Anyone ever heard of 'hypothetical tax' calculation?

Closed Thread
Page 1 of 2 1 2 LastLast
  1. #1

    Join Date
    May 2006
    Posts
    15

    Anyone ever heard of 'hypothetical tax' calculation?

    OK...first a caveat that I am trying to seek some professional advice elsewhere on this question, but thought some of the gurus here might have an opinion...now in as small a nutshell as possible (coconut sized! )...

    - My firm is moving our family to Hong Kong, but I'm to remain a US employee paid on US payroll. The main reasons to do this are it's a temporary assignment (3 to 5 years) and we want to keep our retirement contribution and other benefits (which aren't available if I was employed directly by our Hong Kong office).

    - Other than initial relocation expenses and trips home, we will receive no housing/education benefits -- so basically little to no non-cash comp.

    - The firm is hiring a reputable accounting firm to do our US/Hong Kong taxes (which should be a source of relief) but the explanation for how our taxes will be calculated seems interesting..."your cash compensation will be subject to hypothetical tax withholding which will be based on what your tax liability for [firm] compensation would have been had you continued to be a resident in the US...[the accounting firm] will calculate an estimated hypothetical tax, and we will use this to withhold taxes from your compensation. At the end of the tax year, D&T will finalize the hypothetical tax calculation and it is likely there will be some amount owed by you or by [the firm] in the final settlement... [The firm] will be responsible for any actual tax liabilities on your cash and non-cash benefits...while both parties acknowledge that steps need to be taken to facilitate tax equalization, it is also recognized that there will be legitimate opportunities to minimize the tax liabilities for [the firm] and you...and we confirm our mutual intention to work together to this end."

    So what I *think* my main question should be is...is it better to have my firm paying the actual tax liability and us paying the 'hypothetical calculation' vs. paying US/Hong Kong tax ourselves directly? IOW, are we missing out on a lower overall tax liability given the above scenario, or should we trust that my firm and the accounting firm will work with us to get the best deal, i.e. not paying state taxes, which we would be liable for if we were in the US?

    If you've read this far without falling asleep, thank you...sign me up to buy you a pint once we've arrived!

    Last edited by WSinHKG; 30-08-2006 at 02:47 AM.

  2. #2

    Join Date
    Jun 2005
    Location
    Hong Kong
    Posts
    23,205

    Yes - not at all uncommon for expats - the principle behind "hypotax" is that you get the certainty of knowing what you net income will be when moving to an unfamiliar tax regime. However, I have only ever seen it as part of a package which comes with housing and cost of living allowances. If you move from the US to HK with the same net salary and no housing allowance and (if you have school age kids) no education allowance then you are almost certainly going to be worse off in HK than in the US. At first sight this would appear to be a very poor deal. Are the retirement and other benefits (what are they?) really worth that much?


  3. #3

    Join Date
    May 2006
    Posts
    15

    Thanks for the quick reply PDLM and the clarification on 'hypo-tax' (sounds like a bad vaccination!). Actually most of my cash compensation has been historically bonus-driven vs. base salary, and to offset the risk of moving to a new market I've been offered a multi-year guarantee on total compensation (including bonus) that should amply cover us. In addition to retirement benefits, we also get profit-sharing, life insurance coverage, short and long term disability, financial advice, etc. that add up significantly. On the profit sharing alone, when you factor in not having these contributions for several years and the compounding income lost it is money we would prefer to have (but honestly I haven't done the exact math to see if it ends up more than the tax we'll be paying).

    But I agree with you that we're almost certain to be paying more initially for Hong Kong cost-of-living plus US taxes, but the US HQ is who has put the above deal together... My other option would be to agree to be a Hong Kong employee, with a base salary, none of the above benefits and no guarantee of bonus in a brand-new market with admittedly a much lower tax rate of 15%. We're hedging as best we can based on the above. Also given the new tax laws re: housing it doesn't appear we'd get that great a deal on separate housing benefits anyway. Education benefits I'm less familiar with but no one in our company enjoys them (expatriatehood is kind of a new thing in our business).

    I venture to assume that 'hypo-tax' calculations do take into account the first $80,000 in exemption from US tax and any other economies/comparisons for expats?

    Again thanks for your thoughts. Much appreciated!


  4. #4

    Join Date
    Jun 2005
    Location
    Hong Kong
    Posts
    23,205

    Ah - yes - I forgot that you are taxed for the privilege of being an American wherever you are in the world, so the tax benefits of coming to HK only apply to the first US$80K anyway (I was hypotaxed from the UK where, like most of the world, only the place of employment counts for tax purposes). That being so I can see that it is less of an issue - the only extra cost of the hypotax being the difference between US tax and HK tax (actually 16% now) on the $80K.


