Many Canadian companies may be faced with foreign obligations for reporting and withholding tax on wages paid to employees performing employment duties outside of the country. Cross-border travel continues to be a common trend to meet business essential needs. Whether the business needs are for employment services directly connected to a establishment in the United States or for servicing clients, Canadian employers should be aware of the U.S. payroll reporting and withholding requirements for employees working in the U.S.
Withholding and reporting
Canadian employers that have employees working in the United States are required to withhold U.S. income and other payroll taxes from the wages of these employees, if the wages are not exempt from U.S. taxation by the Internal Revenue Code (IRC) or the Convention Between Canada and the United States of America (the treaty). Generally, these taxes include federal and state income taxes, social security (FICA), Medicare hospital insurance tax and any state unemployment or disability obligations.
In addition, the employer may be required to pay an equal amount of FICA and Medicare taxes, and the entire obligation for Federal Unemployment Tax (FUTA) and any state unemployment or disability obligation dependent on state law for each employee.
Employee wages that may be exempt from U.S. taxation must meet the following criteria:
I. Under U.S. domestic tax rules, withholding is not required where:
• the non-resident employee is temporarily present in the U.S. for a period or periods not exceeding a total of 90 days during the tax year
• the total pay does not exceed US$3,000
• the employee is employed by a non-resident corporation that is not engaged in a trade or business in the U.S.
II. Pursuant to the U.S.-Canada income tax treaty, a Canadian resident and non-resident of the U.S. with U.S. source employment income may be exempt from U.S. tax if the following requirements are met:
• If the Canadian resident employee earns no more than US$10,000 during a tax year, such income will be exempt from U.S. income tax
• the Canadian company does not establish a permanent establishment in the U.S. and
• a U.S. entity is not considered the employer of the Canadian employees, and
• the Canadian employee is not present in the U.S. for more than 183 days in any 12-month period.
If a Canadian employee’s U.S. source compensation is exempt from U.S. income tax, the employer would not be required to withhold U.S. income tax provided that Form 8233, Exemption from Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Nonresident Alien Individual has been completed by the employee and provided to the employer.
The employer is then required to sign and submit Form 8233 to the Internal Revenue Service (IRS).
If Form 8233 is not provided to the employer, the employer will be required to withhold U.S. tax with respect to the U.S. source compensation.
However, the withholding tax should be refunded when the employee files a U.S. non-resident individual treaty income tax return for that year.
There are other taxes to consider:
Social Security and Medicare: A Canadian employee providing services while physically present in the U.S. is subject to the U.S. requirement to withhold and remit U.S. Social Security and Medicare (meaning FICA). FICA is the combination of Social Security taxes and Medicare taxes and is computed based on a percentage of compensation received by an employee.
For a Canadian employee who is in the U.S. on a temporary assignment, relief may be available under the totalization agreement between Canada and the U.S. Form CPT-56 Certificate of Coverage Under the Canada Pension Plan Pursuant to Article V of the Agreement on Social Security Between Canada and the United States is available through the Canada Revenue Agency (CRA) to remain contributing to the Canada Pension Plan (CPP).
The Canadian employee would remain on CPP and would not be subject to the U.S. Social Security system.
Federal Unemployment Tax: The employer may be subject to other payroll taxes, such as federal and state unemployment tax or worker’s compensation, which vary by state.
Federal Unemployment Tax (FUTA) is an employer tax and is calculated on the first US$7,000 of income at a rate of six per cent.
The state may also have an unemployment tax that may be required.
Remittance of tax to the U.S. tax authorities
Form 941 Employer’s Quarterly Federal Tax Return is used to report income taxes, social security tax, or Medicare tax withheld from employees’ paychecks or pay the employer’s portion of social security or Medicare tax.
Reporting to the U.S. tax authorities
The employer is required to report the remuneration related to the employment duties performed in the U.S. on Form W-2, Wage and Tax Statement, U.S. source compensation that is not exempt from U.S. tax under the treaty or where it is exempt from U.S. tax under the treaty but Form 8233 has not been provided by the employee.
Where U.S. source compensation is exempt from U.S. tax under the treaty, and Form 8233 has been provided by the employee, U.S. source compensation should be reported on Form 1042-S,
Foreign Person’s U.S. Source Income Subject to Withholding.
If the Canadian employee does not meet the treaty exemptions, and is subject to U.S. tax, the Canadian employee is required to file a U.S. non-resident income tax return (Form 1040NR) by April 15 following the end of the tax year to report the compensation and compute the tax. The employee may be subject to double withholding on the same compensation.
The employee should apply for a tax waiver (Form T1213) with CRA to request a reduction of her Canadian withholding taxes in anticipation of foreign tax credit claims.
If the Canadian employee is treaty exempt from U.S. tax, she can file U.S. non-resident income tax treaty-based return (Form 1040NR) by April 15 following the end of the tax year to have her U.S. source deductions refunded, if any.
Employer Identification Number (EIN)
Canadian employers that are required to report employment taxes or give tax statements to employees or annuitants will AN require EIN. The EIN is a nine-digit number issued by the IRS and is used to identify the tax accounts of employers to the IRS and the SSA.
An EIN can be applied for by faxing or mailing Form SS-4, Application for Employer Identification Number to the IRS. Employers outside of the United States may also apply for an EIN by contacting the IRS directly by phone.
U.S. tax number for employees
A non-resident employee is required to have a U.S. tax identification number for the W-2.
• Non-U.S. citizen employees who have a U.S. tax obligation are not eligible to receive a Social Security number. Instead, the employee can apply for an Individual Taxpayer Identification Number (ITIN) by submitting Form W-7 to the IRS with the required documentation to verify the employee’s identity.
• A Social Security Number (SSN) can be obtained by filing Form SS-5 “Application for a Social Security Number”. In this case, the employee must provide at least two documents to prove age, identity, and U.S. citizenship or current lawful, work-authorized immigration status.
Marni Halpern and Jennifer Santos work for KPMG LLP in the Global Mobility Services practice, specializing in cross-border payroll compliance and advisory. They can be reached at (416) 777-8500 (main) or by email at firstname.lastname@example.org or email@example.com.
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