Tax5 min read
When your US company pays someone abroad, you may be the tax collector
Most founders learn about withholding when they receive it. The larger risk runs the other way: as a payer, an amount you failed to withhold becomes your own liability, not the recipient's.
You run a US company. You pay a designer in Argentina, a licence fee to a developer in Poland, interest on a loan from a shareholder abroad, and a dividend to yourself in Portugal. Four payments to non-US persons, and US law treats them in three completely different ways.
The asymmetry that makes this worth reading: withholding is the payer's obligation and the payer's liability. If you should have withheld and did not, the IRS collects the tax from you, plus interest and penalties, and your only remedy is against a contractor abroad who has already spent it.
Step one, and it settles most cases: is the payment US-source?
Withholding under this regime applies only to US-source income of a foreign person. Foreign-source income is outside it entirely, and for the typical founder that is the answer to most of the list.
| Payment | Source rule | Withholding? |
|---|---|---|
| Services performed outside the US by a foreign contractor | Sourced where the services are performed — foreign-source | No. No withholding, and no Form 1042-S |
| Services performed inside the US by a foreign contractor | US-source, apportioned by days worked in the US | Yes, generally 30% unless a treaty or an exemption applies |
| Royalties for the use of property in the US | Sourced where the property is used | Yes, 30% unless reduced by treaty — frequently to 0% |
| Interest paid by a US company | Generally US-source | Yes, unless the portfolio interest exemption or a treaty applies |
| Dividends paid by a US corporation | US-source | Yes, 30% unless reduced by treaty |
| Rent for US property | US-source | Yes, on gross rent unless a net-basis election is made |
| Purchase of goods from a foreign supplier | Sale of goods, not FDAP | No |
The three forms
- Form 1042-S — one per recipient, per income type, per rate. It reports the gross amount, the income code, the exemption or treaty code, and the tax withheld. Copies go to the IRS and to the recipient.
- Form 1042 — the annual return of the withholding agent, reconciling everything withheld and deposited for the year.
- Form 1042-T — the paper transmittal that accompanies paper 1042-S forms. Electronic filers do not use it, and electronic filing thresholds have tightened considerably.
These are due in mid-March for the preceding calendar year, and the deposit obligation is separate and earlier — withheld tax has its own deposit schedule during the year, not a single payment at filing.
Getting the treaty rate applied
Reduced rates are not automatic and they are not yours to assume. As payer, you may apply a reduced rate only if you hold a valid W-8BEN or W-8BEN-E from the recipient before the payment, containing a completed treaty claim including the limitation-on-benefits box. The form, line by line.
Absent a valid form, the rule is simple and unforgiving: presume the payee is foreign and withhold 30%. Collecting the form afterwards does not retroactively fix a payment already made gross.
What goes wrong
- Paying gross with no W-8 on file. The defence to a withholding assessment is documentary. No document, no defence — even if the payment turns out to have been foreign-source.
- Treating a foreign contractor like a US one. A 1099-NEC issued to a non-US person is the wrong form and signals to the IRS that you have misclassified the relationship.
- Missing the US-days problem. A contractor who flies in for two weeks of onsite work has created US-source income for that portion. It is small, it is real, and nobody tracks it.
- Interest to a shareholder. A loan from yourself, abroad, into your own US company generates US-source interest. The portfolio interest exemption often does not help a related party, and a treaty claim needs the same paperwork as everything else.
- Assuming a disregarded entity has no obligations. A single-member LLC is disregarded for income tax and is still a withholding agent. The obligation attaches to whoever controls the payment.
The other direction: what to do when it happens to you
If a US payer withholds 30% from you and you believe it should have been less, you have two routes. Fix the form and ask them to apply the correct rate to future payments — which they will usually do. Or file a US return claiming a refund of the over-withheld amount, which requires a US taxpayer identification number and a 1042-S in your hands, and takes a long time.
The second route is why the first matters. The economics of a refund claim rarely work below five figures, so the form has to be right before the first payment rather than after the first shortfall.
A short compliance routine
- Collect a W-8BEN or W-8BEN-E from every non-US payee before their first payment, without exception. Treat it as part of onboarding, alongside the contract.
- Record, per payee, where the services are performed. That single field decides the source question.
- Flag royalties, interest, rent and dividends separately from services. They are the categories that actually withhold.
- Diarise each W-8's expiry — end of the third calendar year after signing.
- If anything on the withholding list is being paid, put the 1042 filings on the compliance calendar alongside the 5472 and the state annual report.
One calendar for every filing the structure creates
Withholding returns, information returns and state filings tracked together, with the documents each one depends on collected before the deadline rather than after.
See the Business OSFounders 8 does not provide tax advice. Tax residency depends on facts and rules specific to each jurisdiction — review your position with a qualified adviser.