3 Questions that Define Reporting and Withholding Obligations
Most U.S. businesses understand that payments to U.S. contractors trigger reporting obligations at the end of the year. Once the amount paid to a contractor crosses certain thresholds, a Form 1099 is prepared and sent both to the business that performed the services and to the IRS. As the economy has become more global and work can easily be performed virtually from around the world, some U.S. businesses have been slow to realize that payments to foreign contractors may trigger similar reporting obligations.
It’s important to note that payments to foreign contractors may trigger reporting and withholding obligations on the part of the U.S. payor—but not in all cases. The reporting and withholding requirements on the U.S. payor depend on the answers to 3 questions.1. Is the payee a U.S. person or business?
It’s never safe to assume that a contractor is or is not a U.S. person. The Internet makes it easy for a business to create a virtual presence almost anywhere. The only safe way to determine whether or not the contractor is a U.S. person is to ask. If the contractor replies that the business is a U.S. business, most payors know to have that contractor fill out a Form W-9 to provide the information that will be used to report payments to the IRS.
If the contractor is not a U.S. business, the payor should require a Form W-8BEN-E (for entities) or Form W-8BEN (for individuals). Once the U.S. business receives this form, it does NOT forward it to the IRS. The U.S. payor simply maintains the form in its records. In the event of an audit, the form will substantiate why payments were not reported.2. Where did the payee perform the services?
If the U.S. payor has one of the Forms W-8BEN on file and the contractor performed all services outside of the U.S., it is likely that no reporting or withholding obligations exist regarding the payments made by the U.S. payor to the foreign contractor.
If the foreign contractor performed some or all of the work related to the contract in the U.S., the payor may have a reporting and withholding requirement related to those payments.3. If the payee performed services in U.S., what does the payor do?
If the foreign contractor did some or all of the work related to the contract in the U.S., the payor has additional obligations under IRS rules. Typically, the U.S. payor will have to report the payments related to the U.S.-sourced work to the IRS on a Form 1042. The payor is expected to not only report the amounts paid to non-U.S. contractors for work done in the U.S. but also to withhold U.S. taxes (typically 30%) from those payments. Note, the 30% rate could potentially be reduced if the payments are made to a country with which the U.S. has a treaty. Like other withholding requirements, failure to comply with them can subject the U.S. payor to penalties and interest. Failure to withhold also could entitle the IRS to go after the payor for the amount of tax that should have been withheld. Depending on the amount of U.S.-sourced work a company pays foreign contractors to perform, failure to properly withhold can quickly snowball into a significant tax obligation.
We’ve provided a quick overview here of the rules that apply when U.S.-based businesses make payments to foreign contractors. If your business engages contractors who may be based outside of the United States, it’s important to consult with a professional who is familiar with the details of the reporting and withholding rules. Contact us for help navigating complex U.S. and international tax rules.
State Revenue Needs Create Opportunities and Pitfalls for Foreign Companies Doing Business in the United States
States need money. If you remember nothing else about state and local taxes in the United States, remember that. Each state has some type of obligation or demand that requires revenue and the elected officials in that state know that their jobs are at risk if they propose a tax rate increase. Once you take tax increases off the table, there are only a few options available to increase state revenue.
Two of those options should be of particular interest to foreign companies that do business in the U.S. The first is to create incentives designed to draw new business into the state. The second is to interpret existing tax rules more broadly and enforce them more stringently.
The Carrot—State Incentives
States want your business. Almost every state offers some type of program that provides incentives for companies to begin or augment operations there. Incentive programs include items like credits for hiring and property tax credits on real estate purchased.
To participate in these programs, you must plan ahead. Many incentives are available only before you start doing business in a state or before your activity in the state crosses certain thresholds. Unfortunately, there is no uniform system of state taxation or state incentives. As a result, most businesses looking to build operations in the U.S. should work closely with a U.S.-based accountant who is experienced in state and local tax incentives.
The Stick—State Enforcement
The driving force behind state taxation is the concept of “nexus,” or the extent of a business’ connection to a state. Until recently, states focused on an analysis of 3 criteria to measure the presence of a business within their borders: sales, property, and payroll. Today, states focus much more on the gross receipts a business generates within the state. This shift has left many companies surprised by a tax liability that they never knew existed until they were notified by the state. Many multi-national businesses that start operations in the U.S. will conduct activities that trigger filing and tax obligations in individual states before they reach any threshold that requires a federal filing.
For foreign companies with existing U.S. operations, a nexus study can provide some comfort that current activities have not triggered state or local obligations, or it can provide a valuable heads-up that a filing or tax obligation has been missed. States have shown a willingness to work with businesses that voluntarily disclose that they have failed to meet a requirement. As long as there’s no reason to suspect a willful failure to comply, a state may reduce the number of back years a company is required to file and waive some or all of the penalties that have accrued.
The complex requirements of each state’s system demand meticulous attention to detail from the businesses that would operate within its borders. Advance planning can help your business qualify for significant incentives that could reduce the cost of operating in a state and reduce the costs of getting your business compliant. Whether your business is planning new operations within a state or trying to bring existing operations into compliance with state laws, it’s important to work with an advisor who understands the unique rules of each state.
Top 100 CPA firm Freed Maxick supports international business’ expansion into the U.S. Contact us to learn about how we can help you avoid the pitfalls while realizing the benefits of doing business in New York or another U.S. state.
4 Reasons Why You Should Consider a “C” Corporation
The United States economy represents the pot of gold at the end of the rainbow for many businesses around the world. Its citizens and businesses consume trillions of dollars in products and services.
If you’re planning for growth into the U.S. or you’re already operating there, you should consider whether an American subsidiary makes sense for your business. When U.S. operations have grown to a point that justifies creating a subsidiary in-country, there are four good reasons why most businesses choose to form a type of entity known as the Subchapter “C” corporation.
- Protection from liability. One downside of operating in the U.S. is the litigious nature of its residents. The creation of a corporate entity in the States helps to protect the foreign parent from many of the “slings and arrows” directed at commercial enterprises in the country.
- Financing. If your plans include getting loans from a U.S. bank, you will almost certainly need a U.S. subsidiary. Financial institutions in the states rarely lend to foreign businesses. Formalizing your presence in the country opens doors to financing options not available to businesses based outside its borders. As noted above, forming your U.S. business as a corporation also provides protection for your non-U.S. interests if the business has difficulty repaying the loans.
- Returning capital to the foreign parent. Some argue that forming a pass-through entity in the U.S. avoids the double taxation that occurs when corporations are taxed once on earnings and shareholders are taxed again on distributed earnings. A corporation can manage this obligation through careful planning. The parent can provide loans to the subsidiary or perform back office support and other business functions. Payments made for such things serve the dual purpose of returning money to the parent and reducing the subsidiary’s taxable income.
- Tax impact to the parent. Multinational businesses are required to create transfer-pricing plans that set prices for inter-company transactions. Those transactions must be made “at arm’s length” to comply with the various countries’ transfer-pricing laws, and the more formal structure of a corporate subsidiary makes that standard easier to achieve.
While planning to create a U.S. subsidiary, seek out business advisors in your home country and in the states who are familiar with creating multi-national parent/subsidiary relationships.
They need to coordinate on the project to make sure that the new organization is structured in a way that maximizes efficiency, observes the rules of both countries, and makes every legal effort to minimize taxes and fees.
Once you’ve determined what type of subsidiary to form, the next question to answer is, “Where in the U.S. should you form it?” We’ll look at some of the considerations at the U.S. state and local level in a future post.
Top 100 CPA firm Freed Maxick can help you navigate the complexity of doing business in the U.S. Learn more here.