American citizens who work remotely from Italy as employees for American Companies: where should they pay their taxes?
The subject of this article regards the tax situation of those American Citizens that live in Italy and work remotely from Italy for an American Company.
The question is the following one: where should they pay their taxes? Only in Italy? Or in America? Or in both countries?
Is it correct that the social security and tax withholdings are both applied by the American employer?
Before getting started, it's necessary to make an important premise.
In Italy, it is very important to outline the two distinctive elements of this "working from remote" employment:
A. The fact that the EMPLOYEE is resident, from a fiscal point of view, in a Country (Italy, for example), while the EMPLOYER is resident in another one (the US, for example).
B. The fact that the employee has a formal authorization by the employer to perform his service remotely.
For more information on the concept of Tax Residence, you can take a look at our specific sections of articles:
or specifically the following articles:
The formalization of these two distinctive elements A and B can take place in two different ways:
- they can be written inside the job contract;
- or they can be formalized in a side letter.
The second method is more frequent in those cases where the working relationship becomes remotely after a certain time: that is the case, for example, of an American citizen who was on vacation in Italy and he found himself stuck in Italy due to the pandemic; or when the American citizen decides to move permanently to Italy while continuing to work from remote for the same American company he was hired.
It's very important that the employee is in possession of one of the aforementioned documents (contract or letter) that formally specifies the authorization of the foreign employer to allow the employee to work in another country in smart working.
This is relevant because, as we will see, there are various tax consequences connected to where the job was actually performed.
Therefore, the first important suggestion is to obtain this document: it must be borne in mind that the letter may also be subsequent to the moment in which the employee started working in Italy in Smart Working for the American Employer.
For example: if the American citizen moved to Italy on January 20, 2022 and he/she immediately started working remotely for the American company, it is not, in our opinion, strictly necessary that the letter from the American employer is dated before 20 January 2022. Letters after January 20, 2022 acknowledging and ratifying the American employer's authorization to work remotely may also be fine for our purpose, as long as such letters are obtained prior to the commencement of any tax litigation and they clarify that the employee is authorized to work in Italy from the beginning, that means from January 20, 2022.
WHAT IS THE TAXATION FOR THE AMERICAN CITIZEN?
The US Employer that has hired an American Citizen living in Italy and working remotely from Italy will apply both social security and fiscal withholdings. Is this correct?
SOCIAL SECURITY WITHHOLDINGS
There are not many doubts regarding the application of social security withholdings: these must be applied and paid to US Social Security by the US Employer pursuant to the Convention between Italy and America on Social Security.
The point is that the US social security legislation is an extraterritorial legislation, based on the provisions of art. 7, paragraph 2 of the same Agreement:
"Services performed by a United States national in Italy which are covered under the laws of the United States shall remain covered under the laws of the United States".
The Italian Social Security legislation, on the other hand, requires that every worker on Italian soil be subject to the Italian social security contribution.
In case of conflict between the Italian and American legislation, the aforementioned Convention tells us to apply, art. 7, paragraph 4, letter a):
"a) A national of one of the States who, with respect to the same period of work, would be subject to the laws of the both States shall remain subject for such period to the laws of the State of which he is national and shall be exempt from the laws of the State of which is not national".
Therefore it is clear that the American citizen who works in Italy for an American company is subject to the US social security coverage.
If the US citizen is also an Italian citizen (thus having double citizenship), we would have to apply art. 7, paragraph 4, letter b) of the Convention:
"b) A national of Italy or a national of both States who, with respect to the same period of work, would be subject to the laws of both States shall, for such period, elect to remain subject to the laws of one of the States and shall be exempt from the laws of the other State".
In this case it is possible for the worker to choose which of the two systems can be applied. In any case, it's very likely that the social security system of the Country where the company is established, will be applied.
For a deeper analysis on the Social Security Convention between Italy and the US, please read the following article:
One important aspect that must be kept in mind by US Employers is that there are some cons to the fact of letting the employee to work rom remote:
1) It's possible that the Italian Fiscal Authority could see this detachment as a Permanent Establishment of the Company in Italy.
2) The US Company is in any case responsible for the employee regards this two important law:
- Italian Safety rules and provisions on the Job's site ("Sicurezza sul Lavoro"): this is very important as it requires the US company to register and have a public insurance with INAIL, that is the Italian National Institute for Accident on the job's site.
- Italian Laws on Severance Payment (in Italian called TFR).
For these two reasons, very often the best way to work from remote is not to be an employee, but to switch to a self-employment position, as independent contractor or freelance. See in particular the following article:
TAX WITHHOLDINGS
On the application of fiscal withholdings by the US employer, the question is whether they should be applied or not.
The simpler answer seems to be positive, for the fact that the employee is a US Citizen: he will have to file the American Tax Return no matter where he has his tax residence.
Therefore, the starting scenario for the US citizen residing in Italy is that of an US employer who applies both social security and tax withholdings to his payroll.
But this answer is too simple: let's see why.
FIRST POINT: WHEN IS THE JOB CARRIED OUT?
Now we can start with the first point of the analysis: in case of remote working, where is the job performed? In Italy or in the US?
In the Country where the employee is physically located (in our case in Italy) or in the Country where his service is "used" and therefore, in our case, in America?
To answer these two questions we will refer to two different sources:
- The answer of the Agenzia delle Entrate to the Interpello 621/2021.
