IRS Issues Directive on Taxation of Nonresident Alien Employees Working in the Gulf of Mexico

The Large Business and International (LB&I) division of the IRS has issued a directive to its field examiners that discusses the taxation of services performed by nonresident alien (NRA) employees on: (1) structures permanently or temporarily attached to the U.S. Outer Continental Shelf (OCS), and (2) vessels or other devices engaged in activities related to the exploration/exploitation of natural resources on the OCS [Industry Directors Directive #2 - Employment Tax and the Employees on the U.S. Outer Continental Shelf, Control No. LB&I-4-0211-005, 3/30/11].

The above services are generally subject to employment taxes.

Withholding tax. Under Code Sec. 3402, employers making wage payments must deduct and withhold federal income tax according to specified tables or computational procedures. Code Sec. 1441 imposes withholding tax at a 30% tax rate on salaries, wages, compensations, remunerations, or other fixed or determinable annual or periodical income (FDAP) of NRAs, to the extent these items of income are gross income from U.S. sources.

Remuneration received by the NRA employees is subject to withholding under Code Sec. 3402. If there is no withholding tax due under Code Sec. 3402, then withholding might be required under Code Sec. 1441. However, the income isn't subject to withholding under either Code Sec. 3402 or Code Sec. 1441 if the remuneration is exempt from U.S. tax under an income tax treaty.

FICA tax. Remuneration for services performed by NRA employees may be subject to FICA tax if a totalization agreement doesn't apply, or the services aren't excepted from the definition of employment under Code Sec. 3121(b)(4).

Under a totalization agreement, a certificate of social security tax coverage issued by one country serves as proof of exemption from social security tax on the same earnings in the other country.

FUTA tax. The same rationale that applies to FICA taxes also applies to FUTA taxes, except that a totalization agreement does not relieve an employer from its FUTA tax obligations.

Code Sec. 3121(b)(4) provides a FICA/FUTA tax exemption for services performed by an individual on, or in connection with, a vessel that is not an American vessel, if: (a) the individual is employed on, or in connection with, the vessel when outside the U.S.; and (b) the individual isn't a U.S. citizen or the employer isn't an American employer.

New directive. The IRS notes that many employers are not complying with their federal employment tax obligations with respect to services performed by NRA individuals in the OCS. The directive references the IRS Office of Chief Counsel's ruling in Chief Counsel Advice 201027046, that remuneration received by NRA employees for services performed on the OCS was subject to employment tax.

The directive includes information on the OCS compliance steering committee (OCS committee), which was established to help identify, develop, resolve, and improve the IRS's coordination of issues related to OCS activities. It also instructs OCS employers to provide all information related to their OCS employment tax obligations directly to the examiner. The examiner should account for quarterly employment tax periods during which an OCS employer had no employees by placing zeroes on the appropriate report, and the same procedure should be used by employers with a continuing OCS presence in filing their future quarterly employment tax returns.

Examiners who are contacted by employers with questions about employment tax obligations for individuals employed on the OCS are instructed to notify the OCS committee of the contact. Examiners who are assigned OCS cases are required, until otherwise instructed, to secure OCS committee approval on whether to assess penalties prior to any discussion with the taxpayer.