Independent contractors, also called consultants or freelancer workers, are self-employed individuals or entities who provide specialized services to the business community. Companies often hire independent contractors to obtain talent without having to hire, train, or provide benefits to additional employees. Employers who engage independent contractors’ services know this practice’s many advantages.
In today’s business environment, many U.S. companies are hiring foreign contractors to add value to their organizations by accessing global insights, increasing productivity, and promoting diversity and inclusivity. But when the specific needs of a U.S. company require them to hire foreign contractors, companies must also be able to stay in compliance with the many rules and regulations that govern international labor laws and tax requirements.
Foreign Employees Must Pay U.S. taxes.
U.S. companies that pay foreign workers to perform services within the U.S. must report all salary payments to the IRS. Foreign workers in the U.S. are generally subject to a U.S. 30% tax rate unless a reduced rate applies due to the existence of an income tax treaty between the U.S. and the relevant country. The U.S. has entered into numerous income tax treaties with countries across the globe to protect workers from being taxed by both the U.S. and their country of residence. The IRS W-8BEN Tax Form ensures foreign workers are not double taxed and determines a reduced withholding tax rate.
To prove their foreign status and claim tax treaty benefits, non-US independent contractors must complete and sign IRS Form W-8BEN and submit the document to their U.S. employer before the first salary payment. In instances where the company does not withhold taxes from the compensation of the foreign contractor and the worker does not satisfy the tax obligation, the company may be held liable for the amount of tax due, plus interest and penalties.
Before You Engage an International Contractor
1. Create an Independent Contractor Agreement.
An Independent Contractor Agreement will define the terms of the business arrangement between the contractor and the company. The agreement will generally include:
· Names of Parties Involved.
· Project Description
· Deadlines and Deliverables
· Payment and Billing Information
· Project Terms
· Confidentiality
· Non-Solicitation
· Dispute Resolution Clauses
2. Define the Terms for Payment
The parties to the independent contractor agreement must work together to define payment terms and a payment schedule.
3. Collect the Required Tax Forms
U.S. companies must collect specific tax forms from foreign contractors before issuing payment. The W-8 forms will document the contractor’s status as a foreign worker or entity and outline the company’s proper tax reporting and withholdings. There are no requirements for U.S. companies to file an IRS 1099 Tax Form to pay a foreign contractor.
The W-8BEN tax form is an Internal Revenue Service (IRS) mandated form used to collect correct Nonresident Alien (NRA) taxpayer information for individuals. This form documents the foreign worker’s status for tax reporting purposes. While a W-8BEN is used for foreign individuals, a W-8BEN-E Form is used for foreign entities. When an international contractor acts as an entity, corporation, or partnership rather than as an individual, a W-8BEN-E Form is issued instead.
U.S. Tax Form W-8BEN
A W-8BEN is an IRS tax form that classifies a foreign worker’s status as a non-U.S. citizen. The form determines proper tax reporting and withholdings for the entity providing the foreign worker’s income. The form is typically collected by the employer and may be submitted to a Foreign Financial Institution (FFI) upon request. Companies are not required to send U.S. Tax Form W-8BEN to the IRS but should maintain the document in company files.
U.S. Tax Form W-8BEN-E
When companies hire an international contractor that is an entity rather than an individual, the entity must complete U.S. Tax Form W-8BEN-E instead of the W-8BEN form.
4. Be Prepared to Withhold Taxes and Report Tax Information
Companies that engage foreign workers are usually responsible for withholding taxes when it pays the foreign contractor for services rendered in the United States. Withholding tax and tax reporting for foreign contractors will depend on whether the contractor is a U.S. worker and whether the services provided are performed within the United States.
· When U.S.-based companies engage the services of a U.S.-based independent contractor, the company must have the contractor complete and sign an IRS 1099 tax form to comply with U.S. tax laws.
· When foreign contractors are not U.S. workers, and their services occur wholly outside the U.S., no reporting is required, and no withholding is required.
· When U.S.-based companies hire foreign contractors who are not U.S. workers, and their services are performed within the U.S., the payments made to the foreign contractor are generally subject to withholding tax and tax reporting. When these circumstances apply, the U.S. company should obtain a completed and signed Form W-8 BEN(E) from the foreign contractor that declares the contractor’s foreign status before making any payment.
· Although Form W-8BEN(E) is not filed with the IRS, the document should be kept on record and maintained in company files.
· If a company does not collect a signed and completed U.S. Tax Form W-8BEN form from the foreign contractor, the worker will be subject to a 30% tax withholding rate on their U.S. income.
5. Ensure Correct Contractor Classification
Misclassifying workers is a common mistake when engaging foreign workers. Misclassification occurs when a company or organization incorrectly categorizes an employee as an independent contractor. The contractor classification is a set of regulations designed to protect the contractor’s interests, and each country has a different definition. The financial and legal risks of misclassification can be costly and include lawsuits, audits, fines, penalties, and worker settlements. Companies can mitigate these risks by working with an experienced employment attorney to ensure that workers are correctly classified and that the organization complies with local and in-country laws.
Collecting the W-8BEN Form
A W-8BEN is the Internal Revenue Service’s (IRS) tax form that classifies a foreign worker’s status as a non-U.S. citizen. The form determines proper tax reporting and withholding for the entity providing the foreign worker’s income. The company is responsible for delivering the W-8BEN tax form to the foreign contractor, and employers must secure a W-8BEN form from all foreign contractors before issuing payment.. The contractor must complete, sign, and submit the W-8BEN to the employer before they can receive compensation. While presenting the form to the IRS is unnecessary, the employer should maintain it in their files. Copies of the document can be forwarded to a Foreign Financial Institution (FFI) upon request. If a company does not collect a signed and completed U.S. Tax Form W-8BEN form from the foreign contractor, the worker will be subject to a 30% tax withholding rate on their U.S. income.
A W-8BEN Form is Valid for 3 Years
A U.S. Tax Form W-8BEN Form is valid for three years. If no change in circumstances has occurred, the form will remain in effect from the date it is signed until the last day of the third succeeding calendar year (For example, if a W-8BEN is signed on Feb 1, 2023, it is valid until December 31, 2026.)
If a change in circumstances affects any of the information on the form, then the W-8BEN is no longer valid. To stay in compliance, the foreign contractors must notify the withholding agent, payer, or FFI within 30 days of the change and file a new W-8BEN Form.
When Companies Expand the International Workforce
When companies expand their workforce, paying foreign contractors can be complicated. A skilled employment attorney can help to navigate the complexities of a global workforce, avoid improper tax reporting, and mitigate the risk of penalties and fines. Suppose you are expanding your team to include foreign contractors. In that case, you should consider working with an experienced employment attorney who can help your organization comply with the many rules and regulations associated with international labor laws and tax requirements.
Treaty Oak Team Will Navigate Your Legal Issue from Inception to Resolution
If you have questions about foreign contractors or a labor and employment law issue, our team of attorneys at Treaty Oak has the experience and expertise to help you find a resolution. Treaty Oak can also assist you with the following:
· Workplace Investigations
· Anti-Harassment Training
· Legal Agreements for Non-disclosure, Non-compete, and Severance.
· Employee Manuals
· Performance Evaluation Materials
· Employment Contracts
Call Treaty Oak for a Free Consultation
Call us at Treaty Oak to schedule a free consultation now. Together you can discuss labor and employment issues in the workplace and how to avoid problems before they happen. Contact the firm’s founding member, Natalie Lynch, by calling her at 512 298-2346 or emailing her.
