Understanding Social Security Tax, Totalization Agreements and Your Benefits, by Steven Weiser

Steven Weiser is a tax lawyer with a practice focusing on international tax matters. His contact information and information on his practice can be found on his web site at http://www.lw-law.com/.

Upon their move to the U.S. many foreign nationals, whether immigrants or temporary residents, often ask whether they are responsible for paying social security taxes and/or whether they are eligible for U.S. social security benefits. Foreign nationals employed in the U.S., even on brief business trips, often find themselves paying or liable for social security taxes in the U.S. and their home country. Often, these individuals find that they fail to qualify for social security benefits in both the U.S. and home country because payments into the U.S. system do not qualify towards benefit eligibility in the home country, and vice versa.

To remedy some of these inequities, the Internal Revenue Code (the “Code”) provides several exemptions for foreign nationals from social security taxes. If an exemption is unavailable the foreign national can look to one of several social security “totalization” agreements that the U.S. has entered into with other countries. Totalization agreements also address the often more important issue concerning benefit eligibility. Finally, many foreign nationals actually plan to pay the U.S. social security tax and avoid their home tax because U.S. tax rates tend to be lower than those of other countries, especially where payments into the U.S. system qualify for benefit eligibility in the home country.

Background

Before we delve deeply into these topics let’s step back and first try to gain an understanding of the U.S. social security tax structure and benefits. The social security tax is divided into two separate tax systems. The first system is covered under the Federal Insurance Contributions Act (“FICA” on your wage withholding statements) and requires equal contributions by the employer and employee. The second system applies only to self-employed individuals (for purposes of this article we’ll focus only on the FICA system). FICA consists of two separate taxes: (i) the tax for old-age (retirement), survivors, and disability insurance (“OASDI”), and (ii) the tax for Medicare. The OASDI and Medicare taxes are imposed against both the employer and employee in amounts equal to 6.2% of the first $87,000 of gross wages paid to the employee (OASDI), and 1.45% of total wages paid to the employee (the Medicare portion). The employee portion of the FICA tax is not deductible for U.S. income tax purposes.

Generally, an individual is not entitled to U.S. social security benefits unless she completes a minimum number of “quarters” of coverage. For 2003, a quarter of coverage is accumulated when wages subject to social security taxes equal or exceed $890. A maximum of four quarters of coverage can be earned each year. Thus, an individual earning $3,560 or more in 2003 earns the maximum four quarters of coverage (even if all wages are earned in one calendar quarter). Once an individual accumulates at least 40 quarters of coverage she is “fully” insured and entitled to a wide variety of benefits. Individuals covered for the equivalent of six out of the previous 13 quarters are treated as “currently” insured and eligible for a lesser level of benefits.

Even though benefits are payable to a person under the law, in certain instances the payment of those benefits may be reduced or even halted. The most common reason for the reduction or nonpayment of benefits occurs because the individual chooses to work beyond normal retirement age while receiving benefits. Also, an alien residing outside the U.S. for six months may have benefits halted until she returns to the U.S. for at least 30 consecutive days (or unless certain additional exceptions apply).

The social security tax is non-refundable. If a foreign national pays the tax, but is later ineligible for benefits, a refund is unavailable. Therefore, foreign nationals employed in the U.S. that do not expect to accumulate enough quarters of coverage to be eligible for U.S. benefits often want to avoid paying the social security tax in the first place. On the other hand, some foreign nationals that hope they or their descendants will be entitled to receive social security benefits may want to pay the social security tax. Finally, some foreign nationals actually desire to pay U.S. social security tax as a means of insuring their rights to similar social security benefits from their home countries, while also taking advantage of lower U.S. tax rates.

Who Must Pay?

If a foreign national works as an employee in the U.S., she must pay social security taxes unless an exemption applies. This is true even in cases where the foreign national is working in the U.S. on a short business trip, has income exempt from U.S. income taxes, receives her salary in a foreign currency, in a foreign bank account, and from a foreign employer with no other business contacts within the U.S. The foreign employer should deduct these taxes from wages even if the foreign national does not expect to fully qualify for future benefits. However, in practice a foreign national generally pays no social security tax unless she wants to and the foreign employer generally withholds and remits no tax. This is because the Internal Revenue Service (IRS) usually does not attempt to collect the tax unless federal income taxes are also due on the foreign national’s wages.

