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Employer tax duty to foreign employees


Dear Tax Talk,
I am a small consulting firm and hire contractors overseas to do some of the work. These freelancers are not U.S. citizens or residents and all services are performed in their home countries. I've been reading Internal Revenue Service Publication 515 and need some clarification; do I need to withhold any taxes or report anything like a 1099 to the government? How do I document this? Invoice, statement of work, e-mails? What is the requirement? -- John

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Dear John,
You and other employers who have shipped jobs overseas luckily have left a few of us here to answer your questions.

If you have been reading Publication 515, you're confused because it mainly deals with withholding on payments to nonresident aliens. To determine whether income is subject to U.S. tax, you need to determine its source. Personal-services income is sourced where the services are performed; in your case, a foreign country.

Since the services are performed in a foreign country and are paid to a foreign person, there is no U.S. withholding. Form W-8BEN is required from a foreign person who is subject to U.S. withholding and therefore would not be applicable in this case. Form 1042-S (similar to a 1099) is used to report U.S. source income paid to a foreign person and again would not be applicable in this case.

Basically, there are no documents specifically required where the payments are to foreigners. However, it's a good idea to document everything to avoid questions later. I would certainly get a copy of the foreign person's passport, and it would be a good idea to get invoiced for the services, even if it is only in an e-mail.

Also, how you make payment to the foreign individual should be documented. If you're wiring to a foreign bank account, that is pretty clear. But I've seen foreigners that maintain accounts in the United States and use debit cards to withdraw their earnings. If you're depositing in a foreign worker's account here, the IRS would probably want to see proof that the person is not actually in the United States. I'm not sure what kind of proof is good here, because if you gave a copy of the passport, the IRS could always claim that you didn't copy all the pages and an e-mail can be sent from anywhere. It would obviously be nice to get a copy of his bank statements showing the overseas withdrawals, but he or she may not be comfortable with that.

Depending on how you pay the worker, you may need to have some evidence to show the individual is indeed in a foreign country. Otherwise look to hire an American.


-- Posted: Dec. 16, 2004




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