IRS Rev. Proc. 2022-19: Relief for S Corporation Owners

CHRIS O'CAMRY: Welcome back to the second part of our conversation on international tax planning. Today, we are going to cover how to handle employee resources globally.

My name is Chris O'Camry, and I'm a tax partner in the Cherry Bekaert Technology Group based here in DC.

My colleague, Raj Tripathi, who is a Managing Director in our International Tax Services Group, and I have so much to cover on this topic that we needed to break it up into two episodes.

If you haven't already listened to our previous episode, which focuses on outbound issues, I encourage you to listen to that first.

In this episode, we'll dive into inbound issues, which tend to be a bit more complex than the outbound piece. We're going to pick up right where we left off.

RAJ TRIPATHI: Absolutely. Let's move now to inbound.

CHRIS O'CAMRY: That was a lot that we just covered regarding outbound.

Maybe it's a good idea to give a quick refresher on what "inbound" means. Don't worry, there is not a test after this.

RAJ TRIPATHI: If a foreign company is trying to expand their operations in the U.S., they have to follow a strategy of understanding their exit strategy.

When entering the U.S., they must determine what type of legal entity they should be setting up and what their permanent establishment risk is when moving employees or hiring consultants.

Whenever a foreign company comes from an inbound perspective to set up a subsidiary, partnership, or LLC, they should perform a feasibility study of the tax implications and the exit plan.

It is also important to understand the different states. The U.S. has 50 states, and those states do not recognize treaties, except at the federal level.

You can only take treaty benefits at the federal level, not at the state level. You have to understand the treaty and what kind of repatriation strategy you should have in mind.

In addition, if the company wants to perform an acquisition in the U.S., you must perform proper due diligence.

You need to determine if it is possible to make a tax-free acquisition or if it is going to be a taxable acquisition. This is where Cherry Bekaert can come in and help you.

Lastly, the PE risk is very important, as is the tax treaty. As I mentioned earlier, only the federal government will recognize the treaty.

Any foreign company doing business in the U.S. has to make sure that any PE risk at the state level is mitigated. You should talk to your tax advisor about how to mitigate that risk.

CHRIS O'CAMRY: Similar to outbound, inbound has complexities associated with both the employee and the entity type.

When a U.S. subsidiary of a foreign parent is established, there are several obstacles to be aware of.

One of the biggest obstacles we run into is when a foreign parent sends a C-Suite executive to the U.S. to help oversee the initial opening or maintenance of a new C-Corp.

That becomes problematic in some ways and needs to be looked at. I know we have a client with a large manufacturing base out of another country and subsidiaries throughout the world.

That parent corporation sends employees to the U.S., which comes with several different structuring opportunities and reasons to be careful about establishing permanent establishment.

Raj, you are the best person to speak to the hurdles and pitfalls that come along with sending C-Suite executives from a foreign parent to a U.S. subsidiary.

RAJ TRIPATHI: This is one of the key issues in the permanent establishment space. When companies do cross-border expansion, they should understand the costs associated with moving employees.

When C-Suite level executives travel to the U.S. on a regular basis, they may be creating a PE risk for the foreign company.

If those executives are meeting clients and making decisions, the risk is that the foreign company will have to start attributing salary, sales, and marketing income to the U.S.

That attribution rule will get triggered, and they have to attribute that income and profits to the U.S. and pay taxes on them.

Be very careful whenever a C-Suite executive travels to the U.S. on a short-term basis or even makes four or five trips in a year.

A lot of times, companies will send people on a short-term basis to the U.S. for a couple of months. We advise clients that they cannot do that unless they use a third-party firm or a secondment agreement.

A secondment agreement is an intercompany transfer of the employee from the foreign company to the U.S. subsidiary where the salary is cross-charged by the parent.

The employee then moves from the parent company to the subsidiary, and the salary is borne by the subsidiary. That employee then works on the U.S. payroll.

This will mitigate the PE risk significantly for the company when they're using this kind of arrangement on a short-term or long-term basis.

You should reach out to your advisors to ensure you are properly putting checks and balances around your PE risk.

Also, keep in mind that the 50 states in the U.S. do not recognize a tax treaty.

The treaty may say that if a person is in the U.S. for 90 days or less, you don't have a PE risk, but once you cross that threshold, there is a risk.

There is also domestic law in the U.S., such as the 183-day test over the preceding three years, that needs to be determined.

However, that is only at the federal level. The states do not recognize the treaty and will require proper filing of state-level payroll and withholding taxes, such as FICA and FUTA.

Lastly, whenever a foreign company sets up a subsidiary in the U.S. and then sets up another branch in a foreign country from the U.S., reporting becomes cumbersome.

I always advise my clients not to set up branches under a U.S. subsidiary because the reporting requirements are complex.

A U.S. subsidiary held 25% or more by a foreign parent has a specific filing requirement. Any reportable transaction needs to be reported by filing Form 5472.

If you do not have proper transfer pricing in place for reportable transactions and do not file Form 5472 correctly, the IRS can levy a penalty.

The penalty is $25,000 per year of non-compliance or non-completion of Form 5472.

That is why I always tell my clients to be mindful whenever a foreign company is coming to the U.S. to set up a subsidiary. Please ensure you are doing proper compliance and analyzing your PE risk.

CHRIS O'CAMRY: I cannot stress that enough. We see this all the time, and as you alluded to, the $25,000 fine is very expensive.

It can be $25,000 per form, and there are penalties associated with employee withholding. It can become a huge problem very quickly for something you might think was a normal business practice.

For those in the audience who have not dealt with this, the first thing to do is reach out to Raj or the Cherry Bekaert team.

I can guarantee that this discussion just saved you a ton of money, not to mention an immeasurable amount of time and headaches.

RAJ TRIPATHI: Absolutely. Anytime you are doing outbound or inbound hiring or hiring consultants in a foreign country, please reach out to Cherry Bekaert.

We are here to help and support you. We have been helping many technology clients with their IP planning, PE risk, and the movement of their employees.

CHRIS O'CAMRY: As soon as an owner, CEO, CFO, or controller starts to hear about foreign employees or entities, the best practice is to reach out to Cherry Bekaert immediately.

In a perfect world, we would be involved from the initial kickoff and the planning phase.

If historical decisions have been made or things are already in the works, it is still okay to call. We work through this all the time, but it is easier if we can implement it from the very beginning.

Cherry Bekaert is here to help. We can take a lot of that complexity out of the equation.

I hope that everyone enjoyed this discussion and was able to take away some valuable points and ideas.

Feel free to contact myself, Raj, or anybody at the Cherry Bekaert team. Our information can be found at Cherry Bekaert's website, which is cbh.com.

Thanks again for joining, and we'll see you all next time.