Employees now have significant flexibility over where they will live and work in their lifetimes but employers sending workers to or from the United States face unique challenges under the U.S. tax system if the employee participates in a non-U.S. retirement plan.

According to The ADP Research Institute’s People at Work 2022: A Global Workforce View, 43% of workers surveyed are considering relocating overseas while that same proportion (43%) are contemplating returning to live in the country of their citizenship. For almost half of those workers, ADP found the relocation has already happened or is underway. For many employees, this relocation will occur just as they reach their prime retirement savings years.

At the same time, failure to comply with U.S. tax and reporting obligations can expose both the employer and employee to expensive U.S. penalties. In addition, U.S. citizens and residents who utilize a foreign pension plan to save for retirement should be aware that the requirement to pay U.S. income tax on plan contributions and earnings may erode the value of their savings over time.

U.S. tax issues related to an employee’s participation in a non-U.S. retirement plan often arise as a result of a U.S. citizen or resident employee being assigned by their employer, or requesting, to work in a foreign country. Some countries require that an employer provide local retirement benefits to employees working in that country and even if not required, many employees choose to take advantage of retirement savings programs in the foreign country for their own future benefit. On the other hand, foreign nationals who are assigned or request to work in the United States may continue to participate in a retirement plan in their home country resulting in U.S. tax consequences.

Under U.S. tax rules, employees participating in a non-U.S. retirement plan do not receive the same tax deferral benefits as employees participating in U.S. qualified plans. Absent a specific exemption provided under the Internal Revenue Code or an income tax treaty, employer and employee contributions (and for certain highly compensated employees, earnings and capital growth in the plan) may be taxable to the employee annually and require federal income tax withholding and reporting by the employer. 

The recent KPMG Work from Anywhere report Current trends in remote working, found that although 89% of the companies surveyed have introduced, or are looking to introduce a remote working policy, “tax and legal challenges are cited as major concerns when introducing remote working across borders.”

The United States in particular, creates unique tax challenges for companies looking to enable remote and cross-border working arrangements due to its worldwide taxation system. In addition to creating U.S. tax withholding and reporting requirements for the employer, participation in a non-U.S. retirement plan by U.S. citizens and tax residents may increase the overall employment cost in cases where, for example, an employee is on a temporary work assignment and the employer has agreed to cover any increased tax cost associated with the assignment.

Non-U.S. based employers are often surprised to learn that under U.S. tax law, they may also be considered responsible for U.S. federal income tax withholding and reporting for certain employees even though they have no physical or business presence in the United States. From the employee perspective, individuals who are U.S. citizens or tax residents may not realize they may be liable for U.S. federal income tax (and potentially FICA and state/local tax) on contributions as well as earnings and capital growth within the plan, and this inability to defer U.S. income tax until retirement age may substantially reduce any long-term benefit of participating in the foreign pension plan.

It is critical therefore that both the employer and employee consult their tax advisor before entering into any type of international employment or work from anywhere agreement. By reviewing the employee’s personal circumstances, the employment contract, the non-U.S. retirement plan rules and tax laws in the foreign country, tax planning opportunities may be identified such as utilizing excess foreign taxes to offset the U.S. income tax or determining whether any exemptions under U.S. domestic law or an income tax treaty are available.