New Beginnings...and Their Implications:
Tax and Related Issues When Employees Relocate to the U.S.
We find that the start of the new school year is popular timing for having employees with families relocate to the U.S. Any Israeli corporation considering relocating an employee should be aware that there are certain consequences, tax and otherwise, to:
The U.S. corporation that will be the employer, and
The Israeli corporation itself, if it chooses instead to continue employing the employee directly.
Tax liability. As soon as the employee sets foot in the U.S., their salary and benefits earned in the U.S. are subject to U.S. federal income tax, state income tax, local income tax, if any, and social security/Medicare tax.
Tax filings. Unlike in Israel, where the taxes are withheld from each paycheck and generally do not require further filing or reporting, in the U.S., the relocation could trigger the employee’s U.S. federal and other tax return filing requirements.
Worldwide income. An employee who lives in the U.S. for more than six months is likely to subject their worldwide income to U.S. tax.
Continued exposure to Israeli tax. At the same time, the employee is not automatically disconnected from Israel. An employee will continue to be subject to Israeli tax unless they undergo a formal process for disconnecting from Israel. Still, an employee planning to relocate for only a short time may prefer not to disconnect entirely. Because the tax issues and circumstances may be complex, the relocation must be coordinated with an accountant who is an expert in Israeli tax and, particularly, the international tax concepts of the impact of relocation from Israel, to ascertain the employee’s exposure to Israeli taxation and to avoid having the employee subject to double taxation (potentially reducible by application of a tax treaty).
Changes in healthcare and pension benefits. Both the Israeli employer and the relocating employee should be aware that a U.S. employer is generally not required to provide certain employee benefits, such as health care and pension benefits that are required by Israeli regulations. Possible compensation arrangements include the employee continuing to receive these or similar benefits in the U.S. from the U.S. company, arranging for benefits on their own, or giving up these benefits. Determining whether the employee will continue to receive these benefits will affect the type of payroll service provider the U.S. employer will use and the cost of the total compensation package the employee will receive in his new position. In the tech space, it is common practice for these benefits to be offered to the relocating employee.
Exercising stock options. Stock options are treated vastly differently for Israeli tax purposes than for U.S. tax purposes. Therefore, before the employee’s income becomes subject to U.S. taxation, they may want to consider steps such as accelerating vesting of the options, and exercising the options, as necessary, to ensure that income arising from the options is not subject to U.S. tax as ordinary income but, rather, will be treated as capital gain, generally taxed at a significantly lower rate. Proper planning should also avoid the issue of double taxation. Again, throughout the relocation planning, the employee should also be coordinating with an accountant who is an expert in the Israeli tax system.
The U.S. employer
Payroll. The U.S. employer should set up a payroll service provider to process the employee’s compensation. As various payroll providers offer different options, the choice of provider will depend in part on the type of compensation package being offered to the employee, as noted earlier.
Transfer pricing. If the relocating employee is the company’s first boots on the ground, a transfer pricing mechanism will be required between the U.S. entity and the related Israeli corporation in order to produce an appropriate profit margin on any revenues generated by the employee’s activity. That profit will be subject to U.S. tax on the corporation i.e. federal, state and local income tax.
Sales tax. Sales generated from the U.S. company may be subject to state and local sales tax. For more information, see our article, “Sales Tax Basics,” here.
Relocation benefits. Relocation benefits paid to the employee to cover costs are considered compensation and are subject to U.S. federal, state and local income tax, as well as employment taxes. As such taxes can easily reach 40%, the U.S. company may choose to gross up the reimbursement amount to reflect that.
The Israeli company, if continuing to employ the relocated employee
Due to the myriad of issues described above, the Israeli company may feel it can take a seemingly easy way out and continue to employ their employee, instead of setting up a U.S. company as employer. In that case, the Israeli company will still face U.S. tax consequences. The employment taxes and sales taxes that would apply if a U.S. company was the employer will still legally apply. The employee’s activity in the U.S. will likely be defined as doing business in the U.S. (in tax lingo, known as creating a permanent establishment) and give rise to U.S. federal corporate income tax, state income tax and local income tax. But now, the exposure to the U.S. tax system will lie with the Israeli company, with the added cost to the company of being forced to recognize a deemed dividend for the profits each year.
Further issues. The tax and related issues of relocating an employee are too extensive to cover exhaustively in this space. Feel free to consult us for more information.
A final note on relocating: Helping your employee feel at home in the U.S. Although we are focused on the tax issues of moving, we know there is tremendous emotional involvement in relocating to a new country. You can direct your employee to resources designed to help them settle in to their new country more comfortably. One we recommend is Homeis, which we are proud to have as one of our clients. Homeis is geared directly to helping immigrants acclimate to their new country. Homeis recognizes the challenges that your relocating employee might have— in addition to the financial issues they are considering—and helps them find fellow immigrants from their home country who can give them advice, community, and a sense of home.