A U.S. outbound expatriate will, in many cases, be reportable on two concurrently running payrolls. Why would anyone do something this complicated you might ask. Why not just employ the expatriate directly from the host country entity so that we, here in the United States, never have to worry about them again unless they return? Some of the reasons include:
- Unlike many other nations, the U.S. citizen or resident must continue to report income, remit taxes, and file U.S. federal (and possibly state) tax returns when living in another country. Payroll reporting and withholding make this easier to deal with.
- A U.S. outbound expatriate usually expects to remain in the home country social security system and have an opportunity to continue to contribute to a deferred compensation program (such as a 401(k) or 403(b) plan). Unlike many other countries where you can contribute to a social insurance program if you are working abroad, you need to be on a U.S. payroll or working in a self-employed capacity to contribute to U.S. social security and Medicare. Same with 401(k) or 403(b) plans.
So, as you come to grips with the fact that there really is a rationale for keeping international transferees on your payroll after all, you will need to become familiar with foreign exchange calculations. You will also need to apply rules that your organization agrees upon in order to account for transactions that are reflected on the host country payroll and that your U.S. payroll will be required to report as well.
Foreign exchange calculations are simple and straightforward. You need to know the currency in which a reportable item was paid, the exchange rate on the date the item was paid, and then simply apply the math.
For example, if the employer paid monthly rent for March of 54,000 Mexican pesos (MXN) on behalf of an expatriate via the accounts payable (AP) department in Mexico, and the exchange rate is 18 pesos to the dollar, then the rent is reflected on your U.S. payroll as follows:
Rent: MXN 54,000
Exchange Rate: ÷ 18
Reportable on U.S. Payroll: USD 3,000
The rent you are reporting on the U.S. payroll will be reported to you in most cases by either an AP report or, more likely, as an item reflected on the pay register or similar report produced with transactions reported on the Mexican payroll.
But how do you determine the exchange rate? Where do you get it from? What date do you use? What month is the transaction reported?
Logically, the most accurate exchange rate would be the spot rate on the date of the transaction. If the transaction was completed on February 29, 2016, and the Mexican employer had pesos in the bank and used those to fund the rent, then an exchange rate reflecting the rent paid on the date of the transaction would be best.
If you go to OANDA.com, one of many exchange rate tracking sites, you will find that the average interbank exchange rate on February 29, 2016 was actually 18.28 MXN/USD. The amount reportable on the U.S. payroll in February (the month the rent was paid) is $2,953.95. If the transaction was complete on March 1, by the way, it should be reported in March.
Trying to follow many reportable transactions occurring on host payrolls for many expatriates can be complex. As a payroll professional facing this challenge, I would suggest you discuss the problem with your accounting or finance department and establish a set of rules that will be consistently applied to the payroll transactions emanating from the host country payroll. These rules can be applicable across the board (e.g., exchange rate on the 15th of the month, average exchange rate for the month, or accounting department-defined monthly exchange rates) or defined separately by income or expense type (e.g., for a special local bonus use the exchange rate on the date of the bonus, last day of the month, for any rent payments). Either way, again, it is the accounting or finance department that is responsible to set this rule, so please reach out to them and not the payroll department.
Once you have defined the rules, you can set up a process for capturing the transactions completed in the host location that also require reporting on the U.S. payroll. The host country, incidentally, needs to complete a similar process for what is reported in the United States. That process could simply be to exchange the equivalent of your payroll register data. You may need some translation assistance if the descriptions are in the local language.
A couple of closing points: Be careful about applying the exchange rates. There seems to be a tendency to presume that there are many more units of foreign currencies than for the same amount of USD (e.g., 18 Mexican pesos per one U.S. dollar). This is not always true. In fact, some of the most common currencies exchanged go the other way, and some flip-flop over time as to which way the exchange goes. For example, on February 29, 2016, the rate of exchange was 0.72 British Pounds per USD and 0.92 Euro to the USD. There were also 1.35 Canadian Dollars (CAD) per USD on that date. But on July 31, 2011, the rate was 1.05 USD per CAD.
So, be sure to focus carefully on the rules to apply and the results before pressing the payroll processing button for your expatriates.
And finally, make sure that you do not double pay items the U.S. payroll needs to report but that have been processed and funded on the host payroll. For example, if $3,000 of rent was paid in the host country, you may want to report income of $3,000 and set up a non-taxable deduction for “Foreign Paid Items” to offset the locally paid item and prevent the double pay.