Withholding Requirements for Non-US Directors

In general, you shouldn’t withhold taxes for outside directors (here's my blog explaining why). As it turns out, however, there are a couple of exceptions to this rule. I blogged about one exception last week. Today I blog about another: directors who are US nonresidents.

Before I get started, I want to note that literally everything I know about this topic I learned from a nifty article written by Sinead Kelly of Baker McKenzie (Keys to Tax Compliance Readiness When a US Nonresident Director Joins a US Board). Sinead’s article goes into far more detail than I have here. If you have any non-US directors on your board, I recommend that you check it out. And consult your global advisors.

Withholding Required for Nonresident Directors

When residents of other countries (i.e., US nonresidents) join the board of a US-based company, it is frequently necessary for the US company to withhold federal income tax at a rate of 30% on payments made to the directors.

There Are Some Exceptions

Companies do not have to withhold taxes for non-US directors if any of the following conditions apply:

• The director is a US citizen.
• The director is a permanent resident of the United States (i.e., a green card holder) or otherwise qualifies as a resident under the substantial presence test.
• There is a tax treaty between the United States and the country that the director resides in that provides an exemption.

Withholding and Reporting Procedures

If none of the above exceptions apply, the company should withhold federal income tax on compensation paid to the director. Unfortunately, this isn’t as simple as adding the director into payroll and including the deposit with your payroll taxes. That won’t work because directors aren’t employees.  Here are the procedures:

• The tax withheld must be deposited via the Electronic Federal Tax Payment System (EFTPS).
• The income and withholding are reported on Form 1042, which must be filed with the IRS by March 15 of the following year.
• The income and withholding are also reported on Form 1042-S, which also must be filed with the IRS by March 15. A copy of Form 1042-S is also issued to the director.

Withholding is only required on income earned for services performed in the US. If directors are performing services outside the United States, withholding could be limited to the income attributable to services performed in the US. But the rules on how to allocate the income are complicated (especially when it comes to equity awards) and the company has to keep detailed records of where and when the director performed services. Thus, Sinead notes that many companies choose to withhold on all compensation paid to non-US resident directors and let the directors sort it out on their tax returns.

The Director’s Obligations

At a minimum, the director will have to file a US tax return (on Form 1040-NR). He/she might also have to make quarterly estimated tax payments (on Form 1040-ES (NR), if the amounts you withhold won’t be sufficient to cover the director’s tax liability.

All of which the director may be none to thrilled about. There is some irony here: US directors want you to withhold taxes but you can't; non-US directors don't want you to withhold taxes but you are required to. The upshot is that no one is happy (least of all, you).

What About Non-US Taxes?

Yep, you could also have an obligation to withhold taxes in the director’s country of residence. The requirements here vary by country.

- Barbara