Employers: Understand Income Tax Issues Brought by ‘Digital Nomads’

The COVID-19 pandemic changed the employer and employee relationship forever. Prior to 2020, remote work opportunities were the exception, not the rule. In the post-COVID era, many employers have transitioned their workforce to allow remote work “from anywhere” in order to retain and attract talent.

Many employees are eager to maximize their remote work opportunities by continuing their job duties while simultaneously traveling the globe. Employers need to understand their potential risk exposure to allowing excited and eager employees to work abroad.

Is a Taxable Presence Created?

One of the biggest concerns for employers should be whether an employee’s presence in a different country creates a taxable presence for the employer entity. If her presence creates a taxable presence for the employer, there could be additional employment tax and corporate tax requirements in the host country that the employer will need comply with.

Generally speaking, there are two types of taxable presence tests. The first test is called a fixed place of business presence (FPOB). A FPOB presence exists if the employer has a fixed place of business at its disposal which wholly or partially carries on the employer’s business. An employee’s home office abroad doesn’t constitute a FPOB presence if the employer doesn’t:

• Require the employee work in the host country;
• Offer an office in the host country;
• Pay for the home office abroad; and
• Have control over the home office abroad.

The second test is called a dependent agency presence (DA). A DA presence exists if an employee has the authority to execute contracts on behalf of the employer and routinely exercises that authority.

Adding to the complexity of the DA presence test, many countries have a different definition of an “employee” and an “independent contractor.” Understanding which individuals would qualify as an employee for purposes of the DA presence test is crucial.

It’s important to note that the there are various tax treaties between the United States and other host countries that modify the definition of the DA presence test. An employer must review the applicable tax treaties to determine if an individual is considered an employee and, in turn, whether the job duties of that individual would cause the employer to have a taxable presence under the DA presence test.

Payroll Issues

In the United States, violations of payroll mandates are a crime. The U.S. is one of many countries that impose criminal liability for payroll noncompliance. Its payroll mandate laws attach to the employee’s “place of employment” rather than the employer’s principal place of business.

An employer must review a host country’s payroll compliance rules to determine if it’s required to follow that host country’s payroll mandates. The employer may be criminally liable in the host country for payroll non-compliance.

Many countries have a standard rate of withholding tax established for payment of income to nonresident recipients. It will be important for an employer to review a host country’s rules regarding payroll and withholding to determine if additional adjustments to payroll must be made. Further, an employer should review applicable tax treaties to determine if tax withholding is reduced or eliminated between the employee and host country.

There are a multitude of tax treaties that address various tax issues that impact employers and employees. However, many tax treaties don’t address social security obligations. An employee may have social security obligations both in the U.S. and the host country. Employers must review a host country’s rules to determine if the employee meets the various threshold requirements for a social security obligation in the host country.

Bottom Line

Employers must recognize the potential risks of allowing employees to choose where, and for how long, they work remotely. If you want to offer remote work “from anywhere” opportunities, you should consider revising your employee handbooks to set guidelines for remote work activities while abroad.

You should identify approved and prohibited countries for remote work and set reasonable timelines for remote work abroad. You should encourage employees to research their own income tax obligations while working abroad for an extended period of time in a particular host country.

Further, you should consider designing procedures to monitor compliance with the remote work policies for those working abroad. Creating detailed records for each employee (including job duties, position, and other helpful information) will be crucial in any tax compliance audit. Many tax issues quickly become complex and are best suited to be reviewed by a tax attorney or an accountant.

Emily Selner is an attorney with Axley Brynelson, LLP, in Madison, Wisconsin. She can be reached at eselner@axley.com.

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