Paying International Contractors: 6 Payment Methods for Foreign Contractors

What Is an Independent Contractor?

An Independent Contractor is a self-employed individual hired to perform specific tasks or projects for a company under a contract agreement, rather than being an employee on the payroll. Independent contractors are responsible for their own taxes, benefits, and often provide their own tools and materials. Companies benefit from the flexibility and expertise of contractors while managing compliance with labor laws and tax regulations.

As a business owner or human resources manager, you may come across the term "independent contractor" in workforce planning. An independent contractor is contracted to perform specific tasks or services for your business, without being classified as an employee. This distinction is important because it affects tax obligations, legal responsibilities, and the level of control you have over how the work is performed. Misclassifying employees as contractors can lead to severe legal, financial and reputational damage.

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Check Out Our Employee Misclassification Guide

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What Is the Best Pay Structure for Independent Contractors?

When determining the best pay structure for independent contractors, you need to consider factors such as the nature of the work, industry standards, and both parties' preferences.

The most common pay structures include:

1. Hourly Rate:

Contractors are compensated based on the number of hours worked. This payment structure is ideal for projects with variable scopes or ongoing tasks, offering flexibility in how work is managed. However, it requires accurate time tracking to ensure fair compensation. To avoid disputes, both parties should agree on the hourly rate upfront. This structure works well for projects where the work volume may change over time.

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2. Per-Project Fee:

In this structure, a fixed amount is agreed upon for the completion of a specific project. It is best suited for well-defined projects with clear deliverables and timelines. The per-project fee encourages efficiency, as contractors benefit from completing tasks promptly. However, it is essential to conduct thorough project scoping to ensure that both parties have aligned expectations regarding the project's scope and deliverables.

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3. Monthly Retainer:

Under a monthly retainer, contractors receive a set monthly fee for providing a predetermined set of services. This model is commonly used in roles that require consistent support, such as consulting or IT services. It provides contractors with predictable income and offers clients budgeting certainty. However, both parties should regularly review the arrangement to ensure the workload aligns with the retainer's expectations.

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4. Commission-Based:

In this pay structure, compensation is tied to performance metrics, such as sales or lead generation. This model is commonly used in sales or business development positions, where the contractor’s incentives align with the company’s goals. It requires clear definitions of performance metrics and transparent reporting to ensure fairness and clarity for both parties involved.

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5. Milestone-Based Payments:

Payments are made upon the completion of specific project milestones in this structure. It is particularly suitable for large or long-term projects with distinct phases. This structure helps manage cash flow and ensures continuous progress throughout the project. Milestones should be clearly defined and agreed upon in the contract to avoid misunderstandings and ensure that both parties are on the same page.

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Best Ways To Pay Independent Contractors & Freelancers

Paying and managing international contractors efficiently, on time and securely is fundamental to keep your operations running smoothly and building good working relationships.

Below are 6 common methods to pay contractors, each with its own set of benefits and drawbacks:

1. Wire Transfers

Wire transfers are a traditional and widely used method for sending funds internationally.

Pros:

• Reliability: Established networks like SWIFT ensure secure transactions.
• Global Reach: Accessible in most countries worldwide.

Cons:

• Costly Fees: Both sender and recipient may incur significant charges.
• Processing Time: Transfers can take several business days to complete.

2. Credit Cards

Using credit cards for payments is less common for international contractor transactions.

Pros:

• Convenience: Quick payments without the need for bank details.
• Rewards: Potential to earn points or cash back.

Cons:

• High Fees: Foreign transaction and processing fees can add up.
• Acceptance Issues: Not all contractors can process credit card payments.

3. Contractor Management Software

A contractor management platform like Playroll allows you to manage and pay contractors seamlessly, making the entire process more efficient and hassle-free.

Pros:

• Automation: Streamlines payment and contractor management, automating tasks such as tax forms and compliance with labor laws.
• Convenience: Allows businesses to pay contractors in their local currency, which ensures legal compliance and improves contractor satisfaction.
• Ease of Use: Facilitates fast and easy payments through platforms like Payoneer, where contractors can convert funds into their preferred currency at transparent, real-time forex rates.
• Compliance: Removes the administrative burden of compliance, allowing businesses to focus on their core tasks while ensuring that hiring practices are aligned with local labor laws.

Con:

• Upskilling: While these platforms can simplify many processes, they may require a learning curve initially, especially for businesses new to contractor management systems.

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Seamlessly manage and pay international contractors in 60+ currencies, featuring built-in compliance with global labor laws.

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4. PayPal

A popular digital wallet service for international transactions.

Pros:

• User-Friendly: Easy setup and instant transfers.
• Widely Accepted: Used in many countries.

Cons:

• Fees: Transaction and currency conversion fees can be high.
• Account Limitations: Potential for account holds or limitations.

5. Freelancer Platforms

Platforms like Upwork or Fiverr facilitate hiring and payments.

Pros:

• Integrated Services: Combines hiring, project management, and payment.
• Escrow Protection: Funds are held until work is approved.

Cons:

• Platform Fees: Both parties may incur service charges.
• Limited Flexibility: Bound by platform rules and policies.

6. Wise

Formerly TransferWise, Wise specializes in low-cost international transfers.

Pros:

• Low Fees: Competitive exchange rates and transparent pricing.
• Speed: Many transfers arrive within one business day.

