Have you ever considered hiring foreign contractors? If you aren't doing it already, you are missing a great opportunity. There are many ways that independent contractors can improve your business. If you haven't embraced this idea because you aren't sure how to go about it, we are here to help. Apart from hiring foreign independent contractors compliantly, paying them is one of the biggest issues. We have tackled the most important challenges that you can face, along with providing you with an objective and detailed list of all your options. In addition, in this article, you will be able to read all about the possible legal repercussions of hiring foreign contractors and how to avoid it. So, let's dive in.
What are the benefits of hiring foreign contractors?
The broad variety of different options available to us via the internet is staggering. The ability to work with people coming from different continents, cultures, perspectives and educational backgrounds is at our fingertips. How can these help you and your business improve?
- Different perspectives - Working with people that don't share our environment and culture can help us see things differently, thus allowing us to tap into an experience we never had. Their points of view will surely bring something new and exciting to the table. Perhaps this is exactly what your company needs.
- Minimal training required - Independent workers are usually very skilled workers, who are hired based on their specific knowledge that will benefit the company. Once you expand your search to the global market, the chances of finding the absolute best fit are increased.
- Cost-efficiency - Even though sometimes, at first, independent contractor fees are higher than employees' hourly rates, the total cost of one employee is much higher, given that the businesses who work with contractors do not cover traditional benefits, and there is no federal tax withholding, which makes hiring them very cost-effective.
What do I need to consider before hiring and paying foreign independent contractors?
There is no doubt that hiring foreign independent contractors is great for your business. So, why isn't everybody doing it? Well, simply because it can be a little complicated. Although recruiting the best market has to offer can be a fairly simple process, hiring is where things get tricky. Before you extend an offer to your potential collaborator, there are a couple of things that you need to have in mind.
Local labor laws
It is very important to note that if you hire a foreign contractor, all of the potential disputes will have to be handled in the court of their home country. This also means that local labor laws will apply, and in most cases, they favor the employee instead of the employer. This could also require you to hire a local lawyer to help you navigate a legal system you aren't aware of, perhaps in a language you don't speak. This is all because you might find yourself breaking laws you didn't even know apply to your business relationship.
You shouldn't let this discourage you. Just because it might happen, it doesn't mean it will. There are ways to avoid getting into any legal trouble, locally or internationally. Let's see what are the ways to reduce potential risks when hiring independent contractors.
Employee misclassification can cause you problems with both IRS and foreign governments
This is one of the most common issues when hiring independent contractors, locally or internationally. There are certain criteria that need to be met in order for someone to be considered either an employee or a freelancer.
This is because tax implications are different for employees and contractors. Employers are required to withhold taxes from their employees' salaries, causing them to spend a significantly higher amount of money on them. If the IRS decides that your independent contractor should in fact be your employee, you will be required to pay all of the Social Security payments that you missed, along with several others - benefits, medicare, unemployment taxes, etc.
Actually, you will be obligated to pay interest on those late payments as well. You, as a payor, will face such liabilities for every foreign individual that you misclassified. When the Labor Department discovers issues with a business and suspects misclassification, they dedicate their resources to investigate every single company's employee, as well as independent contractors, for the last three years.
All of these regulations can be even stricter, under the local law. Make sure that you have aligned any written agreement and your business relationship accordingly. For a more detailed overlook, check this article about employee misclassification.
Determine the necessary tax withholding and reporting obligations, according to the IRS
Like we already mentioned, there is no obligation for withholding tax for your contractors, like you need to do with your employees, according to the labor laws of the United States, as well as US tax laws. For domestic independent contractors, and all about Form 1099-MISC and 1099-NEC, you can read more here.
But what about hiring foreign contractors? Even without tax withholding, tax reporting is still necessary. If you are a US company, or a US person, paying a non-US citizen, you need to report that amount to the IRS using Form 1042 and 1042-S, Foreign Persons’ US Source Income Subject to Withholding. This is only necessary if your foreign contractor has US source income. IRS provides guidance in order to facilitate this determination, but we summarized it here. According to them, even if a foreign freelancer works for a US company, the income they receive isn't considered US source income, if their service is performed outside of the US.
There is another possible option - your contractor is foreign, but they are working in the United States. If you want to avoid tax obligations, you need to meet certain conditions. Luckily, these conditions aren't too harsh. Firstly, the nonresident alien you hired can spend up to 90 days in the US during a tax year. Secondly, they need to have an office or any sort of place of business in a foreign country. And finally, the total amount they will be earning cannot exceed $ 3,000.
It is important to note that provided these conditions aren't met, the business is required to both report and withhold income for the foreign contractor. In this case, they need to provide you with ITIN - individual taxpayer identification number. It is possible to get a tax exemption, for the so-called “independent personal services”, only if the home country of the contractor has a tax treaty with the US. In order to claim this exemption for income tax and tax withholding, the contractor needs to submit Form 8233 to the company.
Collect all the necessary paperwork and tax forms
Just because you aren't required to pay any taxes for your foreign workers, doesn't mean that you aren't obligated to report that you are doing business with them. Every foreign person that you are working with or an entity needs to fulfil a certain form, according to the Internal Revenue Service. Similar to the US contractors filling in Form W-9, every foreign national working as an individual needs to complete Form W-8BEN, and foreign entities need to fulfil IRS form W-8BEN-E.
These forms are used to determine the foreign status of your contractor. This way you can prove that you are meeting all of the IRS's tax requirements. And if they provided you with information that wasn't truthful, the business can't be held responsible. This is a great way to protect your company when dealing with foreign contractors.
If you have doubts about the information provided to you, it is best to withhold taxes on the payments. If your contractor doesn’t owe any taxes, they can file a US tax return and claim a refund for the tax that was withheld.
Now, when it comes to local laws, things aren't as strict. In most cases, if the business has no assets in the country of the contractor, no taxes need to be reported or withheld. Most countries seldom require businesses to report their payments to international contractors to their respective tax agencies.
Bear in mind that this isn't always the case. With so many full-time workers turning into self-employed ones, countries are adapting and changing their laws accordingly. A couple of laws have been enacted, in order to protect independent contractors and to make sure that everyone involved is contributing to the country's economy by paying their taxes.
What can you do to protect yourself? Well, it would be great if you could hire a taxing professional that is familiar with the local tax law and all of your obligations. In this case, even the best CPA can't help you. In addition, you can insert a clause in your written agreement with the contractor, obliging them to provide proof of tax compliance, according to local tax requirements.
Always have a written contractual agreement in place when hiring an independent contractor
A written contractual agreement (or simply contract) between both parties doesn't trump IRS regulations, and you can still be penalized if you misclassify an employee. However, you can protect yourself in different ways and create a stable, mutually beneficial relationship.
We have already mentioned that your written agreement should hold your payee accountable for complying with local laws and regulations, regarding taxes, as well as everything else. What else should you include?
This written contract isn't that different from a typical employment contract. First of all, your written agreement should include general information about the scope of services. It should also include a level of control, deadlines, and other obligations to be met, and in the end, a manner of compensation.
You should also clearly state who owns the work produced by the contractor. According to US laws, copyrights stay with contractors, unless it is stated otherwise. This can cause a significant setback for your company when you terminate a relationship with your contractor.
