Tax memo: US federal payroll tax requirements: Action must be taken by June 30, 2013

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Memo No. 2013-16

Canadian and US companies may not realize that they have failed to comply properly with US federal payroll tax requirements and could face penalties. Fortunately, new rules temporarily expand eligibility to the Voluntary Worker Reclassification Program (VCSP), making it possible to significantly reduce penalties, but employers must act before June 30, 2013.

This Tax memo discusses how the rules apply.

Canadian companies that send employees or self-employed contractors to the United States to perform services may mistakenly believe that they have no US tax liability or tax filing requirements, as long as their employees do not spend 183 days or more in the US each year.

Generally, US employment tax withholding rules are based on where the services are rendered, not on the payor’s residence or place of incorporation. Therefore, a Canadian corporation with employees or contractors working in the US may be required to deduct and remit:

  • US federal withholding taxes to the Internal Revenue Service (IRS); and
  • state taxes to the relevant state tax authority (depending on employees' or contractors' states of residence or work).

Individuals rendering services in the US may be subject to US federal, state and city income taxation and filing requirements. Even when withholding may be avoided based on the Canada-US income tax treaty, certain forms are required to document the exception, and reporting continues to be required.

If employees establish residence in the United States while employed by the Canadian corporation, the Canadian corporation:

  • must deduct and remit income tax (no treaty-based exception exists);
  • may have to deduct and remit social security taxes, Medicare tax and all other amounts normally deducted from US resident employees, and remit them periodically to the IRS; and

may be subject to state and city payroll tax requirements.