What’s the Difference Between Tax Equalization and Tax Protection?

Sophisticated professionals who work on assignment overseas, for a time or permanently, know that the country they are assigned to can cause serious tax implications. Companies that cannot address employees concerns in this regard may find a reduced willingness to go on assignment or their workers may encounter serious tax difficulties. Companies that regularly engage in international work typically attempt to account for foreign tax for their workers. However, there are two distinct systems that are often used to accomplish this same goal:  tax equalization and tax protection.

While these terms sound similar and accomplish similar goals, there are important differences between them. These differences may make one version more a better fit for certain businesses. US Tax Help and CPA Ted Kleinman can assist your company in weighing the relative advantages and disadvantages of each system so that you company can make a well-informed business decision.

What is Tax Equalization?

Many people who must live and work overseas may worry that they will pay excessive tax or suffer from double taxation. However, the U.S. Tax Code has accounted for both the possibility that a U.S. taxpayer assigned to work in a foreign country could face either extremely favorable or extremely unfavorable tax treatment due to the interplay of the U.S. Tax Code and the laws of the nation where the taxpayer is assigned. The intent of tax equalization is to equalize the amount of tax paid so that the taxpayer who is living and working abroad pays what he or she would have paid in tax domestically. That is, the goal of tax equalization is to level out the level of taxation so that it is similar to what the taxpayer would have been assessed should he or she stayed within the United States.

When utilized, an employer is responsible for covering the overseas employee’s or assignee’s tax costs for both the nation they are assigned to and for their home country. For his or her part, the employee then remits payments to the company per terms of the company’s tax equalization policy. These payments should be collected from the employee every pay cycle and once a year the hypothetical tax amount should be reconciled with the actual tax amount. This can lead to the employee or assignee having to remit additional payments or the company having to return a portion of the already paid funds.

What is Tax Protection?

Tax protection has similar goals to tax equalization, but it accomplishes them in a different manner. Tax protection largely puts the burden of home country and foreign tax compliance on the employee. The employee is responsible for paying all local and international taxes. Then, at the end of the tax year an annual assessment of the taxes paid should be performed. If the actual taxes paid are greater than the hypothetical amount of taxes that would have been paid had the worker stayed home, the company must reimburse the worker. If the amount in actual tax paid is less than the hypothetical stay-at-home amount, then the worker does not receive any remittance.

Are there benefits or drawbacks to these methods?

While the tax protection method is often favorable to businesses in the sense, the company does not have to cover taxes for the entire year until the annual assessment is performed. However, this type of system can lead to other negative consequences. First, if the employee is living in a high-tax jurisdiction under a tax protection system, the individual may experience significant cash flow issues. Furthermore, the employee can reap a significant tax windfall if the hypothetical tax was under calculated.

By contrast, the tax equalization method may require additional oversight and administration by the company, but it does provide for greater fairness, increased tax compliance rates, and greater flexibility. Fairness is present in tax equalization schemes because the worker assigned to a foreign country is put in a tax neutral position. This scenario permits for greater flexibility as the individual may move from country-to-country, as work or the project dictates,  without having to account for changes in levels of taxation.

Rely on my International Business Tax Experience

Ted Kleinman of US Tax Help is a CPA dedicated to using his 30 years of tax knowledge and experience to help taxpayers and their businesses maintain compliance with domestic and international tax obligations. To schedule a consultation, call Ted Kleinman of US Tax Help at (541) 923-0903.