One Costly Mistake If You Pay Someone Located Overseas

Do you pay an independent contractor located overseas?

This is becoming more common. Large companies have been taking advantage of cheaper, more efficient labor overseas for decades but now small company owners and even your average Joe are discovering the benefits of something like an overseas virtual assistant. If you want to know more about how a virtual assistant could help you, check out companies like Brickwork, Onlinejobs.ph, and Your Man in India.

First, what is an independent contractor?

The general rule is that independent contractors control the what and the how of the work they perform for the person paying them. The work produced by employees, on the other hand, is fully directed by their company. From a tax perspective, an independent contractor receives a 1099-MISC at the end of the year and is responsible for managing their own taxes while an employee receives a W-2 and gets their taxes managed by their company via paycheck withholdings.

Payments to independent contractors often includes things such as consulting fees, payments for contract labor, and payments for professional services such as fees to an attorney, physician, or accountant, so long as the payments are made directly to the person performing the services.

I pay an independent contractor who is located overseas. Do I give them a 1099?

Nope. You fill out a Form W-8BEN if your individual contractors is an individual person. If you're paying an independent contractor that is a business entity, you'll fill out a Form W-8BEN-E.

A Form W8-BEN sounds boring. Why do I need it?

This form is important for both you, the payer, and the overseas independent contractor, the receiver. You get the benefit of not having to withhold taxes, meaning no messy payroll issues. The receiver benefits because by signing this form, they are claiming full exemption from having to pay US taxes at all. It’s a win-win!

Most importantly, without a Form W-8BEN or W-8BEN-E in place, the IRS may require you to immediately start withholding tax on payments made to the foreign independent contractor.

What else do I need to know?

This tax-exemption is based on whether there is a tax treaty in place between the US and the country in which the foreign independent contractor is located. In some cases, that tax treaty actually may or may not address these types of payments specifically. My guess is that you’d rather spend your day doing something other than getting bogged down in foreign tax treaties, so it’s advisable to speak to your CPA first before filing.

Further, you can’t claim these benefits if the overseas independent contractor has a US-based office available to them or if they spend a significant amount of time in the US during the year.

Finally, this form has to be signed and filed with the IRS every year. If you have questions about whether Form W-8BEN applies to you or need assistance with filing it correctly, feel free to contact us at michael@flaxcpa.com.