Withholding rules for U.S. citizens and resident aliens working for a U.S. employer in a foreign country.

• Author: Gorman, Mary C.

For income tax withholding purposes, the wages of U.S. citizens and resident aliens include all remuneration for services performed as an employee for an employer, regardless of whether the services are performed in the United States.

There are statutory exemptions from federal income tax (FIT) withholding for foreign earned wages. Sec. 3401(a)(8)(A) (i) provides that the term "wages" does not include remuneration that is excludable from the employee's income under Sec. 911, the foreign earned income exclusion. A U.S. citizen may qualify for the foreign earned income exclusion if the employee has a foreign tax home, foreign earned income, and is either (1) a U.S. citizen who was a bona fide resident of a foreign country for an entire tax year, (2) a resident alien who is a citizen or national of a country with an income tax treaty with the United States who was a bona fide resident of a foreign country for an entire tax year, or (3) a U.S. citizen or resident alien who was physically present in a foreign country for at least 330 full days. It is important to note that while both U.S. citizens and resident aliens may qualify for the foreign earned income exclusion, only U.S. citizens are allowed to exempt this amount from withholding under Sec. 3401(a)(8)(A)(i).

The other statutory exemption from FIT withholding is when foreign wages are subject to mandatory withholding in the foreign host country under Sec. 3401(a)(8)(A)(ii). Again this exception from withholding is available only to U.S. citizens. Also, the employer cannot implement voluntary foreign income tax withholding to avoid FIT withholding.

For 2013, the maximum foreign earned income exclusion is $97,600. A resident alien is not exempt from foreign earned wage withholding, but he or she may provide a Form W-4, Employee's Withholding Allowance Certificate, claiming additional allowances in anticipation of the Sec. 911 exclusion or a foreign tax credit.

FICA Liability and Withholding

Generally, Social Security and Medicare (or Federal Insurance Contributions Act (FICA)) tax withholding, and the employer's share of FICA, apply when wages are paid to U.S. citizens and resident aliens for services rendered outside the United States. Unlike with FIT withholding (which requires any employer of a U.S. citizen or resident alien to withhold), the employer must be an American employer for FICA taxation and withholding to apply to foreign-source services.

Sec. 3121(b) provides that employment...