs.gov/individuals/international-taxpayers/tax-treaties,
a page with links to the treaties for each country at
https://www.irs.gov/businesses/international-businesses/united-states-income-tax-treaties-a-to-z, and a page with summary tables showing treaty provisions for certain types of income by country. For example, Table 2, “Compensation for Personal Services Performed in United States Exempt from U.S. Income Tax Under Income Tax Treaties,” is available at
https://www.irs.gov/individuals/international-taxpayers/tax-treaty-tables.

Generally nonresident alien employees also are subject to Social Security and Medicare taxes unless there is a dual coverage agreement with the employee’s resident country. Information is available from the SSA website at https://www.ssa.gov/international/index.html concerning agreements to avoid dual taxation.

Workers who are exempt from U.S. Social Security taxes or similar foreign social taxes must document their exemption by obtaining a certificate of coverage from the country that oversees the coverage. For example, an employee who is based in the United Kingdom but is temporarily working in the U.S. would need a certificate from the U.K. as evidence of the exemption from U.S. Social Security tax.

After the other country issues a certificate certifying that the employee is covered by the foreign system, the employer can stop withholding and paying U.S. Social Security taxes on the employee’s earnings. The certificate should be retained in the employer’s files so it can be produced if the Internal Revenue Service questions why no taxes were being paid for the employee.

If the employee provides a certificate of coverage, you may have to correct the Social Security and Medicare withholding and employer’s tax for prior periods using Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund, and Form W-2c, Corrected Wage and Tax Statement, if a previous year is involved. If the employee is allowed a treaty exemption for all or part of the income tax wages, you also can recover excess withholding for the current year. If income tax subject to a tax treaty exemption was withheld for a prior year, the employee will have to file or amend Form 1040-NR, U.S. Nonresident Alien Income Tax Return, to claim a refund of the excess income tax withholding and additional Medicare tax withheld.

Question: An employee to whom we paid relocation expenses in 2018 is to repay part of the funds in 2019. Do we have to adjust the employee’s 2018 Form W-2 after the repayment?

Answer: Under the tax code overhaul (Pub. L. 115-97) that took effect Jan. 1, 2018, employer-paid or reimbursed moving expenses paid for a move in 2018 are taxable as wages. If the employee has to repay part of that amount, the funds are treated as a repayment of a wage overpayment. Because this was for a prior-year overpayment, the 2018 Form W-2 will have to be adjusted, but only for Social Security and Medicare wages and taxes. The W-2 cannot be adjusted for income tax wages and withholding or for withholding of the additional Medicare tax as these are claimed by the employee as a credit on the employee’s 2018 income tax return.

From the standpoint of the employer, the repayment has no effect on 2019 wages and taxes. However, special rules apply to the employee’s 2019 income tax return for the amount the employee repaid. If the amount repaid is more than $3,000, the employee has the option to claim the excess income tax and Additional Medicare Tax paid for 2018 as a credit against 2019 tax, or take a deduction as a miscellaneous itemized deduction that is not subject to the 2% adjusted-gross-income limitation under the claim of right rules. The procedure is noted in Chapter 12 of IRS Publication 17, “Your Federal Income Tax,” in the section on repayments.

The amount the employee repays to the employer is treated as the gross amount of the overpayment including withheld taxes. For example, if the employee is to repay $5,000 to the employer, that amount includes not only the net amount of benefit received by the employee, but also any income, Additional Medicare, Social Security, and Medicare tax withholding attributable to the $5,000 gross benefit.

The employer will have to refund to the employee any Social Security and Medicare taxes withheld attributable to the amount repaid and prepare and file Form 941-X to claim a credit for the employee and the employer Social Security and Medicare taxes as well as a Form W-2c to correct the Social Security and Medicare wages and taxes for 2018.

As indicated earlier, neither the federal income tax wages and taxes or the Additional Medicare Tax withholding are adjusted, refunded to the employee or claimed by the employer on Form 941-X or the W-2c. The wages remain taxable income and the withheld taxes remain as credits against tax on the employee’s 2018 Form 1040. Those amounts cannot be adjusted after the end of the year.

By Patrick Haggerty

Do you have a question for Payroll in Practice? Send it to phaggerty@prodigy.net.

To contact the reporter on this story: Patrick Haggerty at phaggerty@prodigy.net
To contact the editor on this story: Michael Trimarchi in Washington at mtrimarchi@bloombergtax.com

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