What is tax equalization?
Tax equalization is a compensation approach utilized by multinational companies designed to ensure that an employee is no better nor worse off from a tax perspective as a result of accepting an international assignment. Tax equalization is a cornerstone of the Home-based ‘balance sheet’ approach, designed to achieve multiple goals:
- Preserve – protect an employee’s stay-at-home income and net purchasing power
- Universal – can be used for any Home and Host country combination
- Flexible – easily modified to meet corporate objectives and policy preferences
- Consistent – links employee to Home benefits, encouraging repatriation and tax compliance
- Fit-for-purpose – serves as the foundation for determining cost of living and housing support
With tax equalization, the company covers actual taxes on employment income (including taxable allowances such as housing, COLA, education, etc.), and the employee contributes to tax at a stay-at-home rate (on employment income only).
When an individual accepts an international assignment, income tax (and possibly social security) will most likely be due in the Host location during the assignment period. Under tax equalization the employer commits to funding all Host tax due on employment income on behalf of the employee. The employee is responsible for working with a designated tax provider to facilitate timely and accurate tax compliance (filing tax returns).
When a company pays tax on behalf of an employee, it is typically considered a taxable benefit, and therefore the company must pay tax-on-tax, more commonly known as a gross-up. For example, if an employee nets $100,000 and the tax rate is 50%, in order to cover the ‘tax-on-tax’, the employer would need to pay $100,000 in tax ($200,000 x 50% = $100,000 net). The costly nature of gross-ups make tax equalization one of the most expensive options for compensating expatriates.