Guest Article

(From the July 14, 2008 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

HEART Act Changes Social Security Tax Rules for Foreign Entities' Employees Working on U.S. Government Contracts

The Heroes Earnings Assistance and Relief Act of 2008 ("HEART Act") signed into law on June 17, 2008, contains significant changes to the tax rules for individuals who expatriate from the United States. Another provision of the HEART Act will change the Social Security tax rules for foreign entities employing individuals in connection with U.S. government contracts beginning in August 2008.

Social Security taxes generally do not apply to wages paid for services performed outside the United States unless the employee is a U.S. citizen or resident and the employer is an American employer. IRC § 3121(b). (Special rules apply to certain American vessels and aircraft.) Under IRC § 3121(h), there are five types of American employer:

Section 302 of the HEART Act adds a sixth type of American employer: entities that are part of a domestically controlled group of entities and that employ any U.S. citizen or resident who performs services in connection with a contract between the U.S. government (including instrumentalities) and any member of the domestically controlled group of entities. A domestically controlled group of entities exists if there is a U.S. parent corporation with foreign subsidiaries. It includes all entities linked to the U.S. parent corporation by a chain of entities each of which controls over 50 percent of the next (applying the attribution rules of IRC §§ 318 and 954(d)(3)). The U.S. parent corporation will be jointly and severally liable for the Social Security taxes and any penalties if the foreign entity fails to comply with the new rules. The new rules apply to wages for services performed on or after August 1, 2008.

There are two exceptions to the new rules: services covered by a "section 3121(l)" agreement (in which an American employer requests to have Social Security taxes apply to services performed outside the United States for its foreign affiliate) and services established to the satisfaction of the Treasury Secretary to be subject to a foreign equivalent of Social Security taxes. In addition, the new rules do not change the existing rules regarding totalization agreements; therefore, wages subject exclusively to a foreign country's social security system under a totalization agreement will continue to be exempt from Social Security taxes.

Although the HEART Act may create a new reporting requirement for some foreign employers, those employers can appoint a U.S. company as a common pay agent using IRS Form 2678, and that company can perform the necessary payroll tax reporting (IRS Forms 941, W-2, etc.).

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations. If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Erinn Madden 202.572.7677, Bart Massey 202.220.2104, Mark Neilio 202.378.5046, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Tom Veal 312.946.2595, Deborah Walker 202.879.4955. Copyright 2008, Deloitte.