Still a foreign national, particularly those working in the U.S. for an employer situated here should rely have some legal basis on which to claim relief from the tax. Many exemptions from the U.S. social security tax can be found in the Code, income tax treaties or social security “totalization” agreements.

For example, under the Code a broad exemption from the social security tax is applied to all F, J, M and Q visa holders, provided the “employment” giving rise to wages is performed by a nonresident alien to carry out the purpose for which the alien was admitted to the U.S.

A complete review of the available exemptions from the social security tax is beyond the scope of this article. However, IRS Publication 15, Circular E, Employer’s Tax Guide, (available through the IRS website at www.irs.gov) has a summary in Section 15 concerning the Code’s social security tax exemptions for various types of employment of citizens, resident aliens, and nonresident aliens. Portions of this summary are attached to this article.

If the Code provides no exemption from the social security tax for a foreign national an income tax treaty that the U.S. has concluded with another country may provide an exemption. However, it has been the U.S. Treasury Department’s policy in recent years to exclude social security taxes from the list of taxes covered by income tax treaties (only the income tax treaties with South Korea and Canada, confer an explicit exemption from social security taxes).

If an explicit or implicit exemption from social security taxes is unavailable through an income tax treaty a foreign national can look to a social security “totalization” agreement.

Totalization Agreements

A social security “totalization” agreement is similar to a tax treaty, and has the same force and effect as a tax treaty under U.S. law. A totalization agreement eliminates double taxation that may occur where earnings are subject to the social security taxes of multiple jurisdictions. A totalization agreement also provides benefit protections for workers dividing their careers between the U.S. and other countries. Employees working in the U.S. and abroad often find that they have not worked long enough in any jurisdiction to meet eligibility requirements. The totalization agreements allow such workers to qualify for benefits based on combined coverage credits from multiple countries.

The U.S. currently has totalization agreements in force with the following countries:

• Australia
• Germany
• Portugal
• Austria
• Greece
• South Korea
• Belgium
• Ireland
• Spain
• Canada
• Italy
• Sweden
• Chile
• Luxembourg
• Switzerland
• Finland
• The Netherlands
• United Kingdom
• France
• Norway

 
A totalization agreement provides that an employee is subject to social security taxes only in the country where she works. For example, a citizen of Norway on temporary business in the U.S. is subject to U.S. social security taxes, not Norwegian social security-type taxes, on wages earned from U.S. employment. A “detached worker” exception to this rule provides that if the foreign national is “sent” to the host country (the U.S. in our example) by an employer in the home country, the foreign national is subject to tax only in the home country. The detached worker exception is not available if the foreign assignment is expected to last more than five years.

Often, a foreign national employed in a host country will neither qualify for host country social security benefits, nor home country benefits. However, totalization agreements allow such individuals to elect a “totalized” benefit from either country. In other words, payments made into the social security system of one country count as credits towards eligibility of the other country. For example, each year paid into the social security system of Canada counts as a year (four quarters) towards U.S. eligibility. Computing the amount of benefits is only slightly more complicated.

For example, if an individual accumulates six years of coverage under the U.S. social security system and ten years of coverage in another country’s system that requires 15 years of coverage for full benefit eligibility, both countries will treat the individual as if a total of 16 years had been completed under each system. However, the U.S. benefit would be 5/16 of the benefit computed on the basis of earnings in both countries during the 15-year period (and 10/16 in the other country).

When a foreign national transfers from his home country to the U.S. and wishes to remain subject to his home country social security tax under the terms of the totalization agreement, she must apply for a “coverage certificate” from the appropriate home country governmental authorities. The coverage certificate should not be given to the IRS or Social Security Administration. Instead, it should be furnished to the U.S. employer who must retain a copy of it. Often, a coverage certificate is obtained after U.S. employment has already begun. In almost all instances, the certificate is retroactively effective to the starting date of employment.

Summary

Determining whether a foreign national should pay into the U.S. social security system should include giving consideration to current eligibility status under foreign or U.S. systems, level of earnings and expected benefit, length of stay in the U.S., and the effect of any totalization agreements. Because U.S. social security tax rates tend to be less than those of other countries it is not unusual for a foreign national to seek exemption from home country taxation and subject himself to the U.S. social security tax.

Social Security Taxation for Various Types of U.S. Compensation and Employment

Compiled from portions of IRS Publication 15, Circular E, Employer’s Tax Guide

Note: This summary does not take into account the provisions of any income tax treaties or totalization agreements.

