After much lobbying, the IRS finally issued updated guidance for employers participating in the H-2A program in December 2011.
It is a common misconception that H-2A workers are always exempt from income tax withholding and liability. The new IRS guidance continues to provide for a clear exemption from U.S. Social Security and Medicare taxes under IRC 3121(b)(1), but H-2A workers may still be subject to income taxes, unless specifically exempted under a treaty with the U.S. government. As a general rule, agricultural workers hired under the H-2A program are exempt from withholding taxes because they are working under the condition that their jobs are temporary or only for a season, which would be limited to less than one year. Hence, their compensation has not historically been considered to be wages and thus exempt under the IRS withholding system. However, the exemption is not that simple since there are certain compliance requirements that the temporary H-2A worker must meet in order to qualify for withholding tax exclusion.
The H-2A Employer’s New Withholding Obligations
Beginning in calendar year 2011, an employer is now required to report all compensation paid to H-2A workers over the $600 threshold on Form W-2, Wage and Tax Statement using box 1 (wages, tips and other compensation), rather than Form 1099-MISC. This is a departure from prior guidance prohibiting the reporting of income on Form W-2. The H-2A employer will not withhold Social Security or Medicare taxes. This is a prospective rule in that employers who have already reported compensation paid to H-2A workers on Form 1099 for 2011 are NOT required to amend or re-report this income.
The general withholding rule has always been that payments made to H-2A workers are not considered “wages" for income tax withholding purposes on Form W-2 or Form 943. Therefore, an employer does not withhold any taxes for H-2A workers. However, in order for the H-2A worker to qualify for withholding tax exclusion, they must provide the employer with a Social Security Number (SSN) or an Individual Taxpayer Identification Number (ITIN). Failure to produce the SSN or ITIN to the employer will subject the employee’s wages to backup withholding taxes, which will continue until the H-2A worker submits the required documentation the employer.
Although wages paid to H-2A workers do not trigger any withholding requirements, they are considered wages/income for the purposes of W-2 reporting. If the employee earns more than $600 for the year in which they are employed, the employer is required to issue Form W-2 to the employee.
Voluntary Federal Income Tax Withholding
The IRS has now amended its guidance to allow for “voluntary withholding." Although employers are not required to withhold federal income tax from compensation paid to H-2A workers (unless back-up withholding applies in certain cases), they are now permitted to withhold upon worker request. Because wages paid to H-2A workers are considered to be taxable income, the worker must either file Form 1040NR or 1040NR-EZ if they are considered to be “non-resident" aliens (earning more than the allowable personal exemption), or Form 1040, 1040A, or 1040-EZ if they are considered to be “resident aliens".
H-2A workers are in reality subject to income tax on the income they earn and will owe federal income tax upon filing their income tax return at the end of the year. This often comes as not only a surprise, but an actual hardship to the H-2A workers who incorrectly assume that they are not required to pay taxes as H-2A workers.
To alleviate the unexpected burden on H-2A workers subject to income tax, the IRS has implemented revised guidance specifically allowing an employer to withhold federal income taxes from the worker’s pay as long as both parties agree. The H-2A worker must provide a completed Form W-4, Employee’s Withholding Allowance Certificate, to the employer in order for taxes to be withheld. It is also advisable for the employer to obtain a signed authorization form from the H-2A worker expressly authorizing the employer to withhold taxes and that such withholding is at the request of the employee. It is still unclear about how the New York State Department of Taxation and Finance will address withholding issues.
Another complicating factor is that the U.S. has tax treaties with many countries specifically limiting tax liability for non-resident aliens working in the U.S. for a defined period of time. For example, the U.S. has a tax treaty with Mexico that provides for an exemption from income taxation for “non-resident" Mexican nationals in the U.S. for less than 183 days during a 12 month period. Jamaican workers receive a similar exemption from income tax liability. In assessing the worker’s tax liability at the end of the year, the foreign worker must factor in any tax treaty provisions that apply. Since this can be burdensome and confusing for the foreign worker, the employer should have a system in place to assist the workers in performing this analysis.
The H-2A worker’s tax liability is also dependent on whether they are considered to be a “non-resident alien" or “resident alien" for tax purposes as defined by the Internal Revenue Code. If they are considered a “resident alien," they are generally treated for taxation purposes as a U.S. citizen would be. Whether a foreign worker is considered to be a resident alien or non-resident alien for taxation purposes is determined by either the “green card test" or the “substantial presence test". Under the green card test, if a foreign worker has the status of permanent resident (has a green card), they are considered to be a resident alien for taxation purposes. Under the substantial presence test, if the foreign worker has been physically present in the U.S. 31 days during the current year and 183 days during the 3-year period that includes the current year and the 2 years immediately before that, they are considered to be a resident alien. Because of this, many H-2A workers may indeed be considered to be resident aliens for tax purposes. The formula applied by the IRS in making this determination is complicated and it is best to consult with a tax professional to determine whether or not these tests have been met. There are also exemptions to the substantial presence test, which could change the outcome.
H-2A tax issues can be extremely confusing to the foreign worker who is not familiar with how our tax systems works, which is further complicated by language barriers. Best practice is to establish a tax plan at the beginning of the H-2A work contract, so that the worker will understand their potential tax liability at the end of the season and be able to adequately put money aside. The employer may also want to discuss a plan of voluntary withholding, which would help to alleviate the burden on the worker to set money aside for tax liability.
Leonard J. D’Arrigo is an Immigration Attorney with Whiteman Osterman & Hanna LLP in Albany, New York. He can be reached at (518) 487-7642 or by email at [email protected]