The German individuals who work for DeutschCo will be concerned about any exposure to a U.S. federal tax liability from their assignment to the U.S. distribution center. A German individual’s U.S. federal tax liability depends on two levels of inquiry. First, is the individual a U.S. citizen or resident? Second, if the individual is a nonresident alien in the U.S., does the treaty exempt the individual from taxation?
The U.S. taxes its U.S. citizens or residents on their worldwide income. Assuming that the German individuals are not U.S. citizens, U.S. taxation on worldwide income will still occur if they are residents under both the Internal Revenue Code and the treaty.
Non-resident aliens are individuals that are not U.S. citizens and have failed to meet the residency requirements. If the individuals are nonresident aliens, the treaty determines their tax exposure.
Under Article 16 of the treaty, salaries, wages, and other similar remuneration earned by the German individuals for services performed in the U.S. do not incur U.S. tax if the employee is present in the U.S. for less than 183 days during the year and the compensation is not borne by a U.S. employer (a U.S. subsidiary or branch). If the individual meets this test, no U.S. tax is due on the compensation. Although the first alternative (the $ 10,000 alternative) is simple, the second alternative merits further discussion.
If the German individuals are in the U.S. for less than 183 days, their U.S. taxation depends on whether they are employees of either a U.S. employer (USSub or branch) or of DeutschCo. If the German individuals are employees of DeutschCo, they do not have a U.S. tax liability, and should file a Form 1040NR that discloses the treaty position and reports the excluded amount. But if the German individuals are employees of either USSub or branch, they have a U.S. tax liability, which requires withholding of thirty percent of their compensation, the filing of a Form 1040NR with limited deductions and exemptions, and possible liability for the U.S.’s social security system.
Employers of employees in the U.S. must withhold and remit the employee portion of the social security tax (“FICA”) on all remuneration paid. In addition the employer must pay their portion of the social security tax. For 2000, a rate of 6.2 percent applies to the first $ 72,600 of compensation for the old-age, survivors, and disability insurance portion (“OASDI”) for both employee and employer. The Medicare rate of 2.9 percent applies to all compensation.
The U.S. has a totalization agreement with Germany that can eliminate the U.S. social security tax for the first five years a German individual works in the U.S. To obtain the exemption, the employer must transfer the employee to a U.S. location and receive a certificate of coverage from the Federal Minister of Finance.
Please note that the federal tax treatment of DeutschCo’s U.S. operations and these German individuals are at odds. If the German individuals are employees of either USSub or branch, DeutschCo avoids any inadvertent permanent establishment status as described above. But for the individuals to avoid U.S. tax, DeutschCo must employ them, which may result in DeutschCo having an inadvertent permanent establishment that the U.S. can tax.
The German employees may also be liable for state income taxes depending on the respect the various states provide the treaty.
This topic is part of the free webinar 'U.S. Taxation for German Business' at March, 9th 2016 at 3 pm CET.
(From: German American Trade, Vol. 12 No. 5)