Payments to Foreign Contractors for Services: 4 Mistakes to Avoid

Hiring foreign contractors offers an exciting opportunity. It opens doors to understanding the needs of consumers abroad and, by stepping off the beaten path to build your team, it can invigorate your global workforce with new energy.

But every odyssey has its obstacle, and wading overseas tends to come with a slew of new legal considerations. These can make payments to foreign contractors for services rendered a complicated and risky endeavor.

Fortunately, being aware of business challenges is the best way to avoid legal and material penalties that can injure businesses growing a global workforce. Below, we detail 4 of the pitfalls you may encounter when, making payments to foreign contractors and how to avoid payroll errors and penalties from financial institutions.

#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 hop aboard. But when your business recruits a labor force through the remote workers interview process from more than one country, setting your workers up to receive compliant international payments starts with onboarding. 

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 it’s incumbent on you to have your foreign contractors complete a W-8BEN, it’s their responsibility to submit them. 

If you haven’t yet established trust with your foreign contractors, be sure to cement 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.

#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 essential 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 abrogate these conditions, your business will be responsible for both reporting these breaches and withholding income from your international contractors. 

One of the common mistakes when paying foreign contractors is failing to pay taxes. The contractor's location may impose tax obligations to the local government, and laws and regulations may require the business to withhold taxes on payments made to the contractor.

When you pay international contractors, these foreign taxes may include income, social security tax, and other payroll taxes. In some cases, the contractor may also need to file a tax return in the foreign country to report the income received from the foreign business. It's important for businesses to understand the tax payment process in the foreign contractor's country to avoid any legal and financial repercussions when paying foreign contractors.

#3. Presuming equivalence of foreign employee classifications

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

Correctly classifying domestic employees can feel like a familiar process, but successfully classifying foreign independent contractors can incur penalties if executed incorrectly. 

To avoid them, your firm may be best off recruiting a professional to vet your contractor’s contract and ensure it squares with the employment local labor laws and definitions in their country of residence before making an paying international contractors. 

#4. Not being apprised of a specific country’s local tax laws

If you’ve adequately finalized your tax filing, forms and worker categories, there are 5 typical methods for paying foreign independent contractors:

• Bank-to-bank wire transfers (international bank transfers)
• International wire transfers to a bank account
• International money orders
• Digital wallets like PayPal
• Paper checks

However, 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 a professional global payroll payment service like Playroll before ferrying funds overseas. Most international contractors must pay their own taxes even if their income lands up in their bank account from abroad.

Payments to Foreign Contractors With Playroll

While thrilling, hiring international contractors comes with a host of practical exigencies—payroll and payroll taxes being one of them—that can hamstring businesses’ internal operations while attempting to stay up to snuff with domestic and foreign markets - tax codes.

For some, a payroll management system can seem like a snore—but at Playroll, pay is how we roll. 

We’re a VAT IT-powered company devoted to using our global payroll-inflected experience to help resolve barriers to pushing business overseas. Contact us today to learn more about how we can streamline your payroll solutions professional services, reenergize your business and start bringing new foreign contractors on board from abroad, with just a few clicks. If you have to expand abroad, we also have some employer of record services you can take advantage of.

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