RSU tax withholding for foreign sub employees addressed

The IRS has released Chief Counsel Advice (CCA 202327014) with guidance on whether a domestic U.S. parent company must apply income tax withholding and payroll taxes to restricted stock units (RSUs) granted to common law employees when the employees are transferred to a subsidiary controlled foreign corporation (CFC) before the RSUs vest.

RSUs are a form of equity compensation in which an employer promises to transfer company stock and/or cash at some point after the employees have satisfied the specified vesting conditions (for example, remaining continuously employed through the vesting date). RSUs typically generate taxable income when the stock is transferred to the employees, which occurred shortly after the vesting date in the RSUs addressed in the CCA.

The guidance addresses the application of payroll taxes for Medicare and Social Security under the Federal Insurance Contributions Act (FICA) and federal income tax withholding (FITW) for employees who were either U.S. citizens or remained U.S. residents during all relevant times, including before and after they were transferred to the CFC.

Under the particular facts addressed in the CCA, the IRS concluded that the taxable income generated by the RSUs are wages for FTIW purposes and the U.S. parent is responsible for withholding and reporting with respect to the entire taxable compensation, including any portion attributable to the services performed during the vesting period while the employees were performing services as common law employees of the CFC entirely outside of the U.S. In reaching these conclusions, the IRS noted that Treas. Reg. Sec. 31.3401(a)-1(b)(7) provides that FITW wages generally include compensation for services performed by a citizen or resident of the U.S. as an employee of a foreign corporation, unrelated to whether the foreign corporation is engaged in a trade or business within the U.S.

However, the IRS also noted that the CCA does not address whether the exception provided in Section 3401(a)(8)(A) applies. This exception generally provides that FITW wages do not include compensation paid for services performed by a U.S. citizen in a foreign country if, at the time the compensation is paid, either (i) it is reasonable to believe the compensation will be excluded from gross income under Section 911 (which allows for the exclusion of certain foreign earned income), or (ii) the employer is required by the law of the foreign country to withhold income taxes upon such compensation. In addition, the CCA noted that it does not address the potential implications on the analysis if the CFC’s country has an income tax treaty with the U.S. 

The IRS also concluded that the portion of the RSU income attributable to the services performed for the CFC outside of the U.S. are not considered wages for FICA tax purposes because the definition of “employment” for FICA purposes generally excludes services performed outside the U.S. for an employer that is not an “American employer” (which is generally defined to exclude foreign corporations).

The IRS explained further that an employer must use a reasonable method for allocating the amount of the RSU income that is attributable to services performed in the U.S., and indicated that, under the particular facts addressed in the CCA, the time basis apportionment method prescribed in Sections 861 and 862 for determining the source of services income could be used to determine the total RSU income subject to FICA taxes.

The IRS also emphasized that the existence of a Social Security totalization agreement between the U.S. and the CFC’s foreign country could impact whether FICA taxes are owed on the portion of the RSU income attributable to services performed for the U.S. parent in the U.S. Similarly, an agreement under Section 3121(l) by the U.S. parent could also impact whether FICA taxes are owed for services performed for the CFC outside of the U.S.