  5. #5

    Join Date
    May 2006
    Posts
    15

    Yep, I think that Beatles song referring to a certain 'Tax Man' was implicating us Yanks. But again thanks for the help on understanding what 'hypotax' is in the first place...feel far more enlightened.


  6. #6

    Join Date
    Sep 2004
    Posts
    483

    Would have to agree with the other poster that it's probably better not to be tax equalized.

    If you are tax equalized you pay "hypotax" which will mean that you pay exactly the same tax as you would have done had you stayed in the USA.

    If you are NOT tax equalized in HK your 1st US$80K will be exempt and you only pay local taxes on this. Above the $80K you will pay US tax (with a tax credit for any HK tax paid). Since HK baseline taxes are generally lower you should end up paying LESS tax than you did in the USA.

    My hubby and I both came over from USA. He was tax equalized and I was not....I got the better deal with lower taxes paid overall in past 2 years. He just took another job and opted out of tax equalization for that very reason.


  7. #7

    Join Date
    Mar 2006
    Location
    Pokfulam
    Posts
    204

    It depends on how much you make. You will have to pay both HK tax and US tax if you make above US$80k. I did the calculations a while back that if you make above a certain threshold, although you do get the first $80k tax-free, it's better off to do the hypo tax.

    The following is a very over-simplified example. Let's say for simplicity sake that you make US$1 million. With hypo tax, including social security, state and local taxes, roughly 40% is gone. So you're left with let's say $600k. If you don't do hypo tax, you're taxed on US$920k. You're still in the same high tax bracket but depending on what state you live in (some states have residency rules and you'll still end up having to pay it if you intend to return) you might not have to pay state taxes. Let's assume your state tax is 5%. So instead of 40%, you get taxed 35%. 65% of US$920k leaves you US$598k. BUT, you still have to pay the HK taxes, which I'm sure is more than US$2k.

    On the other hand, if you make US$100k, you have the first US$80k "tax-exempt" and only pay tax on US$20k, then of course hypo tax is not a good idea for you.

    I know I'm using some ridiculously simple numbers to do a back-of-the envelope calculation, but I just want to illustrate the point that if you are a highly paid U.S. citizen, hypo tax is actually a "cheaper" way for you.


  8. #8

    Join Date
    Sep 2004
    Posts
    483

    Applefan - I see what you're getting at, but keep in mind that you get a Tax Credit for any HK tax paid above the $80K threshold. So, you're not double-taxed on the income above $80K. Check out form 1116 (Foreign Tax Credit). Now, I'm not sure if the Tax Credit is limited, but as long as you can take full credit you are still better off without the equalization. In my case the credit was always 100%, maybe because I didn't make enough money to have it limited...


  9. #9

    Join Date
    May 2006
    Posts
    15

    Thanks applefan and nina for the helpful info. I'm going to ask the accounting firm to run a scenario using hypo-tax on our 2005 income to see what that looks like. I'll also ask them to run the same scenario if we paid it out ourselves. But I think we should be able to end up with the numbers being essentially the same, and here's why:

    What I've been told is that hypo-tax can be calculated using any allowances we might expect to benefit from, including, for example, the $82,500 exemption plus a state tax exemption (our state waives the tax for people who work abroad b/c there are _a lot_ of us). I have to imagine that means they'd also factor into the hypothetical calculation the fact that we get some credit for any Hong Kong tax paid. Incidentally there don't seem to be any rules governing the hypothetical calculation, it's just what you and your employer agree to. In subsequent discussions my employer seems very keen on the idea that the accountants and I will work together to optimize things for both parties. That means whatever's cheapest in terms of tax for both of us should work. Which hopefully means we take advantage, in both 'hypo' and real terms, of whatever methodology gets us the lowest overall tax bill.

    Here's hoping it works out that way. Thanks again for all of the advice.


  10. #10

    Join Date
    Mar 2006
    Location
    Pokfulam
    Posts
    204

    Nina: I was told that there's no tax treaty between HK and US (unlike between China and US) so there was some sort of limit for tax credit. Can't remember the exact details.

    WSinHK: I think my company does hypo tax differently. I was told that the hypo tax is calculated based on what I would have paid if I worked in the U.S. (thus no $82k exclusion, etc). It was used so that I'm no better off or worse off than if I stayed there. But if your company allows different treatments, then by all means get what's best for you and your family!


Closed Thread
Page 1 of 2 1 2 LastLast