Reporting Payments to Foreign Contractors
This article will review the process of reporting for tax purposes payments made to independent contractors who are not U.S. Persons for Tax Purposes. Due to changes in the tax code in 2018, it is now much more likely that payments to foreign contractors will be subject to backup withholdings due to the elimination of the $4k Personal Exemption, which foreign individuals are no longer able to claim. Below is the process for determining backup withholdings and filing the appropriate taxes. For more information about paying foreign individuals, see IRS Publication 515.
What is a "U.S. Person for Tax Purposes"?
Generally speaking, a U.S. Person for Tax Purposes is someone who is clearly subject to U.S. tax. If an independent contractor is a U.S. citizen or otherwise authorized to work in the U.S. and successfully completes an IRS Form W-9, it is likely that they are a U.S. Person for Tax Purposes, and can be issued a 1099 to report their payments at the end of the year. If these conditions do not apply, the contractor is considered a "foreign contractor," and you'll need to follow the instructions in this article to report annual payments.
How do I know?
Usually, a Member will tell us if they are planning to pay someone who is a foreign contractor. Sometimes, the contractor themselves will alert us when they receive a request to process a Form W-9 (which they cannot complete without a US Tax ID).
Calculating Backup Withholdings
Whenever a Member requests a payment to a contractor who is not a US Person for Tax Purposes, the Financial Operations Lead should request a W8-BEN, and add the Financial Maintenance Lead to the task.
The Financial Maintenance Lead will then explain to the Member that payments for work that took place on US Soil are subject to 30% in backup withholdings. The FML should ask the Member to estimate what percentage of the fee is for work performed on US soil, and then use that to calculate the withholdings.
The FML will also encourage the Member to recommend to the Contractor that they speak with their accountant to determine if they may be eligible for a lower withholding rate due to a tax treaty between their country and the US. If that is the case, they need to note that in Part II of the W8-BEN. If the contractor isn’t sure, it’s safest to withhold at the 30% rate, since the contractor can always file for a tax refund. If the IRS determines that the Member has under-withheld, the Member will be liable for paying any outstanding tax owed. (Also, when making this recommendation to the Member, always note that ArtsPool cannot provide tax advice.)
NOTE: Foreign contractors delivering work outside the United States are NOT subject to backup withholdings. The FOL should still collect a W8-BEN to have on file, confirming the contractor is a foreign citizen, but we will not need to issue any tax forms at the end of the year.
Once the FML has calculated the withholdings, taking into account any special withholding rates noted in Part II of the W8-BEN, the FML will set up the bill coding the full amount of the fee to the appropriate Professional Fees line, and coding the deduction to Payroll Taxes Payable. When the bill is approved, the FML will add the FOL to the task to make the payment.
Members who deduct backup withholdings need to pay those taxes to the IRS using the Electronic Federal Tax Payment System (EFTPS). If the member does not have an EFTPS account, follow the enrollment instructions in collaboration with the member. Please note that it can take several weeks to complete this process due to the requirement that the PIN must be mailed in hard copy to the member.
Once logged in, complete the following steps:
- Tax Form Selection: enter or select form 1042 W/H US Source of Income Foreign Person.
- Select Federal Tax Deposit
- Enter the Payment Amount, Tax Year and Settlement Date (to be no later than the quarterly due date)
- On the screen that requests your Global Intermediary Identification (GIIN) Number, enter one if you have it, otherwise click next without entering it.
- GIIN Numbers are not relevant to US corporations. Foreign corporations must register with FATCA to get a GIIN number before collecting and paying backup withholdings.
- Make Payment
- Print to PDF or take screenshot of the payment confirmation and upload it to the bill task in the ArtsPool App, noting “proof of payment attached in documents tab.”
- FMT should then pay the bill in Xero by clicking into the invoice and using the “Make a Payment” section at the bottom of the page, selecting the current date of payment, the member’s checking account used to pay the bill, and noting in the reference “online payment.”
If you receive a message indicating that your member has not enrolled for the tax form, hit continue to override, taxes will be reconciled at time of tax filings.
The deadlines to make these filings depend on the amount withheld, per the 2018 1042 instructions (below copied directly from the Deposit Requirements section):
- If at the end of any quarter-monthly period the total amount of undeposited taxes is $2,000 or more, you must deposit the taxes within 3 business days after the end of the quarter-monthly period. (A quarter-monthly period ends on the 7th, 15th, 22nd, and last day of the month.) A business day is any day other than a Saturday, Sunday, or legal holiday in the District of Columbia.
- If at the end of any month, the total amount of undeposited taxes is at least $200 but less than $2,000, you must deposit the taxes within 15 days after the end of the month. If you make a deposit of $2,000 or more during any month except December under rule 1, earlier, carry over any end-of-the-month balance of less than $2,000 to the next month. If you make a deposit of $2,000 or more during December, any end-of-December balance of less than $2,000 should be remitted with your Form 1042 by March 15, 2019.
- If at the end of a calendar year the total amount of undeposited taxes is less than $200, you may either pay the taxes with your Form 1042 or deposit the entire amount by March 15, 2019.
At the end of the year
Send the following to ArtsPool's accountant to confirm what year-end reporting is required:
- What is the person's country of citizenship?
- What is the person's country of residence?
- Was any of the work be performed in the U.S.? If so, how much (percentage)?
- What country other than the U.S. (if any) was any of the work performed?
- How much was the person paid?
- What amount was withheld and paid to the IRS?
ArtsPool's accountant will confirm which annual form (if any) should be used to report these payments (usually a 1042-S.) Instructions for the 1042-S (and other forms) vary from year to year, and should be reviewed directly from the IRS as needed. Track 1099 is able to process the 1042-S, but it cannot be imported from Xero. You must select the 1042-S form and manually enter the data. Note that if there are any fields or drop-down menus in Track 1099 about which you are uncertain, confirm the data with ArtsPool's accountant prior to submitting the form.
As with 1099s, choose postal mail delivery (so exclude any email address from the record) and be sure to report to the IRS through Track1099 as well.