How Social Taxes Apply to Mobile Employees
August 02, 2023
Companies that have mobile employees with equity awards already know how complicated the taxation of those awards can be. Usually, the focus is on the income tax; however, other taxes are also relevant and can be significant. Unfortunately for mobility compliance, these other taxes do not necessarily follow the same income allocation rules as those for income tax. Such taxes include the following:
- Social taxes
- State and local taxes
- US state payroll taxes, such as state disability
A mobility compliance project is not complete if these taxes are not appropriately addressed. However, oftentimes, the system capabilities for reporting and withholding these taxes can be limited. For instance, it is not uncommon to encounter a payroll system where the wages subject to income and social taxes must be the same. In such cases, the company is often forced to ignore the social tax allocation principles and utilize only those for income tax instead.
Every mobility compliance project should begin with a conversation with the payroll team on how well their systems can cope with differing allocations of income for various types of taxes that apply to the same transaction. This is something that should be reviewed independently for each country. This blog is the first in a series of three blogs in which we will review each of the three types of taxes (bulleted above) in more detail.
In some countries, social taxes are significant; the social tax rates can be as high as, or higher than, income tax rates. Unfortunately, the income allocation rules for social tax on equity awards held by mobile employees are even less clear than those for income tax. And to make matters worse, whereas income taxes can be reconciled through the filing of personal tax returns, in general, employees cannot recover social taxes that have been over withheld.
To avoid subjecting individuals to duplicate social taxes, some countries have entered into social security agreements, which are similar to double tax treaties but are for social taxes. The EU has a social security regulation that applies across its member states (as well as European Economic Area countries) to allow mobile employees to be treated equitably. International social security agreements not only address where employees may be liable to pay social taxes but also consider benefits and pension coverage. These agreements also allow employees who are working temporarily in one country to be covered under their home country social system, avoiding a gap in coverage for their home location. This is known as a Certificate of Coverage and should be applied for by the employer.
Unfortunately, there are far fewer social security agreements than double tax treaties; for example, the United States has almost 70 double tax treaties covering income tax but only 30 social security agreements. Employees (or rather their employers) can get caught in situations where no income tax is owed due to the application of a double tax treaty, but social taxes are still due on the same income.
To address social taxes on equity awards for mobile employees, companies typically take one of two default positions:
- Subject the employee to social tax only in the current country. This would allow the employee to maximize benefits in the country they are currently residing in but could lead to a mismatch between the income subject to income tax and that subject to social tax in each country.
- Allocate the income subject to social tax between countries in the same manner as for income taxes.
The default may need to be altered when there is no social security agreement between the two countries. Furthermore, some countries do not subject equity awards to social tax, thereby creating a gap in liability that may also need to be addressed.
Social tax compliance is an important aspect of mobility compliance. As previously noted, it is important to get the social tax accurate as the employee is not able to correct any under or over withholding in their personal tax return. Therefore, it is important to understand if any payroll system limitations exist upfront so they can be addressed in the positions that the company takes. Sometimes the tail wags the dog.
Rutlen Associates LLC