Taxation of RSUs When US Employees Transfer Abroad

In July 2023, the Office of Chief Counsel released Memorandum 202327014, which addresses the taxation of restricted stock units granted to US citizen and/or resident employees (including green card holders) by a US issuing company where the employees subsequently transfer overseas to work for a subsidiary company prior to the vest date. In short, the memorandum confirms the IRS’s viewpoint that

1. US income tax withholding is due on the full income including the portion that is sourced overseas.
2. Social Security should only be withheld on the US sourced income.

The memorandum does not address situations where an individual transfers to a country with a tax treaty or a social security agreement.

The memorandum’s contents are aligned with existing federal legislation. There are several practical issues with the application of the US tax laws regarding RSU grants to US citizens/residents who transfer abroad that the memorandum did not clarify or ease for employers. I am including the discussion of the memorandum in this blog for completeness.

What the Memorandum Covers

The memorandum reiterates the IRS perspective for the federal taxation of US citizens and residents who receive a grant of RSUs while resident in the United States and then subsequently transfer overseas. The memorandum addresses the domestic tax implications for federal income tax, social security, and Medicare.

It is important to note that the memorandum also assumes that the issuing company is a US company. The Federal income tax withholding position taken in the memorandum depends on this. It references but does not address the exception to federal income tax withholding where non-US income tax is withheld for a US citizen.

What the Memorandum Does Not Cover

The tax implications of any applicable double tax treaty and social security agreement that the United States has with the individual’s new country are not addressed. The United States has approximately 70 double tax treaties and 30 social security agreements. Most of these agreements are with countries where US headquartered companies do the most business; therefore, the memorandum is of limited usefulness in many, if not most, situations. Furthermore, as noted above, situations where there is non-US income tax withholding are not addressed.

As would be expected from a federal department memorandum, state taxation is not addressed.

Chief Counsel’s Position for Federal Income Tax

Federal income tax applies on all income for US citizens and residents (including green card holders) on worldwide income, regardless of where they reside.

The memorandum references, but does not address, the exceptions where:

1. Foreign income tax withholding applies on the foreign sourced income. This exception is provided under US domestic law for US citizens but can be extended to non-US citizens through the application of a double tax treaty.
2. The individual is likely to earn less than the foreign earned income exclusion ($126,500 for 2024). Note that we have ignored the housing exclusion for the purposes of this blog.

Chief Counsel’s Position for Social Security Taxes

Wages for social security purposes are not defined in the same way as for federal income taxes. Social Security wages are related to US earned income. The memorandum applies the US default sourcing methodology of US workdays from grant to vest over total workdays in the same period.

Example

Zoey, a US citizen, starts work for ACME, Inc., a US company in the United States and is granted an RSU on January 1, 2020. The RSU cliff vests in four years. On January 1, 2022, Zoey moves to work for a subsidiary for ACME in a non-treaty country that does not withhold tax on RSUs. Her annual salary is $200,000.

On December 31, 2023, the RSUs vest and Zoey recognizes income of $4,000.

Amount subject to US federal income tax withholding and reporting by the employer: $4,000.

Amount subject to US social security and Medicare: $2,000 ($4,000 x two years in the US divided by four years of vesting in total).

Considerations for Companies

The first consideration is whether a company is tracking citizenship. Many companies do not. Tracking citizenship would make it imperative for the company to comply with US wage withholding on worldwide income unless an exemption applies. A strict application of this rule would result in US wage withholding on a US citizen hired overseas to work for a subsidiary in a non-withholding country, say Singapore. Many companies cannot comply with this requirement without putting the individual on US payroll. There are many resulting technical and practical considerations including data privacy that are not addressed herein.

The second area of consideration is whether there are any system limitations, particularly with the payroll system. The memorandum reiterates that for US citizens and residents who transfer overseas to a non-treaty country, income tax is applied on the full income, but social security is applied on the pro-rated income, as illustrated in the example above. Many payroll systems will be unable to cope with this difference without manual intervention.

As stated above, the memorandum does not address situations in which a double tax treaty and/or a social security agreement can apply. Specific advice is still required to ascertain the correct payroll tax obligations for each situation.

The treatment of the issuing company as the overall payor of the RSUs is at odds with the regulation for Section 1032. The examples included under this regulation provide that awards granted to an employee of a subsidiary of an issuer are deemed to be granted by the subsidiary with an equivalent capital contribution being made from the parent company to the subsidiary. It is this treatment (capital contribution) that allows for a tax-free repatriation of stock-based compensation recharge to a US parent company.

Conclusion

Companies should note that the Chief Counsel Advice Memorandum is prepared for the internal use of IRS agents and should not be used as a precedent. Given the memorandum’s limitations, companies are going to continue to need specific advice on mobile employee situations.