What is tax equalization

Tax equalization is a payroll policy that protects international assignees from additional taxes by ensuring that their assignment neither increases nor decreases their tax obligations. When implemented, it puts the employee in a tax-neutral position.

Companies use tax equalization to protect international assignees from heavier tax burdens. Learn how this policy works and its impact on payroll compliance.

US taxpayers on international assignments are still subject to federal tax laws. When an employer sends an employee to work in a foreign country, the employee may need to pay the tax costs in their home and host country. This imposes a heavier tax burden on the employee.

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How does tax equalization work?

Under a tax equalization policy, the employer shoulders any extra tax burden that falls on an employee due to an international assignment. The employee continues to pay the same (hypothetical) tax they would have paid if they had stayed in their home country.

If the tax due is higher than an employee’s hypothetical stay-home tax (hypotax), the employer pays the difference. If it is lower, the employer keeps the difference.

Let’s consider Rose. Rose earns an annual gross salary of $100,000. If Rose is assigned to Japan, where the income tax rate is 30%, she has to pay $30,000 in taxes.

As Rose’s US employer, you must ensure that this tax bill does not exceed what she would have paid had she not been assigned to Japan. So, if Rose's tax bill in the US would have been $25,000 (25%), you must cover the $5,000 difference.

If, instead, her tax bill in Japan is lower, you can keep the difference. Whatever her assignment, Rose should only ever pay $25,000 in taxes (her hypotax).

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Is tax equalization different from tax protection?

Tax equalization and tax protection policies do the same thing – they protect international employees from extra tax burdens. However, tax equalization places the burden of tax compliance on the employer. You pay all the host and home country taxes due and deduct the employee’s contribution from their taxable income at the end of the pay period.

Under tax protection, the employee is responsible for maintaining tax compliance. They pay the tax due in their host country, and you reimburse them for all extra costs incurred over their hypotax at the end of the pay period. If their tax due is lower than their hypotax, you don't need to reimburse them. They keep the windfall.

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What are the benefits of a tax equalization policy?

High employee retention

A tax equalization policy makes navigating different tax regimes easier for international assignees. By taking over home and host-country tax obligations, employers protect their staff’s financial well-being, building loyalty and improving talent retention rates.

Increased mobility

Tax equalization also improves mobility. When workers are assigned to different countries, a tax equalization policy provides blanket tax neutrality. They can travel across tax regimes and tackle different projects without needing to account for taxation changes.

This flexibility is invaluable for growing global teams. It eliminates assignment roadblocks, where it is easier to fill positions in low tax rate regions than it is in high tax rate countries.

Equity in compensation

Tax equalization policies create equity in compensation. Since employees maintain the same tax obligations regardless of assignment, international assignees and home-based employees receive the same compensation for the same work.

Higher compliance

Finally, tax equalization places the burden of compliance on employers. It is easier to monitor and manage compliance at the organization level than to follow up with each international assignee.

Further, employees in tax-neutral situations have no incentive to under-report their taxes. This compliant environment protects a company’s reputation and financial interests.

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How does tax equalization impact payroll processing?

HR departments must calculate hypotaxes for international assignees. This involves considering their income, social security obligations, home property, etc.

At the end of each pay period, you must account for how host country taxes might affect an employee's income. You must then adjust the company's financials and cover the extra costs to keep the employee's net income unchanged.

At the end of the year, you must compare the taxes paid on behalf of an international assignee to their hypothetical tax liability. If these numbers do not match, you must request or pay remittance to the employee to balance the books. You can do this automatically or through corporate channels.

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What are the challenges of implementing a tax equalization policy?

Tax equalization policies tend to exert a heavier taxation burden on the employer. You can keep the money you get from moving employees to low-tax areas. But if you move employees to high-tax areas, you may pay more taxes. You need additional oversight to weigh this expense against your organization’s bottom line. You also need more HR people power to:

• Calculate hypotax liabilities for different international assignees
• Implement hypotax withholding
• Track tax accounts every pay period
• Balance payments

This job and executing a tax equalization policy require intricate calculations, detailed recordkeeping, and meticulous compliance tracking.

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Can you vary tax equalization policies across different regions?

Yes. Another problem with putting in place a tax equalization policy is that tax laws change by region. Countries have different reporting requirements, social security laws, income tax definitions, etc.

The Netherlands's government, for example, offers tax concessions for highly skilled foreign workers. This can reduce the tax liability of international assignees to the country compared to local nationals.

In the UK, employers pay family allowances as cash allowances. German employers calculate the same allowance as a taxable income deduction or allowance payment, whichever benefits the employee the most. A tax equalization policy that doesn't include family allowances in hypotax calculations would help the German-based employee over the UK-based employee.

A well-defined tax equalization policy should be adaptable. Use Deel’s short-term and long-term international assignment templates to create a policy that accounts for all the tax regimes in your global network.

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Is tax equalization a compliance issue?

Tax equalization isn't a compliance issue by itself. But if an organization doesn't use it correctly, it can cause problems with compliance.

Assigning employees oversees changes in their tax liabilities and residency. When you implement a tax equalization policy, you promise to pay for any extra debts that come from the change.

This means you must pay ‌taxes under the new regime according to the country's tax laws. Failure to comply with ‌reporting requirements or payment procedures under the new regime can attract penalties and fines. The compliance problem becomes more complex when you assign employees to different regions.

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What is the role of tax equalization experts in tax equalization?

Tax equalization experts can help you address the compliance concerns that arise from international assignments. They can:

• Adjust your tax equalization policy to make it more cost-effective
• Analyze local tax authority and company data to create a standard hypotax calculation
• Track regulatory changes across different tax regimes in your global network
• Maintain compliance with tax payments

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Implement compliant tax equalization policies with Deel

Over 80% of companies use tax equalization policies to protect employees from double taxation. By preventing employees from paying more taxes than they would have if they stayed in their home country, you can build employee loyalty, compliance, and mobility.

Deel's global platform, mobility experts, and policies can help you create standard tax equalization rules for your international assignees. Our tax and payroll experts help you choose and put in place the best policies for your company to protect your employees and the company's money.

Learn more about how Deel supports your global mobility efforts. Book a demo today.

More resources

• Employee Relocation Policy Template
• Expat Contract Localization Policy Template
• Short-Term International Assignment Policy Template
• Long-Term International Assignment Policy Template