8 Tips for Documenting Your Operations with Non-U.S. Persons
With globalization, many U.S. companies are finding lower-cost services and investments outside of the U.S. Whereas most U.S. entities are familiar with Form 1099 requirements for independent contractors, IRS tax filings for companies making payments for services provided by foreign persons is often less well understood. (NOTE: The IRS defines foreign persons as including nonresident alien individuals, foreign entities and governments.)
For payments and associated withholding relating to foreign persons, the IRS requires that Form 1042-S be completed. This form is similar to a Form 1099, but it specifically relates to a foreign person’s U.S.-source income, which is generally subject to 30% withholding.
People generally associate this form with what is called fixed or determinable annual or periodical (FDAP) income. The IRS uses that term to include a broad range of payments made to foreign persons. Here are a few tips for properly documenting your operations with foreign persons:
- Always ask for the Form W-8BEN, W-8BEN-E or other variation from the foreign person.
- Ask for either email or physical confirmation that the foreign person is not a U.S. citizen or Green Card holder.
- Contact a tax professional before making any payments to a foreign person, because if withholding has not been taken, the U.S. party is liable as the withholding agent.
- Understand the type of services being performed and where they are performed.
- Properly document each type of income and expense paid to the foreign person, with additional notations on invoices to ensure proper withholding, if applicable.
- Register with the Electronic Federal Tax Payment System (EFTPS) to make any withholding payments due within a few days of the physical payment.
- A withholding agent is any person, U.S. or foreign, that has control, receipt or custody of any amount subject to withholding who can disburse or make payments of an amount subject to withholding or who makes a withholdable payment.
- Certain types of payments to foreign persons must be reported, including:
- Compensation for independent personal services performed in the U.S.
- Compensation for dependent personal services performed in the U.S. (if claiming treaty benefits)
- Pension distributions and other deferred income
- Cancellation of indebtedness
- Effectively Connected Income (ECI)
- Certain distributions attributable to dispositions of U.S. real property interests
- Gains related to contingent payments received from the sale or exchange of patents, copyrights and similar intangible property
Speak with a tax advisor regarding the types of payments made to foreign persons and if withholding is applicable. The foreign person can often utilize a favorable income tax treaty to reduce or eliminate withholding. If no documentation is received from the foreign person, the U.S. withholding agent should withhold 30% of the gross payment, at a minimum, to cover themselves from being liable personally. Forms 1042-S are due to the IRS by March 15 of the year following the physical payment and a one-month extension may be obtained by filing Form 8809.