Working and residing outside the United States for a foreign corporation presents a challenge for a US citizen with respect to the reporting of taxable income. There are only a handful of Bermuda-based employers who provide their US citizen employee with a Form W-2. If you do not receive a Form W-2, this column will explore what items of income should be reported.

Salary and Bonus

The most obvious items of income to be reported on your US tax return are salary and bonus. This list can then be expanded to other cash compensation such as a home leave allowance, a car allowance, a mortgage subsidy and a cost of living allowance.

Stock Based Compensation

Most stock option plans outside the United States are non-qualified plans. As such, the difference between what you will pay to purchase your employer's stock, and the fair market value of the stock on the date of purchase, is considered compensation, and not a capital gain. For example, if you can purchase a share of stock for $85, and the fair market value of the stock on date of purchase is $100, you have $15 of compensation income.

If you employer grants you restricted stock, the fair market value of the stock on the date stock vests must be included in taxable income. For example, your employer might grant you 1,000 shares of stock on July 1, 2003, with the proviso that you must to continue working for four years for the company to earn the stock, with vesting to take place pro rata. So on July 1, 200 250 shares of stock will vest and be given to you. The fair market value of the 250 shares must be taken into taxable income in 2004.

Non Cash Compensation

This could take the form of residing in a residence owned or leased by your employer, use of a leased company car, or access to a country club. The actual cost to the employer is considered to be taxable income to you. You have an obligation to ascertain the value of these benefits and to report them in your taxable income.

Payments Made On your Behalf

If your employer makes a payment on your behalf, you realise a taxable benefit on your US tax return. Two common items in Bermuda are the employer payment of the employee portion of the Bermuda Social Insurance and the Bermuda salary tax. While these items must be included in your taxable income, you may be able to claim these as a foreign tax credit.

Pension Plans

Most pension plans in Bermuda are not “tax qualified” plans under US law. As such, if you are vested in your pension, you have immediate taxable income when your employer makes a contribution to the plan, and also of the investment income in the plan.

As an example, we will suppose that your employer has a plan in which you immediately vest. At the beginning of 2004 your employer puts $5,000 into the plan, and dividends and interest in the amount of $750 accumulate in the plan during the year. At the end of the year, there is $5,750 in your account. A US citizen is required to include the $5,750 in taxable income in 2004, even though they will not receive a pension benefit for 20 or 30 years. The only positive to come out of this is that no income tax will be due on the pension when it is paid out. In subsequent years, you must take the difference between the fair market value of your account at the beginning and end of the tax year into taxable income. If you participate in the Bermuda NPS plan, these rules apply to you.

Bermuda NPS

Several employees in Bermuda have a US tax qualified pension plan such as a 401(k) plan that their US employees participate in that allow the employee to defer payment of US income tax on the employee and employer contribution to the plan, and on the investment income in the plan.

However, Bermuda law has a hidden tax trap for individuals who have dual Bermuda/United States citizenship, and United States citizens married to Bermudians. Suppose your employer has a US tax qualified plan whereby 5 percent of your salary can be put into the US tax qualified plan, and your employer will match your 5 percent contribution.

Under Bermuda law your employer is required to put this money into the non-qualified Bermuda NPS pension plan and it cannot be put into the US tax qualified plan. Hence, you must now include your employer's contribution in income, and your cannot defer the US income tax on your own contribution. As noted above, this has a negative tax consequence to US citizens.

What can be done about this? There are three potential solutions. One would be to have the Bermuda government accept a US tax qualified plan such as a 401(k) plan as being an alternative to participation in the Bermuda NPS plan. The second solution would be for the employer to attempt to have the Bermuda NPS plan be deemed to be “tax qualified” under US tax law. The third solution is to change the legislation and allow an individual to elect to “opt out” of participation in the Bermuda NPS plan.

The tax advice given by this column is, by necessity, general in nature. You should, of course, check with your own US tax consultant as to how specific transactions affect you since tax advice varies with individual circumstances.

James Paul Sabo, CPA, is the President of ETS Ltd., PO Box HM 1574, Hamilton HM GX, Bermuda. Questions should be sent to: jsabo@expatriatetaxservices.com