Focus on Compliance: Expatriates
Jun 27, 2018
Multinational corporations frequently transfer employees to work in foreign countries for extended periods. Expatriation raises questions regarding the employee’s status as a participant in the company’s non-qualified deferred compensation plan. Legislation adopted in 2008 (the Heroes Earnings Assistance and Tax Relief Act) may also require that deferred compensation benefits be included in income on the expatriation date.
Does Expatriation Trigger the Right to a Distribution From the Plan?
Under Internal Revenue Code Section 409A (“IRC 409A”), payments from non-qualified deferred compensation plans are permitted only upon the occurrence of a distributable event that is reflected in the plan document. Subject to the terms of the plan, the permissible distributable events include (i) separation from service, (ii) disability, (iii) death, (iv) a future date specified at the time of deferral, (v) a change in control, or (vi) an unforeseeable emergency.
Expatriation may trigger the right to a distribution from the plan if it constitutes a separation from service under IRC 409A. Usually, however, expatriation does not qualify as a separation from service.
Separation from service is defined under IRC 409A as termination of employment with the “employer.” ”For this purpose, the “employer” means the entity for whom the employee provides services, and any other entity that is part of its controlled group or with which it is under common control. Unless the plan document provides otherwise, a controlled group or common control will generally exist if there is direct or indirect common ownership of 50% or more. As a result, an employee who is transferred to a foreign company will not have incurred a separation from service if the foreign company is part of a related group of companies that have the required level of common ownership.
Regulations do permit plan sponsors to modify the level of common ownership that creates a controlled group or common control. For example, a plan document can specify that common ownership of any percentage between 50% and 80% will be used to determine whether another entity is part of the company’s controlled group. The regulations also permit a plan document to specify that common ownership of between 20% and 50% will be used for this purpose, if the company has a valid business reason for doing so. If the plan document does not specify an alternate definition, the 50% standard must be used. Changes to this plan provision can generally be applied only with respect to future contributions to the plan.
Should Plan Deferrals be Suspended When an Employee Expatriates?
It is not clear whether deferrals can be suspended when an employee is transferred to a foreign country in the middle of a tax year. Under IRC 409A, deferral elections are generally irrevocable for the balance of each calendar year. If the employee transfers to a foreign company that is part of the plan sponsor’s controlled group, some would argue that deferrals should be continued. However, continuing deferrals may create logistical challenges. Additionally, the foreign country may not permit pre-tax deferrals, such that further deferrals are excludable from U.S. taxation but not necessarily from taxation by the foreign country.
If it is not practical – or beneficial – for an expatriate to continue deferring for the balance of the year, outside counsel should be consulted to address whether deferrals can be stopped. As a proactive measure, you may want to discuss with outside counsel whether modifying your plan’s definition of deferrable compensation (for example, to exclude foreign source income) would better support cessation of deferrals.
Are there Special Tax Rules that Apply to Expatriates?
Special tax rules apply to certain U.S. citizens who relinquish citizenship and to certain long-term residents of the U.S. who cease to be lawful permanent residents, if they meet specified tax liability or net worth thresholds or fail to certify compliance with U.S. tax laws (“covered expatriates”).
Under the special tax rules, a covered expatriate is subject to taxation on his deferred compensation benefits as though such benefits had been distributed to him on the day before the expatriation date, unless he notifies the plan sponsor of his status as a covered expatriate and agrees to irrevocably waive his rights to claim any reduced income tax withholding that may be available under a tax treaty with the U.S. If timely notice and waiver are provided, the deferred compensation is not taxable until actual payment; however, mandatory 30% income tax withholding will be applied to any payments.
Notice of status as a covered expatriate should be provided to the plan sponsor on IRS Form W-8CE by the earlier of (i) 30 days after the expatriation date or (ii) the day prior to the first distribution that occurs on or after the expatriation date. The covered expatriate will also need to file Form 8854 with the Internal Revenue Service by the due date for filing his tax return for the year that includes the day prior to the expatriation date.
Newport Group employs a staff of attorneys who are available to discuss questions you may have regarding expatriates or your non- qualified deferred compensation plan generally. Our attorneys have a combined 60 years of experience in the insurance, banking, executive compensation and employee benefits industries. If you would like to discuss this or any topic with a member of our legal staff, please contact your Relationship Manager.
Newport Group, Inc. and its affiliated companies do not render tax or legal advice and the material contained within should not be interpreted or relied upon as constituting tax or legal advice. You should consult your tax or legal advisors with respect to specific tax or legal decisions.