When a U.S. nonprofit organization engages in foreign operations, one of the many potential legal issues may involve employment taxes, and more specifically social security taxes (known in the U.S. as “FICA” taxes for Social Security and Medicare taxes). For U.S. citizens working abroad for a U.S. organization, U.S. FICA tax obligations will apply to both U.S. employers and their employees (for their respective portions). In addition, social security tax obligations may arise under foreign countries’ laws, for U.S. workers within their own jurisdictions.
How may U.S. employers and employees avoid such potentially onerous double taxation? First, through “totalization agreements” pursuant to international treaties between the U.S. and other countries. Second, and quite importantly, through complying with the accompanying “certificate of coverage” requirements – and knowing the related legal compliance rules!
Totalization Agreements – Background Considerations
To avoid the problem of dual coverage, the U.S. has entered into International Social Security treaties, or Totalization Agreements, with various countries that are mostly in Europe. The U.S. began such treaties in 1978, with new countries added periodically and the total currently at 28 countries. (A list of the covered countries may be found here).
Not only do Totalization Agreements prevent double taxation of individuals covered by two national social security systems, they also allow individuals under certain circumstances to combine contributions to two social security systems to meet eligibility requirements for benefits—hence the name “Totalization.” If workers divide their time between the U.S. and foreign countries, they may not acquire enough credits in any country to meet minimum eligibility requirements for benefits. This lack of continuity under a single social security system may result in a worker’s ineligibility to receive benefits from any country, despite the fact that he or she may have been paying into social security systems for a combined total number of years that otherwise would have resulted in receiving benefits.
Applicable Totalization Agreement Rules
To evaluate social security obligations and coverage requirements for U.S. employees working internationally, the following rules and applicable considerations should be carefully evaluated and followed through.
1. Territoriality Rule
Generally, if a U.S. nonprofit sends an employee to work in a foreign country, that foreign country may impose social security taxes on the employee and the employer. This is known as the “territoriality” rule, which focuses on the location in which the employee works. Consequently, absent a Totalization Agreement, dual tax obligations will automatically arise. Note however that some foreign countries do not have any employment-related social security, so the dual coverage issue will not arise.
2. Detached Worker Rule
The “detached worker” rule is an exception to the territoriality rule. It allows employees (not self-employed individuals) who are sent to work in a foreign country for five years or less to remain within the U.S.’s social security system as a “detached worker.” In other words, they are sufficiently “detached” from the foreign country and “attached” to the U.S., for FICA purposes. Consequently, the employees and their employers may pay only FICA taxes, not any foreign social security taxes.
Note that this detached worker rule applies to all U.S. Totalization Agreements except the U.S.’s agreement with Italy, which does not impose such five-year constraint.
3. Self-Employment Rule
Individuals considered self-employed for social security purposes, such as ministers, are responsible for their own social security obligations. U.S. employers do not ordinarily pay FICA taxes for them. For ministers working in most countries with a Totalization Agreement, the applicable social security coverage requirement will be that of the country of the minister’s residence – regardless of the minister’s assignment duration. For example, if a minister who is a U.S. citizen moves to South Korea to assist with starting a church, the minister will be subject to South Korea’s social security coverage because it is the place of the minister’s residence. Since such coverage is non-U.S., it may be helpful for the U.S. employer to clearly document the employee’s ministerial role and absence of any FICA tax obligation, such as through an employment contract.
Certificates of Coverage
If a Totalization Agreement applies for a particular foreign employment assignment with resulting U.S. coverage only (i.e., as a “detached worker”), then the U.S. employer (or a minister, if self-employed) should prospectively apply for a “certificate of coverage” from the U.S. Social Security Administration. An online application may be found . Notably, information that an employee has worked in the U.S. for six months or more, prior to the application date, should provide bright-line evidence of the requisite “attachment” for the certificate’s approval. This certificate should reflect that U.S. coverage (and not foreign coverage) is proper for both current payroll tax obligations and the employee’s future Social Security benefits, which may be important in the event of a U.S. or foreign country tax audit.
Conversely, if the employee’s foreign assignment (other than Italy) is for more than five years, then the U.S. employer and employee should apply to the foreign country’s social security system for similar clarification of the foreign country’s sole coverage. Again, such certificate may be important in the event of any IRS inquiry, especially if the IRS asserts that the U.S. employer should have been paying FICA taxes for multiple missing years.
Note too that if a U.S. employer hires a U.S. employee who is already in a foreign country, that employee may fall within the foreign country’s social security system regardless of his or her work assignment duration because of the above “attachment” considerations. In other words, the U.S. Social Security Administration may view such employee as “detached” from the U.S. and “attached” to the foreign country of residence, and therefore deny the certificate of coverage application on that basis.
U.S. employees who wish to be covered under only the U.S. social security system but continue working abroad in countries with Totalization Agreement have two options. First, they may come back to the U.S. for work here for at least six months and seek a new certificate of coverage, per above. Second, they may apply to the U.S. Social Security Administration for an extension of their certificate of coverage. In either case, again, they must demonstrate sufficient “attachment” to the United States, such as through work, family ties, business relationships, and other fact-specific information. If neither option is workable, then they must come under the foreign country’s social security system based on their long-term assignment there.
Retirement Benefits Eligibility – Totalizing Effect
Looking ahead to retirement, an employee who meets one country’s basic social security eligibility requirements may receive benefits from that country. For example, a U.S. citizen will become qualified for U.S. social security benefits after earning forty credits (10 years total of work). If an employee or self-employed individual works long enough to meet the basic social security requirements of the U.S. and a foreign country, the employee may receive benefits from both countries, although benefits earned may be correspondingly reduced to prevent a windfall.
What happens, however, when an employee or self-employed individual does not meet the basic social security requirements of any country because his or her time has been divided between working in the U.S. and working abroad? In this situation, a Totalization Agreement may help the employee qualify for partial benefits based on combined credits earned under both the U.S.’s and foreign country’s social security systems. The amount of partial benefits received will generally be based on the worker’s earnings while under the payor country’s coverage. To receive partial U.S. social security benefits under this combination (i.e., totalization) approach, the employee must have earned at least six credits (one and one-half years total of work) in the U.S. Likewise, to receive partial benefits in a foreign country, the employee must have earned a minimum number of foreign credits, which varies from country to country.
Planning Ahead and Acting Now
If your nonprofit organization is considering sending a U.S. citizen to work internationally, it should carefully consider the impact such assignment may have on social security coverage. If your nonprofit organization already has such workers abroad, now may be a good time for a “social security check-up” to ensure compliance with coverage requirements in both the U.S. and the foreign countries in which they work. As outlined above, key steps include checking whether a Totalization Agreement applies, which country’s social security system applies, evaluating the resulting implications, and then taking appropriate action to ensure legal compliance for both employer and employee.