Hypo Legal or Not
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Subject: Hypothetical Withholding – IRS Letter Ruling 8204074
LTR-RUL, UIL No. 61.00-00 Gross income; UIL No. 451.00-00 General rule for taxable year of inclusion; UIL No. 3121.00-00 Definitions; UIL No. 3306.00-00 Definitions; UIL No. 3401.00-00 Definitions, Letter Ruling 8204074, (Oct. 28, 1981)
Letter Ruling 8204074, October 28, 1981
Uniform Issue List Information:
UIL No. 0061.00-00
UIL No. 0451.00-00
General rule for taxable year of inclusion
UIL No. 3121.00-00
UIL No. 3306.00-00
UIL No. 3401.00-00
This is in reply to your letter dated April 15, 1981, and subsequent correspondence, requesting rulings concerning payments made under Company’s *** (Policy).
The Policy was implemented to prevent an employee who is assigned to work in a foreign country from paying more taxes on his Company earned income than he would have paid if he had not been assigned to a foreign country. The Policy is only applicable to employees whose foreign assignments are expected to last 12 months or more.
Under the Policy, the monthly salary of an employee assigned to work in a foreign country is reduced by the amount of the ‘Estimated Hypothetical U.S. Tax.’ The Estimated Tax’ is computed by applying the appropriate U.S. federal income tax rates to the employee’s base salary plus other Company payments that the employee would have received for services rendered if not on foreign assignment less an estimated deductible amount. The employee has no claim to the amount of the ‘Estimated Tax’ withheld from his salary.
Advances are made by Company to or on behalf of an employee on foreign assignment under the Policy to cover the payment of both foreign and domestic taxes required to be withheld, pursuant to the tax laws of various countries, from the employee’s gross base salary as reduced by the amount of the ‘Estimated Tax’ for each payroll period. Advances are paid in the amount of any domestic or foreign income tax or social insurance tax withholding, or payments of estimated tax obligations required to be withheld by an employer or paid by the employee.
When an employee’s foreign and domestic tax returns are filed after the end of the taxable year, a ‘Final Hypothetical Tax’ is computed. The ‘Final Tax’ is a final estimate of the domestic tax liability which the employee would have incurred if not on foreign assignment using the employee’s actual itemized deductions if greater than the assumed amount of itemized deductions specified in the Policy. After the employee’s domestic and foreign tax returns are filed, the employee is reimbursed for any taxes paid on Company income (i) less the amount of the ‘Final Tax,’ (ii) plus the amount of the ‘Estimated Tax’ by which his salary was actually reduced, and (iii) less advances paid by Company to or on behalf of the employee for the related taxable year.
A *** Worksheet, which shows the computation of the ‘Final Tax’ and the amount of taxes subject to reimbursement for the taxable year under the Policy, and income tax returns are prepared for each employee by the Company. A settlement for any amounts owed to or by the employee under the Policy for payment of taxes is made after Company gives final approval to the Worksheet. The amount of advances made during the taxable year are entered on the Worksheet and if in excess of the amount calculated as payable under the Policy, must be repaid by the employee to Company even in the event his employment with Company terminates. Additionally, if the employee receives a tax refund for a taxable year in which he was covered by the Policy, all or a portion of the refund proceeds are due to Company in repayment of tax advances made. However, if the amount of advances paid during the taxable year are below the amount calculated as payable under the Policy, the employee will receive the balance of the amount determined as payable.
Section 61 of the Code provides that except as otherwise provided by law, gross income means all income from whatever source derived, including compensation for services.
In Old Colony Trust Company v. Commissioner, 279 U.S. 716 (1929), VIII-2 C.B. 222 (1929), the Supreme Court considered whether the payment of income taxes payable on an employee’s salary by his employer pursuant to a contractual agreement constitutes additional taxable income to the employee. The Court held that the payment of the taxes was made in consideration of services rendered by the employee and includible in the employee’s gross income. The Court stated that it is immaterial that employer paid the taxes directly to the Government. The discharge by a third person of an obligation owed by the taxpayer is equivalent to the receipt of the amount of discharge by such taxpayer.
Revenue Ruling 78-374, 1978-2 C.B. 67 discusses the federal income tax treatment of a ‘staff assessment’ withheld from the salary of a United States citizen employed in a foreign country by an international organization. The employee accepted the employment with the understanding that only the net salary would be paid. The amount of the ‘staff assessment’ is never received by or made available to the employee under any circumstances. Additionally, the ‘staff assessment’ cannot be used to offset any foreign tax liability or any other liability of U.S. citizens employed by the organization.
Revenue Ruling 78-374 held that the ‘staff assessment’ withheld by the organization is not includible in the employee’s gross income under section 61 of the Code. The only compensation received by the employee is the net salary. The employee has no claim to, or control over, nor derivesany economic benefit from such amounts withheld.
Section 451(a) of the Code provides that the amount of any item of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under the method of accounting used in computing taxable income, such amount is to be accounted for as of a different period. Section 1.451-1(a) of the Income Tax Regulations provides the general rule that under the cash receipts and disbursements method of accounting, items of income are includible in gross income when actually or constructively received.
Section 1.451-2(a) of the regulations provides the general rule that income although not actually reduced to a taxpayer’s possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer’s control of its receipt is subject to substantial limitations or restrictions.
Section 3121(a) of the Federal Insurance Contribution Act (FICA) and section 3306(b) of the Federal Unemployment Tax Act (FUTA) provide, with certain exceptions that the term ‘wages’ means ‘all remuneration for employment.’ Section 3401(a) of the Code, relating to income tax withholding, contains a similar definition.
Based on the information submitted, we conclude that advances made by Company to or on behalf of an employee under the Policy to reimburse an employee for the payment of foreign and domestic taxes, or taxes required to be withheld from the employee’s salary, are includible in the gross income of the employee in the taxable year such advances are paid by Company to such employee or to cover the payment of foreign or domestic taxes required to be withheld from the employee’s salary during the taxable year. Additionally, advances made under the Policy for any taxable year are ‘wages’ for purposes of the FICA, FUTA, and federal income tax withholding when they are includible in the gross income of the employee. However, the amount of the ‘Estimated Tax’ withheld from an employee’s salary during the taxable year is not includible in the employee’s gross income for such taxable year.
No opinion is expressed concerning the federal income tax consequences of advances paid by Company under any provisions of the Code other than those specifically stated herein.
A copy of this ruling should be attached to the next federal income tax return filed by Company. A copy is provided for this purpose.
This ruling is directed only to the taxpayer who requested it. Section 6110(j)(3) of the Internal Revenue Code provides that is may not be used or cited as precedent.
Anthony Manzanares, Jr.
Chief, Individual Income Tax Branch
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