U.S. citizen hired in U.S. but working and resident abroad. How should my employer be handling my taxes?

Question

I am a U.S. citizen living abroad. I was hired as an employee of a small U.S. company with the understanding that I would be working from outside the USA.

I am pretty sure my employer is not correctly reporting this situation. For instance, they are reporting my income to California even though I am not a U.S. resident. Now they are asking for an I-9. How do I straighten this situation out? Seems be heading for trouble.

Thank you!

Answer 1

For instance, they are reporting my income to California even though I am not a U.S. resident.

But you are. The US doesn't have a notion of physical presence, you're resident by mere citizenship. In case you didn't know that before - US citizens and residents (those who are not citizens, but pass the physical presence/green card test) are taxed on their worldwide income. Where you are might matter for various tax treaties, but that only if you're not a citizen of that country as well.

You're resident of California if that was the last State of residency before you left the US, and California taxes worldwide income as well. However, there are certain provisions that may allow you to become CA 'non-resident', check it out with a professional (CPA/EA familiar with the CA FTB residency rules). In that case you'll only pay taxes on CA sourced income (your salary), but not other income (interest in the foreign bank).

Now they are asking for an I-9.

Every US employer must.

How do I straighten this situation out? Seems be heading for trouble.

If by trouble you mean paying your taxes, then there's nothing to straighten out.

But do consult with a US-licensed CPA/EA who provides services in the country you're located at (US embassies some times provide listings of those, if not - there's always Google). There might be some additional issues you're unaware of that might affect you (FBAR, for example, various exclusions and deductions, additional reporting requirements...).

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Chris mentioned dual taxation - that is a very real and valid concern. Even though you're taxed by the US on your US-sourced salary, being a resident in another country subjects you to the tax laws of that country. They might want to tax you on that money as well, and you may have to pay taxes twice if there's no protection in a tax treaty against that.

Note about @Paul's answer: your personal tax return may indeed include certain forms that will reduce your tax in the US, either through the foreign income exclusion (form 2555, an audit red flag), foreign tax credit (form 1116) or a combination of both.

But your question was about the employer. To the employer - you're a California resident, and the employer will treat you as such. What you personally do with your 1040 is not their problem or concern, its yours. I strongly suggest you to get a professional advice on that (and if you don't want to pay the CPA and instead learn it yourself - that's fine, but when the audit time comes it will cost you much more to hire representation anew instead of having the CPA/EA who advised you ahead of time defend his advice).

Answer 2

As an American, I had a great time living and working in Hong Kong for 6 years.

You need to go do some serious reading before talking to anyone. One person in HK wanted me to pay them US$2,000 to do my relatively simple taxes. A CPA in the US can usually do your taxes for a lot less than that, even after using the overseas express mail a few times, but if they don't do these regularly you may want to be able to detect that and/or be able to point them in the right direction.

There is a Foreign Earned Income Exclusion that could allow you to eliminate ~ $80,000 a year from your income for US income tax purposes on the grounds that you live overseas. The reason this exists is that the US Government realizes that the foreign country has their own taxes that you will be required to pay because you live there under their laws. In my case, my employer was foreign, and I had a foreign address where I lived year round, and my only US address was a relatives' address who forwarded mail. So for the US authorities there weren't any murky issues.

One way to make sense of all this is to consult the source directly:

http://www.irs.gov/Individuals/International-Taxpayers/Foreign-Earned-Income-Exclusion---Can-I-Claim-the-Exclusion-or-Deduction%3F

where you will find this interesting paragraph from the IRS website when you click on the link on #1 Do you have Foreign Earned Income?

Source of Earned Income: The source of your earned income is the place where you perform the services for which you received the income. Foreign earned income is income you receive for performing personal services in a foreign country. Where or how you are paid has no effect on the source of the income. For example, income you receive for work done in France is income from a foreign source even if the income is paid directly to your bank account in the United States and your employer is located in New York City.

After some interaction with @littleadv, I decided to post the rest of this section from the IRS website, so you can see exactly what their examples say.

If you receive a specific amount for work done in the United States, you must report that amount as U.S. source income. If you cannot determine how much is for work done in the United States, or for work done partly in the United States and partly in a foreign country, determine the amount of U.S. source income using the method that most correctly shows the proper source of your income. In most cases you can make this determination on a time basis. U.S. source income is the amount that results from multiplying your total pay (including allowances, reimbursements other than for foreign moves, and noncash fringe benefits) by a fraction. The numerator (top number) is the number of days you worked within the United States. The denominator (bottom number) is the total number of days of work for which you were paid.

Example: You are a U.S. citizen, a bona fide resident of Country A, and working as a mining engineer. Your salary is $76,800 per year. You also receive a $6,000 cost of living allowance, and a $6,000 education allowance. Your employment contract did not indicate that you were entitled to these allowances only while outside the United States. Your total income is $88,800. You work a 5-day week, Monday through Friday. After subtracting your vacation, you have a total of 240 workdays in the year. You worked in the United States during the year for 6 weeks (30 workdays). The following shows how to figure the part for work done in the United States during the year. Number of days worked in the United States during the year (30) ÷ Number of days of work during the year for which payment was made (240) × Total income ($88,800) = $11,100. Your U.S. source earned income is $11,100.

These calculations are typically for US persons who have taken a long-term job assignment and really do live a foreign country. Generally it is expected that they can prove that they live in the foreign country (have a home or flat), or were physically there (from, say, passport stamps) 330 days per year. If neither of those apply, the FEIC doens't apply. So there is no ~$80,000 relief for a US person who works in Australia for 3 months. However, while the FEIC isn't available for short foreign jobs or occasional foreign assignments, there may be other forms like the foreign tax credit, that do still apply. But they only apply to the extent you owe and pay taxes to a foreign country, so there is no free lunch....

None of this magically gets a person out of paying taxes.

Also, see IRS Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.