Foreign disregarded entities may face U.S. FICA tax issue.

• Author: Van Leuven, Mary
• Position: Federal Insurance Contributions Act

In recent years, many organizations have restructured their international businesses to operate through entities disregarded for U.S. federal income tax purposes (DBs). Although these organizational structures may provide benefits from a corporate income tax perspective, this item shows how-restructuring into foreign DEs may also affect the employment tax treatment of the organization's individual employees.

In the United States, the Federal Insurance Contributions Act tax (FICA, consisting of Social Security and Medicare tax) is imposed on wages from employment. For this purpose, employment includes services performed by an employee inside the United States, regardless of the citizenship or residence of either the employee or the employer. If services are performed outside the United States, employment subject to FICA is generally limited to services by U.S. citizens or residents as employees of an American employer.

The term "American employer" includes U.S. corporations as well as partnerships if two-thirds or more of the partners are U.S. residents. Hence, U.S. citizens and residents who work abroad for foreign corporations (including foreign subsidiaries of U.S. corporations) are generally not subject to FICA. Some employees might prefer this treatment--perhaps because the increase in retirement benefits would be minimal compared to the tax they would have to pay while working outside the United States--and others might prefer the FICA tax coverage. The focus of this item is on how a foreign DE might obtain FICA tax coverage for its employees.

Before 2009, Notice 99-6 allowed DEs to satisfy employment taxes (FICA and income tax) in one of two ways: (1) calculation, reporting, and payment by the DE's owner, as though the employees of the DE were employed directly by the owner (branch treatment); or (2) separate calculation, reporting, and payment by each state law entity under its own name and taxpayer identification number (separate employer treatment). By choosing the branch treatment, a foreign DE of an American employer would be considered a branch of the American employer, with U.S. citizens and residents employed by the foreign DE treated as employees of the American employer, subject to FICA tax.

However, this branch treatment is no longer available. Regulations issued under Regs. Sec. 301.7701-2 (T.D. 9356), effective January 1, 2009, made Notice 99-6 obsolete. Under these regulations, a foreign DE of an American employer is...