UPDATE - 9/23/14: For payments to foreign ENTITIES, see our blog post Payments to Foreign Entities: Form W-8BEN-E.
UPDATE - 7/22/16: For a discussion of substantiating deductions for payments to foreign contractors, see our blog post Substantiation of Deductions to Foreign Contractors.
One question that often comes up is how a domestic U.S. business should treat payments to a foreign contractor for services performed outside the U.S. Is a Form 1099 required? Is withholding required?
As long as the foreign contractor is not a U.S. person and the services are wholly performed outside the U.S., then no Form 1099 is required and no withholding is required.
Not a U.S. Person
So, how do you “know” that the foreign contractor is not a U.S. person? If the contractor is an individual, perhaps he or she is a U.S. citizen living outside the U.S.? While you may be able to rely on certain presumptions regarding the foreign contractor’s status (Treas. Reg. §1.1441-1(b)(3)), it is generally easier to simply ask him or her to complete a Form W-8BEN. By signing Form W-8BEN, the foreign contractor is certifying that he or she is not a U.S. person.
In this circumstance there is no need for the foreign contractor to get a U.S. taxpayer identification number or to complete Part II of Form W-8BEN. All that the foreign contractor needs to do is to complete the basic information in Part I and sign in Part III, attesting that the information is true, correct, and complete. No Form 1099 then needs to be filed for payments to foreign persons. Treas. Reg. §1.6041-4(a).
The Form W-8BEN is not filed with the I.R.S. It is kept on file with the U.S. payor in case the U.S. payor is audited. If audited, the Form W-8BEN supports why no Form 1099 was issued and why no tax was withheld.
Where Were the Services Performed?
Now that you know that the foreign contractor is not a U.S. person, how do you know that he or she is not performing some or all of the services in the U.S.? Perhaps he or she spends two or three months a year at his or her second home in the U.S. and he or she works on your project while in the U.S.?
You won’t know if the services are performed in the U.S., unless you ask. There is no special form for this. The easiest way is to get a signed statement from the foreign contractor that he or she will not perform any of the services in the U.S. It is typically best to attach this statement to the W-8BEN.
Form 1042 must be filed with respect to certain payments to foreign persons. Code §1461 and Treas. Reg. §1.1461-1. However, Form 1042 is required only for payments of “U.S. source income.” If the payments are for services and the services are performed outside the U.S., then the payments will be foreign source income (Code §861(a)(3) and Treas. Reg. §1.861-4), and no Form 1042 will be required.
When in Doubt, Withhold
Say that you have some reason to doubt the veracity of the foreign contractor’s statements. Perhaps you know that he or she was born in the U.S. (which would make him or her a U.S. citizen, unless he or she renounced his/her U.S. citizenship)? Perhaps you know that the foreign contractor spends a good amount of time in the U.S. and you believe some of the services may be performed in the U.S.?
If you do not withhold tax on the payments to the foreign contractor but you are required to withhold, then you, as the payor (i.e., the “withholding agent”), can be held liable for the tax that you did not withhold. Treas. Reg. §1.1441-1(b)(7). Thus, if you are uncertain as to whether you need to withhold, it is generally better to withhold. If the foreign contractor does not owe U.S. tax, then he or she can file a U.S. tax return and claim a refund for the tax that was withheld.