Reporting U.S. Business Payments to Foreign Individuals for Services Performed Outside the U.S.December 17, 2018
*Editor’s note: This article was originally written in 2012 but has been updated as of December 17, 2018 for accuracy and comprehensiveness.
The world we live in is global, and as a result every business and person is linked in some manner to international business activities. When considering the applicable tax consequences, any activity should give rise to the question – are there reporting requirements that I need to consider?
Reporting Requirements: FAQs
1. One common question received is how a domestic U.S. business should treat payments made to a foreign service provider for services performed entirely outside of the U.S.
- Are there any reporting requirements?
- What forms are required to be filed?
- Is the U.S. entity required to withhold tax on the payments?
Simple answer: as long as the foreign service provider is performing all of the services outside of the U.S., there is no 1099 or withholding requirement for the domestic U.S. payor. On the other hand, if the foreign service provider performs any of its service in the US, then the US payor is potentially required on the payment and to issue a Form 1042S to the foreign service provider reporting the gross payment and any amounts withheld for US tax purposes. In the case where all of the services are provided outside of the US by the foreign individual then the U.S. payor does not have any obligation to withhold.
2. How do you know if the contractor you are using is not a U.S. person? How can you be sure that they are not a U.S. citizen working outside of the U.S.?
The easiest way to be sure is to ask the contractor to complete a valid Form W-8 which allows them to certify that they are not a U.S. person and whether a withholding requirement exists under the applicable tax treaty. Form W-8 is not required to be filed with the IRS but is required to be kept by the U.S. payor to support the foreign contractor’s representation of their residency and whether withholding was required. Note this documentation is crucial to have in case your company is audited by IRS.
3. How can you be sure that the foreign contractor is not performing the services in the U.S.? What if they are in the U.S. for an unrelated reason and decide to work on your project while here?
Again, the only way to be certain is to ask. For record keeping, it is best to have the foreign contractor sign a statement confirming that none of the services provided were provided in the U.S. This statement can be attached to the Form W-8.In most cases, a foreign contractor is subject to U.S. tax on its U.S. source income. Most types of income received by a foreign contractor are subject to a 30% tax. A reduced rate may apply if there is a tax treaty between the foreign person’s country of residence and the U.S. Typically, Form 1042 and related Form 1042S must be filed when U.S. persons (including corporations, LLCs, partnerships, and self employed individuals) are making certain payments to foreign persons. A 1042S will be issued to the contractor or vendor for their records (similar to Form 1099 reporting for domestic vendors). Form 1042 is only required for payments of “U.S. source income” even if it is determined that no withholding is required.
If you are unsure, you can always withhold on any payments made to a foreign contractor. If the foreign contractor or vendor does not owe any U.S. taxes, they can claim the withholding taxes by filing the applicable U.S. tax return to refund any amounts withheld. Since this process can be time consuming and cause a delay in your foreign vendor’s ability to receive full payment, it is advisable that the right questions and forms be filled out before the transaction occurs.
If you have made payments during 2018 to foreign vendors and are unsure of your responsibilities, please do not hesitate to contact any member of the International Tax Services Team.
Read more on tax issues by visiting the KLR Tax Blog.