This blog post will inform a US company on the necessary steps to take to establish a proper relationship with a foreign independent contractor, tax and withholding requirements, and shielding itself from liability. It will also serve as a helpful guide for foreign independent contractors to understand the important big picture components of the work relationship.
The Necessary Contractor Forms
US businesses contracting with non-US persons to perform work outside of the US must collect and keep on file a W-8BEN (for individuals) or a W-8BEN-E (for entities). These forms are used to establish that the independent contractor is a foreign person or entity and that the work is performed outside the US. Although a company may rely on certain presumptions regarding the foreign contractor’s status (Treas. Reg. §1.1441-1(b)(3)), it is generally better practice to ask them to complete a W-8BEN. The business is entitled to rely on claims made on the form to determine tax reporting and withholding obligations. If the information on the form is different from fact, and the worker does not qualify as a foreign contractor, the principal is not liable for not meeting the tax requirements. If audited, the Form W-8BEN can establish why no Form 1099 was issued and no tax was withheld.
Companies do not file Form W-8BEN with the Internal Revenue Service (the IRS), but rather, keep it on file in case of an IRS audit. The foreign contractor does not have to get a US taxpayer identification number (ITIN) or to complete Part II of Form W-8BEN. They just needs to complete the basic information in Part I and sign in Part II, and no Form 1099 then needs to be filed (Treas. Reg. §1.6041-4(a)).
Generally, no IRS reporting of the compensation or tax withholding is required in these circumstances. Also, generally no Form 1099 is required for payments to foreign contractors for services performed outside the US and no withholding is required (as long as the foreign contractor is not a US person and the services are wholly performed outside the US).
How to Substantiate the Deduction
The company paying the contractor will want to deduct any amounts paid to the contractor. Normally, to do so, a company would file an IRS Form 1099, but this is not necessary when the payment is made to a non-resident independent contractor for services performed abroad. First and foremost, to substantiate the deductions, the company must maintain books and records evidencing how much was paid, why it was paid, and to whom it was paid.
As an example, one way to substantiate deductions to a foreign contractor might be to produce the monthly invoices sent from the foreign contractor to the US company at the end of each month. Copies of the monthly invoices, along with copies of monthly credit card or bank records showing payments in the corresponding amounts to the foreign contractor, would likely be sufficient to substantiate the deduction.
Complying with Local Tax Agencies
If the principal is not a resident of the country and has no permanent establishment in the country where the foreign contractor is a resident, then generally there is no requirement to report or withhold taxes in the country. It is important to assure that the independent contractor complied with the local tax requirements by specifying the duty in the work agreement, or by asking for proof of tax compliance.
A US company is subject to US non-resident alien (NRA) reporting and withholding requirements when they make payments of US sourced fixed or determinable annual or periodic income (FDAP) to a foreign person not associated with such person’s US trade or business.
If any portion of the services is performed in the US or by a US person abroad, withholding or 1099 reporting could be required. Any independent contractor agreement should clearly state where the services are to be performed, since liability for the tax, penalties, and interest would otherwise fall on the company contracting the services.
Foreign Contractor Performing Services within the US
Businesses are required to report payment over $600 annually on Form 1099-MISC. If the foreign contractor performs service in the US, certain conditions must be met to avoid US tax obligations:
- The nonresident alien performing labor services is present in the US for less than 90 days during the tax year;
- The total pay does not exceed $3,000; and
- The pay is for labor or services performed for an office or place of business maintained in a foreign country.
If any of these conditions are not satisfied, a principal has to report and withhold income of a non-resident independent contractor. In order to avoid this, you should specify in your contract that services are not to be provided while the contractor is within the US, and that the contractor must notify the company when traveling to the US for any reason.
Protect yourself by requiring any non-resident alien independent contractor to complete a Form W-8BEN, and you may rely on claims made on the form to determine tax reporting and withholding obligations. This form is not filed with the IRS, and you keep it in case of an audit. In this event, there is no need for the foreign contractor to get a US taxpayer identification number or to complete Part II of Form W-8BEN. Generally, no Form 1099 is required for payments to foreign contractors or services performed outside the US and no withholding is required (as long as the foreign contractor is not a US person and the services are wholly performed outside the U.S). If audited, Form W-8BEN supports why no Form 1099 was issued and why no tax was withheld.