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Foreign Contractors and US Companies

Foreign Contractors and US Companies
Ines Zemelman, EA
16 February 2022

Hiring Foreign Independent Contractors

One of the many issues with a global economy and the growing popularity of digital nomads and freelancing are the tax implications across borders. What tax considerations are important when a US company makes a payment to a non-US independent contractor? Does the company need to withhold taxes? Is the foreign contractor required to submit a United States tax return? Does the company need to issue a Form 1099?

Who is an independent contractor?

Independent contractors are people who offer their professional services to clients. They are usually self-employed owners of small businesses that you hire for a fixed period of time, on a per-project basis or on a contract basis. Independent contractors may go by similar names such as 1099 contractors, freelancers, International contractors or self-employed workers.

In the US, the IRS says generally "an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done."

Is the independent contractor an employee of the company? 

No. The independent contractor is not an employee of the company (payer / hirer). As mentioned in the definition above, the Independent contractor has a “Full degree of control” on his result output whereas an employee is fully under the control of a company (payer / hirer).

What if a Foreign contractor is a US person?

Do I need to issue Form 1099 to a foreign contractor?

If the foreign independent contractor meets the definition of a “US person”, and all or part of the services performed by the contractor is inside the United States (US-sourced income), then withholding MAY be required, and Form 1099-NEC (previously known as Form 1099-MISC) must be issued if the total income is more than $600 in the year.

What is US-sourced income?

According to the IRS, the source income gained by offering services is determined by the location where the services are performed. Even if an overseas independent contractor works for a US company, the income they receive is NOT considered US-sourced income as long as every aspect of the services performed are outside of the US. If any part of the services performed in the US, then the portion of income earned out of that services will be considered as US-sourced income.

Do I need to collect Form W-9 from the Contractor?

US companies use IRS Form W-9 (Request for Taxpayer Identification Number and Certification) to get information from independent contractors they hire who are US persons and all or part of their services performed in the US

Form W-9 helps employers to collect the name, address, and Social Security Number (or Tax Identification Number, known as TIN) of the 1099 contractors.

Employers only need to ask for a filled-out Form W-9 from contractors if they paid more than $600 in the course of a year. This form does not need to be submitted to the IRS since it is only a prerequisite for filling out Form 1099-NEC.

What if a Foreign contractor is a Non-US person?

If the Foreign contractor does NOT meet the definition of a “US person”, and all of the services performed by the contractor occurred outside of the United States, then withholding MAY not be required, and Form 1099-NEC need NOT be issued - provided that the country of residence has a tax treaty with the US.

Tax exemption of so-called “independent personal services”, i.e. services by the independent contractor, is possible if the country of residence of the contractor has a Tax Treaty with the United States with the related article - which exists in most tax treaties.

Without the Form 1099, it is important to keep good records to substantiate any deduction, including to whom the payment was made, why the payment was made, and the amount.

Although tax law is clear, it hinges on whether or not the contractor is a “US person”, so how does a company determine this? Request W-8BEN from the contractors to certify their foreign status. Keep this form on file in the event you are audited. It will support why you did not withhold tax and why you did not issue a 1099-NEC.

Do I need to collect Form W-8BEN (or W-8BEN-E) from the Contractor?

The equivalent of the Form W-9 for foreign contractors is the IRS Form W-8BEN. It has two variations: Form W-8BEN for individuals and Form W-8BEN-E for foreign companies or self-employed workers operating under a business entity).

These forms are used to self-certify that a person (or entity) is not, in fact, a US person. The hiring company is entitled to rely on the claims made on these forms to determine obligations regarding tax reporting and withholding. If you don't collect a W-8BEN from your contractor, you're obligated to withhold a 30% income tax from their pay.

Unsure if they are a US person?

If you have any doubt about the requirement to withhold, go ahead and do it and use a Form 1042. In the event that there was a withholding requirement, you can be liable for any tax that was not withheld. If your contractor doesn’t actually owe any US tax, they can claim a tax refund by filing a United States tax return.

What if a Foreign contractor is a Non-US person and his country does not have a Tax Treaty with the US?  

If the contractor is a tax resident of his country without the tax treaty with the US (i.e. Singapore), then the payor is required to take a 30% tax withholding from the compensation paid and issue form 1042-S reporting income received and tax withholding made. 

Flow Chart presentation: US companies with Independent Contractors 

US companies with Independent Contractors

Contractor who received 1042-S, TFX can file your 1040NR 

If you are a nonresident contractor qualifying for treaty income exemption who received form 1042-S and had tax withheld, TFX can prepare your non-resident tax return to receive the refund for tax withheld.

 

Ines Zemelman, EA
Founder of TFX