If you're an employer based in the U.S. hiring U.S. citizens for remote work, you may be wondering about potential income tax exemptions for your employees.

It's crucial to grasp that regardless of where their employer is located, U.S. citizens are obligated to pay income tax to the Internal Revenue Service (IRS). This includes Americans residing outside the U.S., who are subject to income and social security taxes similar to those within the U.S.

Navigating these tax obligations can be daunting for employees. Thus, it's wise to understand the exemptions available to them to avoid double taxation.

Enter Form 673: Completing this form allows employees to enjoy exemptions from U.S. withholding tax imposed by their American employer. Let's delve into the basics of Form 673 and its advantages.

What Exactly is Form 673, and Why Should You Care?

Form 673, also known as IRS Form 673, is intended for taxpayers seeking exemption from U.S. legislation withholding income tax on wages earned while residing in another country.

Consider this scenario: An employee works for a U.S.-based company while living in Belgium. According to U.S. tax laws, they're required to pay taxes on income earned from an American employer, despite residing outside the U.S.

By completing Form 673, the employee can request an exemption from this tax obligation, enabling them to receive their wage without income tax withholding by their employer.

Who Needs to Fill Out Form 673?

U.S. citizens living abroad and employed by American companies are eligible to complete Form 673. Typically, American employers withhold income tax from U.S. citizens by default. However, by submitting this form, employees can request their employer to exclude some or all of their wages from U.S. tax withholding.

Form 673 includes a section known as the "Physical Presence Test." U.S. citizens who have lived in another country for more than one year and intend to continue residing there for another year can indicate their eligibility for exemption by checking the box next to the "Physical Presence Test" within Form 673. This demonstrates that they have spent over 330 days in a foreign country within a year, making them eligible for exemption.

Once Form 673 is completed, employees must submit it to their employers to implement necessary payroll adjustments, including pausing income tax withholding. If an employee decides to return to the U.S., they can fill out Form W-4 to resume income tax withholding.

How to Complete Form 673: A Step-by-Step Guide

Let's break down the process of filling out Form 673 into three sections:

1. Introductory:

Provide your full name and Social Security Number (SSN) as required.

2. Section 1:

Here, employees must furnish evidence to establish their eligibility for tax exemption based on either of the two tests:

  - Bona fide residence test: Proving residence in a foreign country for at least 365 days.

  - Physical presence test: Demonstrating at least 330 days of presence in a foreign country within a year.

Meeting the criteria of either test allows employees to qualify for tax exemptions.

3. Section 2:

This section requires employees to provide details for overseas housing exclusion, including:

  - Yearly rent amount.

  - Expenses related to utilities, property insurance, household maintenance, occupancy tax, etc.

  - Deductions from the base housing amount.

4. Section 3:

Employees must furnish certifications to support their claims made in Section 2, ensuring that reported amounts do not exceed total housing costs.

Submitting Form 673 to the Employer

After completing Form 673, employees must submit it to their employers. Employers require a completed Form 673 to halt U.S. income tax withholding on the employee's wages. If an employee is deemed ineligible for exemptions, the employer will continue withholding income taxes. Hence, it's crucial for employees to ensure accurate completion and provide all necessary certifications before submitting Form 673.

Penalties and Correcting Errors

Failing to submit Form 673 does not constitute a legal violation. However, it renders employees ineligible for exemptions, resulting in potential double taxation. Incorrectly completed forms may lead to continued withholding of U.S. income tax or require professional assistance to rectify discrepancies.

In instances where an employee is ineligible despite filing Form 673, such as not meeting the 330-day presence requirement, they must settle all income taxes owed by the end of the fiscal year.

Understanding Form 673 empowers both employers and employees to navigate tax obligations effectively, ensuring compliance and mitigating financial burdens.