IRS Holds Foreign Tax Return Preparation for Expats Taxable

Answers some questions regarding the taxation of expatriate employee benefits.

In a 28 November 2017 Legal Memorandum issued to one of its field offices, the IRS Office of Chief Counsel addressed the tax treatment of fees a company paid to a large CPA firm to prepare U.S., state, and foreign tax returns for its expatriate employees under a typical equalization program. See ILM 201810007.

The costs incurred included expenses to prepare U.S. returns, state tax returns, and foreign tax returns, as well as making the tax calculations necessary to equalize taxes and pay any necessary equalization payments, responding to inquiries from foreign taxing authorities, and assisting the company’s payroll tax department. The company included amounts for federal and state return preparation in the income of employees but did not include foreign tax return preparation or any of the costs for equalization. In calculating the inclusion amounts, it relied on survey data as to the cost of simple returns. 

On examination, the IRS agents determined that the entire amount invoiced to the company for each employee was taxable. It reasoned that the proper amount was not an average for simple returns but was the amount each employee would have had to pay for the actual services provided. That amount approximated the entire amount the company paid the CPA firm for each employee. However, the agents excluded from that calculation amounts attributable to the tax equalization services and other advice provided.

The Office of Chief Counsel concluded that there was no basis to exclude any of the tax preparation costs from the incomes of employees, and that both domestic and foreign tax preparation was taxable. Those amounts were held subject to FICA and federal income tax withholding. With respect to the value of those services, it was agreed that the proper measure was the amount the employees would have had to pay for such services independently. However, it also agreed that since there was insufficient data from which to determine those amounts, the best measure of the value was the amounts paid by the employer. It recognized that those amounts were no doubt lower than the employee could have obtained independently, but nevertheless were the most supportable under the facts available. Finally, the memorandum supports the conclusion that fees for equalization services are not taxable.

How This Will Impact Mobility

The new memorandum answers several questions regarding the taxation of benefits provided to expatriate employees that have not been explicitly addressed previously by the IRS. Worldwide ERC® member companies will need to take the conclusions into account in conducting their expatriate programs.

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