- The OECD commentary on art. 15 of the OECD Model Convention against double taxation.
THE ANSWER TO INTERPELLO 621/2021
The Agenzia delle Entrate with the Interpello 621/2021 gives an interesting answer on the subject of Smart Working.
This is what the Agenzia delle Entrate says:
"In this regard, by place of performance of the working activity, in the particular
hypothesis of (...) smartworking or remote work, it is necessary to take into account the place where the employee is physically present when he carries out the activities for which he is remunerated".
Therefore it's clear that the reference for the Agenzia delle Entrate is certainly the place where the worker is physically present: in our example, in Italy.
THE COMMENTARY TO ART. 15 OF THE OECD MODEL OF CONVENTION
The OECD Commentary on art. 15 (which concerns the income from employment) confirms what it's indicated by the Interpello 621/2021: to identify the Contracting State in which the work performance is actually carried out, it's necessary to consider the place where the employee is physically present when exercising the activity for which he is remunerated.
Therefore, from the analysis of these two sources, there is no doubt that in the case of a US Citizen who works in remote working in Italy for a US Employer, the job services are rendered in Italy.
Having this point clear, let's move on to the second point of the analysis: art. 15 of the Convention against double taxation between Italy and the United States.
ART. 15 OF THE ITALIAN - AMERICAN TAX CONVENTION
The text of art. 15 is the following one:
" Article 15 - Dependent Personal Services
1. Subject to the provisions of Articles 16 (Directors' Fees), 18 (Pensions, Etc.), 19 (Government Service), 20 (Professors and Teachers), and 21 (Students and Trainees), salaries, wages, and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State unless the employment is exercised in the other Contracting State. If the employment is so exercised, such remuneration as is derived therefrom may be taxed in that other State.
2. Notwithstanding the provisions of paragraph 1, remuneration derived by a resident of a Contracting State in respect of an employment exercised in the other Contracting State shall be taxable only in the first-mentioned State if:
(a) the recipient is present in the other State for a period or periods not exceeding in the aggregate 183 days in the fiscal year concerned;
(b) the remuneration is paid by, or on behalf of, an employer who is not a resident of the other State;
and
(c) the remuneration is not borne by a permanent establishment or a fixed base which the employer has in the other State".
Now, from Paragraph 1 of art. 15 of the Convention, two fundamental rules come out:
RULE 1:
INCOME RECEIVED BY AN EMPLOYEE THAT IS A TAX RESIDENT OF A CONTRACTING STATE IS TAXABLE ONLY IN THAT STATE, UNLESS THIS ACTIVITY HAS BEEN CARRIED OUT IN THE OTHER STATE.
RULE 2:
IF THE ACTIVITY IS CARRIED OUT IN THE OTHER CONTRACTING STATE, THEN THE INCOME RECEIVED BY THE EMPLOYEE IS TAXABLE IN THAT OTHER STATE.
Let's analyze better these two rules.
RULE 1 establishes the general principle of exclusive taxation of the employee's State of Residence.
Therefore, following this rule, the taxation is exclusively in Italy, since the US citizen employed by the US company is Tax Resident of Italy.
RULE 2 establishes, however, that if the activity is carried out in the other State (in our case, in America), then the income is also taxable in that other State and there is a concurrent taxation.
Therefore, starting from the assumption that the job that the US citizen performs remotely from Italy is carried out in Italy (as we have already seen before) we will have that in our case only the first RULE 1 comes into play.
Therefore, FOLLOWING THE CONVENTION, the income from employment received by an American citizen residing in Italy who is an employee of an American employer and who works remotely from Italy, pursuant to art. 15 of the Italy-USA Convention, is taxable ONLY in Italy.
For this reason, it could be possible for the US citizens living in Italy and working from remote for a US employer to ask the employer to avoid the application of Tax withholdings because of his being resident in Italy.
This point is a difficult one for many US companies, as the US Labor consultants and Tax consultants are often reluctant to avoid the application of a Tax withholding: so in a certain amount of cases the US citizen will find both US Social Security AND Tax withholding applied inside his payroll.
Now, let's see what are the main operative steps from a fiscal perspective.
STEP 1:
The US Employer applies both social security and withholding taxes to the American citizen residing in Italy.
STEP 2:
From the analysis of the aforementioned sources, it's clear that in the case of remote working from Italy, there is exclusive taxation in Italy of the employee's income.
Therefore in the Italian Tax Return, the income indicated inside the Form W2 must be reported and the Italian taxes will be calculated.
STEP 3:
It's not possible to reduce the Italian taxes with the Fiscal Withholding that the American employer has already applied in the US: this is due to the fact the taxation is exclusive in Italy. Being the Italian one an "exclusive" taxation, it's not possible to offset the Italian Taxes with the American withholding.
STEP 4:
The US Citizen must still file his Tax Return in the US due to his US Citizenship.
However, in order to avoid double taxation, he will be able to offset the Italian taxes that he has paid in Italy from the US taxes, as Foreign tax Credit.
If the withholding that his American employer has applied in the payroll are higher than the remaining taxes to be paid after offsetting the Foreing Tax Credit, he will receive a tax refund.
The important point is that the US citizen that works remotely from Italy for an American Company has to pay taxes twice (American withholdings before and Italian Taxes then) before being able to ask for a refund for the American withholdings inside the American Tax Return.
This raises a financial issue over the first couple of years, as there is a double tax payment before being able to receive the refund back.
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