The people you hire to work in your company could make or break your business. If you’re a small business owner, then you understand just how important it is to manage your growing workload while finding innovative ways to cut down on expenses.
You don’t need us to tell you about the benefits of outsourcing work and hiring independent contractors, as opposed to having full-time employees on your payroll. Sometimes, you need someone with a set of skills and experience level that you can’t find (or even afford) if you were to source for talent locally.
But, before you hire the next overseas freelancer you come across, keep in mind that there’s a right way to do it. Otherwise, you could potentially be exposing your company to legal liability issues under international laws that you may not be prepared to deal with.
With that being said, the first thing you need to figure out is – How do I pay a foreign contractor and reduce the risk associated with the entire process?
Contractor vs Employee
While the difference between the two terms may seem inconsequential, make no mistake about it – they mean two entirely different things from a legal standpoint.
If the IRS or a US court determines that the individual you hired to work in your company as an independent contractor is, in fact, an employee, you could get into legal trouble for not meeting the minimum requirements for an employee.
The potential liabilities you could be looking at include paying that individual’s Medicare taxes, Social Security, unemployment tax, worker’s compensation premiums, and all unpaid benefits dating back to when you first engaged them. Not to mention the fact that you’ll also have to pay the penalties and interests associated with those payments.
If the worker lives outside the US, you may have to pay even more liabilities under the applicable local laws. EU countries, for instance, require that you pay a minimum of four weeks’ worth of paid vacations and holidays for every calendar year. The same applies to workers in Peru and Argentina.
How to Make Sure That Your Contractor Is Not an Employee
So, how do you distinguish between an employee and an independent contractor? Sometimes, the line between the two is not always clear.
You would think that the existence of a written and signed agreement would be enough evidence to prove the existence of a principal-contractor working relationship. Well, it is not.
The government uses various testing standards to analyze whether the individual in question should be classified as an employee or contractor.
For starters, if a contractor works exclusively for one principal, they are considered a de facto employee. This arrangement is particularly hard to dispute if they’ve been working for a particular company for a long time.
Second, if an independent contractor has their own office and supplies, the government will likely view them as an independent contractor as opposed to an employee.
Finally, if the written contract has a non-compete or non-solicitation clause, this may be seen as evidence of an employer’s control over the worker after the termination of the binding contract. It would be an indicator of the individual’s “employee” status within the company.
Payments to Foreign Contractors for Services
If you hire an independent contractor who is based in the US, the IRS requires that you report all annual payments that exceed $600. However, a whole different set of rules apply when paying foreign independent contractors.
If a foreign contractor performs services outside the US, in most cases, you won’t have any reporting or tax withholding obligations. It is different if the foreign contractor in question performs their services within the country.
To avoid the tax obligations that come with hiring them, you need to meet the following conditions.
- The foreign contractor performing the services within the country is only present for less than 90 days during the tax year
- The total amount you pay them for their labor or services shouldn’t exceed $3,000
- The payment should be for services performed for a place of business or office maintained in a foreign country
If you don’t meet the above conditions, you’re required to withhold the foreign contractor’s income, and report this when filing taxes. The exception to this rule is if the foreign contractor is from a country that has an existing tax treaty with the US.
How Do I Report a Payment to a Foreign Contractor?
A principal is not obligated to report payments made to foreign contractors that don’t meet the stipulated requirements outlined in the previous section.
Nonetheless, you should still have them (the foreign contactor) complete Form W-8BEN – which is the applicable foreign contractor tax form for individuals, or W-8BEN-E – foreign contractor tax form for entities.
The IRS uses the claims made on the form to determine your company’s tax withholding or reporting obligations. The forms are supposed to establish the status of the contractor as a foreign person or entity.
Keep in mind that if the information provided on the form does not meet the conditions for classifying them as foreign contractors, you are not liable for meeting the tax requirements.
On the other hand, if you are not a resident of a foreign country nor do you have a permanent establishment/premises/place of business in the country where the foreign contractor you have hired is a resident, then you don’t have to withhold income or report to the local tax agencies of the country in question.
When in Doubt, Consult a Tax Lawyer
In a nutshell – How do I pay a foreign contractor?
First, you need to make sure that the person you’ve hired as an independent contractor is not an employee by both US law and the local laws in their country of residence.
- They’re performing services within the US for more than 90 days
- The cost of said services is $3,000 or more
- The services in question are not performed in a place of business that your company maintains in a foreign country
…then you’ll need to withhold income before you pay them and report it when filing your company taxes. If those three conditions aren’t met, then you don’t have to.
Finally, if you’re not a resident of the foreign country in question, nor do you have a permanent establishment there for your business, you can pay the contractor without withholding income and reporting to the local tax agency.
Always consult a tax lawyer to review how your principal-contractor relationship is interpreted by US laws and those of the contractor’s country of residence, to understand the legal risks involved and your tax obligations.