Employment Tax Withholding on 401(k) Salary Deferrals for Non-Residents

[Guest EMM118]

A U.S. employer maintains a 401(k) plan under which 10 employees who provide services to the employer work and reside in Mexico. Their compensation is considered non-U.S. source income as 100% of the services provided by these individuals are performed in Mexico and these individuals are non-U.S. citizens. If they were U.S. citizens they would be taxed on their world-wide income.

Is the Employer required to withhold employment taxes if these individuals participate in the U.S. employer's 401(k) plan?

Thanks in advance.

Ed

[Guest mjb]

How can they participate in the plan if they are paid in pesos not dollars? Also check currency laws for mexico to see if pesos can be expatriated to the US. US plan can exclude foreign nationals w/ no US source income- what does plan provide.

[GBurns]

What is the connection that you see between employment taxes and 401(k)?

[Guest EMM118]

What I am concerned with is taking the position that the employees do not have any U.S. source income, but elect to defer $20,000 under a U.S-based 401(k) plan. Payroll is run in the U.S. and amounts are sent to Mexico. Certain of these individuals are the parents of the owners of the Company and the owners wanted them to be able to defer amounts.

I know that many large companies automatically withhold 30% on payments to non-resident aliens and then just figure that the individuals will get a credit when they file their tax returns in Mexico. We would like to avoid that. At the same time, we have no guarantees that the individuals will file Mexican tax returns.

Thanks. Ed

[Guest Harry O]

I don't know of any large companies that simply withhold 30% on income earned entirely in Mexico by Mexican citizens. The reason why not is that the Mexicans cannot get a credit for the U.S. tax since, in the view of the Mexican tax authorities (and the IRS if the shoe was on the other foot) the employee had no actual obligation for the tax since none of the work was performed in the U.S. So no credit. Why would Mexico give away its tax dollars to the U.S.?

The answer to your question is that none of these payments to the Mexican employees are "wages" for U.S. employment tax purposes as long as all work is being performed in Mexico. The fact that the employees are deferring some money into a U.S. 401(k) plan does not change the answer.

However, distributions from the 401(k) plan will be partially subject to U.S. tax. This is a complicated area and the U.S.-Mexico tax treaty should be consulted for special rules that may eliminate or reduce the U.S. tax on certain distributions.