Employee may claim foreign tax credit when employer pays the tax

Plain-English summary

An employer directly paid an employee's foreign income tax liability without withholding that amount from the employee's wages. The IRS advised that the payment is additional compensation taxable to the employee for U.S. income tax purposes because it discharges the employee's legal obligation. Even though the employer remitted the money, the employee is treated as paying the foreign tax because foreign law imposed the liability on the employee. The employee therefore may elect to claim a foreign tax credit under sections 901 and 905, subject to the usual limitations and instead of an itemized deduction.

Ruling snapshot

• Question: Who is treated as paying foreign income tax when an employer directly satisfies an employee's liability?
• Outcome: Advice given
• Key authorities: IRC §§ 901, 903, 905; Treas. Reg. § 1.901-2

Full text (IRS public release)

ID:      CCA_2016040115005811
UILC:    901.01-00

Number: 201617009
Release Date: 4/22/2016
From:
Sent: Friday, April 01, 2016 3:00:58 PM
To:
Cc:
Bcc:
Subject: Employer Payment of Employee Foreign Income Tax Liability


This confirms our oral advice concerning the U.S. tax consequences when an employer
pays an employee’s foreign income tax liability directly to the foreign tax authority, but
does not withhold tax from the employee’s wages to cover the payment of that
liability. The situation presented involves an employee who is subject to tax in both the
U.S. and a foreign country on wages for services performed in that country. The foreign
levy is an income tax within the meaning of section 901 and Treas. Reg. §1.901-2(a)
that is eligible for the foreign tax credit. The foreign country may or may not view the
employer’s payment of the employee’s foreign income tax liability as additional
compensation income taxable to the employee. However, it is well-settled that for U.S.
income tax purposes, the discharge of an employee’s tax or other legal obligation by his
employer in connection with the employer-employee relationship is compensation for
services that is taxable as gross income to the employee and deductible by the
employer (subject to applicable limitations). See Old Colony Trust Co. v. Comm’r, 279
U.S. 716 (1929).

The employee may elect under sections 901(a) and 905(a) to claim a foreign tax credit,
subject to applicable limitations and in lieu of an itemized deduction, for the amount of
foreign income taxes paid or accrued during the taxable year. In the circumstances
described above, the employee is the person who is considered to pay the creditable
foreign tax. The person by whom tax is considered paid for purposes of section 901
and 903 “is the person on whom foreign law imposes legal liability for such tax, even if
another person (e.g., a withholding agent) remits such tax.” Treas. Reg. § 1.901-
2(f)(1). The regulation’s parenthetical reference to a withholding agent is an illustrative
example, and does not limit the principle that in determining the identity of the person
considered to pay the tax for purposes of section 901, legal liability is determined by
reference to the person on whom the tax is imposed under foreign law, and not by
reference to the person that remits the tax payment. The regulations confirm that tax is
considered paid by the person on whom foreign law imposes legal liability even if
another party to a direct or indirect transaction with the taxpayer agrees, as a part of the
transaction, to assume the taxpayer’s foreign tax liability. Treas. Reg. § 1.901-2(f)(2).

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