Hiring foreign independent contractors when your business is based in the U.S.
Hiring foreign independent contractors has become commonplace for many U.S.-based businesses looking to outsource certain jobs. Thanks to websites dedicated to bringing clients and contractors together, a business owner can find someone to do just about any job at any time. But hiring remote workers as independent contractors requires understanding your legal obligations to that professional and the government.
Your first task is to be sure that you are hiring an independent contractor rather than mislabeling a new employee. Independent contractors are hired for their services on a project-based or fixed-term basis. The independent contractor receives monetary compensation from the employer, but does not receive other employee benefits.
An independent contractor might bill themselves as a freelancer, or they may be a sole proprietor or part of an LLC or other business entity. It’s the scope of a task or assigned project that makes an independent contractor, not the label on their business cards.
Independent contractors typically work part-time for many clients, but this is not always the case. They can also operate similarly to full-time employees for short periods of time, according to their contract. The contractor also can negotiate the terms of their labor or delivery with the client.
Employees, on the other hand, have higher expectations of their time and commitment to the company. They must attend required meetings, training, and follow all rules and protocols of their employer. In return, they receive benefits such as paid vacation, worker’s compensation, and potentially insurance, retirement matching, and other benefits.
There are greater responsibilities for the hiring company for employees versus independent contractors. The employer of record is responsible for withholding payroll taxes, completing the necessary tax reporting, managing workloads, and maintaining a positive working relationship with employees on an ongoing basis. An independent contractor requires little more than a contract, a project assignment, and a deadline.
When hiring a foreign independent contractor, be sure you stay within the bounds of contract employment. Otherwise, you may be inadvertently hiring a new employee, which has different tax implications and obligations.
How to pay foreign independent contractors
Since work performed by foreign independent contractors happens outside of the United States, it is treated differently than employee payment or even contractor pay for work done inside the United States. This is true even for neighboring countries like Canada and Mexico.
According to the IRS, the location where the work is performed determines the source of the income for tax purposes. This means that work performed in Spain is a source of Spanish income, even if the company pays for the work in U.S. dollars from a U.S. company. If the work is happening inside the United States, however, it is US source income and is handled differently for taxpayer purposes.
This creates a different set of rules for tax compliance. U.S.-based companies should not withhold taxes from money paid to independent contractors if the work is happening outside of the United States. Additionally, the company does not need to report the taxes of foreign contractors to the IRS. The freelancer is responsible for sorting out their own tax obligations.
Once you’ve determined that your foreign independent contractors are performing work outside of the United States and that they are, indeed, contractors for your small business, paying them is straightforward. The method of payment is something determined between the client and contractor, but might include money wired between banks or paid through international payment platforms like PayPal or through your bank account.
Since the independent contractor is solely responsible for reporting their income and following local tax laws in their own country, your responsibility is to simply submit payment according to the agreed-upon terms. The contractor will handle any tax withholding and liability according to local laws.
Tax forms needed for foreign independent contractors
That’s not to say that there isn’t any additional paperwork required when you hire foreign independent contractors. The contractor is required to report and handle the tax payments within their own country, but the IRS requires you to report any money you pay to foreign independent contractors.
IRS Form W-8BEN or IRS Form W-8BEN-E
You will need to collect information and file Form W-8BEN for any foreign individuals you contract with over the course of the tax year. If you contract with a foreign company or self-employed workers who operate under a business entity, you’ll need to collect IRS Form W-8BEN-E.
What this form does is verify that the independent contractor you’re hiring is a citizen of a different country, not the U.S., and that they are not performing their work in the United States.
The forms are valid for three years and should be collected from every foreign independent contractor. If you don’t collect a W-8BEN from a foreign contractor, you’ll need to withhold income tax from their pay—30%, to be exact. The W-8BEN forms don’t need to be submitted to the IRS, but you’ll need to have them on file for every foreign contractor you hire.
IRS Form 1099-NEC
File Form 1099-NEC or Form 1099-MISC with the Internal Revenue Service if you hired any independent contractor who was based in the United States for at least 90 days of the working arrangement and was paid more than $3,000. To collect the necessary information for the 1099-NEC, including the contractor’s social security number or EIN number, you will need to issue these contractors IRS Form W-9. The W-9 is not submitted to the IRS since it is only used to complete the 1099-NEC for each contractor, which is submitted.
If you hire a U.S. citizen who is living abroad, you are still required to issue a Form 1099-NEC, just as if the contractor was living inside the United States. If your foreign independent contractor is not a U.S. citizen and was never present in the United States during your working arrangement, Form 1099-NEC is not required. Either way, if you need help come tax filing time, Bench’s team of bookkeepers and tax experts can make sure your books are in order and everything is filed correctly and on time.
Working with international independent contractors can bring your company terrific benefits. A huge knowledge and talent pool allows you to find the workers you need for every aspect of a project. Working on a per-project basis gives you the freedom to bring in experts when you need them and keep your project expenses lower than finding new employees for the tasks.
As you seek out the talent you need for a specific project or task, take the extra time to outline the contractor agreement, to specific payment terms, and to have the contractor sign an NDA. Most importantly, be sure you’ve filed all necessary forms with the IRS to maximize the benefits of your foreign independent contractors and minimized the potential headaches.