Cons:

• Account Setup: Both parties need to create accounts.
• Availability: Not all currencies or countries are supported.

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Tax Forms Needed To Pay Foreign Independent Contractors

When engaging foreign independent contractors, U.S. companies have to navigate specific tax documentation to ensure compliance with IRS regulations. The primary form required is the Form W-8BEN for individual contractors, which certifies their foreign status and may allow them to benefit from tax treaty provisions, potentially reducing or eliminating U.S. tax withholding obligations.

For foreign entities, the equivalent form is the Form W-8BEN-E, which serves a similar purpose in establishing the entity's foreign status and eligibility for treaty benefits.

In situations where payments to foreign contractors are subject to withholding, businesses must file Form 1042-S, detailing the income paid and any taxes withheld. Additionally, an annual summary of all such payments and withholdings is reported through Form 1042. Notably, U.S. companies are generally not required to issue Form 1099-NEC to foreign contractors, as this form is designated for reporting nonemployee compensation to U.S. residents.

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4 Common Mistakes for Payments to Foreign Contractors for Services

1. Missing the Mark During Onboarding

Hiring a US-based contractor is relatively straightforward compared to hiring foreign contractors. To hire contractors in the U.S., complete a 1099 form and onboard your contractors. But if your business is hiring internationally, setting your workers up to receive compliant international payments starts with a good onboarding process for contractors. 

Namely, they have to fill out the form W-8BEN.

A W-8BEN form, or a certificate of foreign status, is how the IRS - internal revenue service confirms your new hire is eligible for a lower tax withholding rates – traditionally, around 30% of their earnings. This form will reflect:

• The name of your international contractor
• The international contractor's country of residence
• Their taxpayer ID number (TIN)
• The business entity from which they’re receiving their income

While you need to make sure all foreign contractors complete a W-8BEN, it’s their responsibility to submit them. 

Be sure to confirm their status as international contractors in your agreement with them. This way, you can avoid tax penalties and cover your bases even if they fail to hold up their end of the bargain when it comes time to report their income in their home country.

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2. Failing to Meet Tax Reporting Requirements

Just as foreign contractors must submit their own W-8BEN form to clear them for employment, there are two critical documents you’ll need to submit to keep your company in the IRS’s good graces when paying international contractors:

• Form 1042
• Form 1042-S

These tax forms detail the taxes your business has withheld from your international contractors' earnings and are key for compliance with US income tax laws.

In addition to filling out both of these reports accurately, your business is responsible for adhering to the following 3 terms in your work with a foreign contractor:

1. Your foreign independent contractor may not earn more than $3,000 from your business in a single tax year.

2. Your independent contractor must have an established location (complete with an address) where they do business in the contractor's country.

3. Your foreign independent contractor may spend no more than 90 days in the US throughout their contract with your firm as stated in their independent contractor agreement.

If you violate these conditions, your business will be responsible for reporting the breach and withholding income from international contractors. A common mistake when paying foreign contractors is failing to withhold taxes.

The contractor’s location may require tax payments to the local government, and businesses may need to withhold taxes on these payments. These taxes can include income tax, social security, and other payroll taxes. In some cases, contractors may also need to file a tax return in their country. Take the time to research tax requirements in the contractor’s country to avoid legal and financial issues.

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3. Assuming Foreign Worker Classifications Are the Same

The global marketplace often faces the bitter truth that some things get lost in translation.

Many countries have a unique set of labor laws and terms designed to protect local and foreign workers in various work settings. Furthermore, certain types of work may only be legally performed by an employee, rather than an independent contractor. 

Depending on where your foreign contractor resides, the category of their employment status may be affected by:

• How independent contractors are trained for their position
• Whether independent contractors use tools provided by their business
• How vital a contractor’s work is to a business’s functions
• How much supervision independent contractors receives from a business
• How much a company stands to gain or lose in relation to their contractor’s labor

Classifying domestic employees is often straightforward, but misclassifying foreign independent contractors can lead to penalties. To avoid this, it's a good idea to hire a professional to review your contractor’s contract and make sure it aligns with the labor laws in their country before you start paying international contractors.

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4. Ignoring Local Tax Laws for International Payments

Every individual country follows its own rules about how transnational workers are entitled to receive money transfers. The payment method you select must conform to the regulations stipulated by their home government to remain compliant. 

You also need to keep in mind that international money transfers come with transaction fees, bank fees, and fluctuating exchange rates. Make sure to clarify who's covering the hidden fees when you pay contractors.

Even further, when you pay international contractors, your must comply with the local laws of their country or state of residence. Because individual tax codes can be dense to interpret – and are constantly in flux – it’s in every global company’s interest to consult international payroll companies before ferrying funds overseas. Most international contractors must pay their own taxes even if their income lands up in their bank account from abroad.

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Manage Payments to Foreign Contractors With Playroll

While exciting, hiring international contractors comes with a host of challenges, payroll and payroll taxes being one of them, which can hamstring businesses’ internal operations while attempting to stay up to speed with domestic and foreign markets' tax regulations. Our contractor management platform allows for seamless invoicing of independent contractors in one place, in your choice of 60+ currencies. Want to consolidate payroll processes globally? We also offer global payroll services to map and standardize any source of data without disruption to your current systems.

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Book a demo to learn more about how we can streamline your multi-country payroll for contractors and scale your business without the compliance headaches.