 

Classes of Employment or Individuals	Application of Social Security Tax
Nonresident Aliens	Taxable on income attributable to services performed in the U.S., unless a specific exemption under the Code applies.
Resident AliensService performed in the U.S.   Service performed outside the U.S.	Same as a U.S. citizen   Taxable if (1) working for an American employer, or (2) an American employer agrees to cover U.S. citizens and resident aliens employed by foreign affiliates.
Deceased workerWages paid to beneficiary or estate in the same calendar year as the worker’s death   Wages paid to beneficiary or estate after the calendar year of worker’s death	Taxable     Exempt
Disable worker’s wages paid after the year in which the worker became entitled to disability insurance benefits under the Social Security Act.	Exempt if the worker did not perform any services for the employer during the period in which the payment is made.
Employer business expense reimbursement:Accountable plan: Amounts do not exceed government specified per diems or standard mileage   Amounts in excess of government specified per diems or standard mileage   Nonaccountable plan	Exempt     Taxable     Taxable
Family employees:Child employed by parent (or partnership in which each partner is a parent of the child)   Parent employed by child     Spouse employed by spouse	Exempt until age 18 (or 21 for domestic service)   Taxable if in the course of the child’s business   Taxable if in the course of the spouse’s business
Foreign government employees and employees of international organizations	Exempt
Homeworkers:Common law employees   Statutory employees	Taxable   Taxable
Hospital employees:Interns   Patients	Taxable   Taxable (except for state or local government hospitals)
Household employees:Domestic service in private homes         Domestic service in college clubs, fraternities and sororities	Taxable if paid $1,400 or more in cash in 2003. Exempt if employee is under 18 at any time of the calendar year and is not the principal occupation of employee.   Exempt if paid to regular student; also exempt if an income tax-exempt employer pays the employee less than $100 in a year.
Insurance for employees:Accident and health insurance premiums under a plan for employees and their dependents   Group-term life insurance costs	Exempt     Exempt, except for cost of insurance that is includible in the employee’s gross income. Special rules apply for former employees.
Insurance agents or solicitors:Full-time salesperson   Other salesperson	Taxable   Taxable only if a common law employee
Newspaper carriers and vendorsNewspaper carriers under age 18; newspaper and magazine vendors buying inventory at fixed prices and retaining receipts from sales to customers	Exempt
Noncash payments:For household work, agricultural labor, and services not in the course of the employer’s trade or business   To retail commission salespersons ordinarily paid solely on a cash commission basis.	Exempt       Taxable
Officer of an S corporationDistributions considered as wages to the extent amounts are reasonable compensation for services to the corporation	Taxable
PartnersPayments to members of a general partnership	Exempt
RailroadsPayments subject to the Railroad Retirement Act	Exempt
Retirement and pension plans:Employer contributions to qualified plans   Elective employee contributions and deferrals to a qualified cash of deferred compensation arrangement (e.g., 401(k))   Employer contributions to individual retirement accounts under simplified employee pension plans (SEP)   Employer contributions to 403(b) annuities     Employee salary reduction contributions to SIMPLE retirement accounts   Distributions from qualified retirement and pension plans and 403(b) annuities	Exempt   Taxable       Exempt, except amounts contributed under salary reduction SEP agreement     Taxable, if paid through salary reduction agreement   Taxable     Exempt
Salespersons:Common law employees   Statutory employees   Statutory nonemployees	Taxable   Taxable   Exempt
Severance or dismissal pay	Taxable
Service not in the course of the employer’s business, other than a farm operated for profit or for household employment in private homes	Taxable if employee receives $100 or more in a calendar year
Sick pay	Exempt after the end of 6 calendar months after the calendar month services last performed.
Students, scholars, trainees, teachers, etc.Student enrolled and regularly attending classes, performing services for: Private school, college or university   Auxiliary nonprofit organization operated for and controlled by school, college or university   Public school, college, or university   Full-time student performing services for academic credit, combining instruction with work experience as an integral part of the program   Student nurse performing part-time services at nominal earnings at hospital as incidental part of training   Student employed by organized camps   Student, scholar, trainee, teacher, etc., as nonimmigrant alien holding F-1, J-1, M-1, or Q-1 visas	Exempt   Generally, exempt       Generally, exempt   Taxable       Exempt       Taxable   Exempt if service is performed for purpose specified in section 101(a)(15)(F), (J), (M), or (Q) of Immigration and Nationality Act. However, taxes may apply if employee becomes a resident alien.