Compensation and Benefits Bulletin
As the business world continues going global, it isn’t unusual for a non-U.S. tax resident to join a U.S. company’s board of directors. When that happens, the company and the non-U.S. director need to address various U.S. and foreign tax issues to ensure that they comply with tax law.
Compensation paid to all directors — even non-U.S. tax residents — is subject to U.S. tax. However, the reporting requirements for non-U.S. residents are very different. For example, there’s usually no withholding requirement for U.S. directors, but there is for non-U.S. directors.
The first step is to confirm whether the individual director is a nonresident for U.S. federal tax purposes. If the director isn’t a U.S. citizen or a permanent resident of the United States (i.e., a green cardholder), the residency determination depends on whether the director meets the substantial presence test.
An individual meets the substantial presence test for any calendar year if he or she was present in the United States on at least 31 days in the current calendar year and meets a numerical test using a formula applied to the number of days on which the individual was present in the United States during the current year and the two preceding calendar years. Individuals who have spent more than 121 days in the United States in consecutive years should review the substantial presence test.
If no treaty is in place, as a rule, compensation paid to a nonresident director is subject to U.S. federal taxation. The income will be taxed as either “fixed, determinable, annual or periodic” (FDAP) income under Section 871(a)(1)(A), or as “effectively connected income” (ECI) under Section 871(b), which means the income is effectively connected with the conduct of a trade or a business in the United States.
From the director’s standpoint, the difference in how the income is characterized is important because FDAP income is taxed at a flat 30%, collected via withholding at source, with the director generally not required to file a U.S. federal tax return unless he or she has other U.S. income or investments. If the income is considered ECI, however, it will be subject to U.S. taxation at graduated rates. Income tax is required to be withheld at source by the company, but if it is insufficient, the director is required to make quarterly estimated tax payments by filing Form 1040-ES (NR). He or she must also file an annual U.S. federal nonresident tax return (Form 1040NR).
An individual sitting on the board of a U.S. company and attending the meetings would normally be viewed as being engaged in a trade or business in the United States.
Compensation for services performed both inside and outside of the U.S. is generally sourced based on the location where the services are performed (so directors should carefully track their workdays) and nonresidents of the U.S. are generally taxed only on their U.S. source income. All compensation is not created equal, however, when it comes to sourcing, and complications may arise depending on the type of compensation, such as equity awards.
If there’s a tax treaty between the director’s foreign country of residence and the United States, the director may be exempt from U.S. taxation (or be subject to a lower withholding rate) on the compensation paid for services performed.
Compensation for U.S. residents
U.S. resident directors are generally considered independent contractors and compensation for their services is self-employment income. This means the income isn’t subject to withholding and must be reported to the director on Form 1099-MISC. This usually requires the director to make quarterly estimated tax payments. Compensation paid to non-U.S. resident directors is subject to nonresident withholding under Section 1441. The U.S. company engaging the nonresident director is obligated to withhold U.S. federal tax at a rate of 30% on the income paid to him or her for board services, unless a tax treaty applies.
As discussed previously, the amount of compensation subject to withholding could be reduced based on the U.S. and foreign sourcing of the income. In this case, the company should obtain documentation from the director on how U.S. source income is calculated. If the director requests treaty application, he or she is responsible to provide the company with Form 8233 (Exemption from Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Nonresident Alien Individual).
Even when a tax treaty applies, the company must report the U.S. source income and withholding on Form 1042-S (Foreign Person’s U.S. Source Income Subject to Withholding), which must be filed by the company by March 15 of the year after the tax year. So, for the 2015 tax year, filing is required by March 15, 2016. In addition, the withholding agent is required to furnish Form 1042-S to the recipient of the income by the same date. Penalties for nonfiling can be significant.
A nonresident director should obtain a U.S. individual income tax identification number to make sure that withholding is properly credited. He or she should also file an annual U.S. tax return (Form 1040NR) to report all U.S. source income during the year.
As mentioned previously, the United States usually views directors as independent contractors, but this isn’t the case in all countries. If directors are treated as employees (such as under Canadian law), it’s possible the U.S. company will be considered an employer in the foreign country, which may trigger corporate filing requirements in the director’s resident country. Companies should be cautious in appointing directors from these countries because the reporting requirements may be substantial, even for a modest director fee.
Bringing a nonresident director onto a U.S. board of directors offers great opportunity and international experience that can be vital to an organization’s global growth. However, the situation can become complicated quickly when determining what is and isn’t taxable, and the type of withholding and reporting that goes with the compensation paid. It’s important to structure the right package for the non-U.S. director so that the U.S. and foreign taxes are handled in a tax-efficient way.
+1 212 542 9880
Tax professional standards statement
This document supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the subject of this document, we encourage you to contact us or an independent tax professional to discuss the potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this document may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this document is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.