Services from non-US vendors: when Form W-8 isn’t the correct documentation
Published: July 19, 2022
Navigating IRS withholding and reporting on services income (Form 8233, Form W-8, Form W-4, Form W-2, and Form 1042-S)
When executing a health check project, one of the most common issues I see faced by the vendor payments team (also called accounts payable) is understanding IRS Form 8233 and when it must be collected. The language used by the IRS can be confusing, so I developed a simple table below to aide in the discussion and assess exposure. This table is a simplified way to look at the different payment flows but does not contemplate every possible outcome. This is high level, generic, and should be applied to each unique set of circumstances with caution.
So what’s the problem?
As you can see in the table, if a vendor is performing independent personal services (i.e. as a sole trader) inside of the United States then a Form W-8BEN is insufficient to achieve a 0% rate of tax withholding. This risk is amplified by the IRS position that when the payer of income does not have knowledge of the source then they must assume (default) that it is United States source income (i.e. that the services were performed inside of the United States). Form 8233 is also not something you can just email your vendor and have them send over quickly: it requires them to provide thoughtful entries about the various types of income they will earn throughout the year and once the payer (also called the withholding agent) receives it, then they must review it, sign it, and mail a copy to the IRS. The withholding agent must then wait 10 days after mailing the Form 8233 before releasing the payment at the reduce tax withholding rate.
Notes on table
This table is a simplified way to look at the different payment flows but does not contemplate every possible outcome. This is high level, generic, and should be applied to each unique set of circumstances with caution.
Box 5 on Form 1042-S is for “Withholding Allowances” which no longer exist. In prior years, IRS Form W-4 and IRS Form 8233 contained sections for Non-Resident Aliens (an IRS term for non-US payees) to claim a withholding allowance deduction, which was a small personal exemption available to them. The IRS restructured the personal exemption system a few years ago and completely removed it, replacing it with a higher Standard Deduction. Non-Resident Aliens (“NRAs”) were previously allowed to take a withholding allowance deduction related to these personal exemptions but generally cannot avail of any Standard Deduction. In these prior years, withholding agents would report in Box 5 the amount of the withholding allowance claimed by NRA recipients on payments for personal services (amongst others), which was then deducted from the gross income in Box 2, with the net taxable and withholdable amount reported in Box 6. In cases where no withholding allowance was available, Box 5 would be left blank, Box 6 would be left blank, and the withholding agent would calculate the withholding based on the gross income in Box 2.
Exemptions under the tax treaties are summarized in the IRS tables at https://www.irs.gov/pub/irs-utl/Tax_Treaty_Table_2.pdf. Some treaties may not have a section for Independent Personal Services and may instead be found under the section for Business Profits.
NRAs must have a Social Security Number (“SSN”) in order to complete a Form W-4. They cannot use an Individual Taxpayer Identification Number (“ITIN”). If the NRA does not have an SSN, then they must obtain one. In the case that they are not eligible for an SSN, then they would be subject to the highest rates of tax applicable. If there is an exemption that applies under a treaty, then this is always the preferable method (0% vs graduated rates) and does not require an SSN when completing the Form 8233. In order to use an ITIN on Form 8233, the NRA must provide proof that their application for an SSN was rejected.
In the case of an employee receiving a payment that is “dependent personal services” income, they should only be giving this documentation to and receiving year-end tax forms from the employer themselves. It is not expected that this situation should arise in a vendor payments fact pattern. In the case of a non-employee receiving a payment that is “independent personal services” income, the party requesting documentation and issuing the year-end tax forms should be the company doing business with them through a vendor payments relationship / fact pattern. Where the vendor payments contract is with a foreign company whose staff perform services in the United States, the documentation requested and year-end tax forms issued should relate to the business entity.
What now?
Some steps to take could include:
Discuss Form 8233 with your vendor payments teams to assess their knowledge of the Form and the scenarios in which they may be required to collect it.
If you determine that the vendor payments teams were not previously familiar with Form 8233, then review and assess historic payments for any risk exposure to the performance of services inside of the United States.
Review if vendors provide invoice-by-invoice confirmation regarding the location of where they perform their services.
Conflicting information checks: review expense reimbursement reports from vendors to see if any meals / flights / hotels show up inside of the United States which may indicate that some or all of the services were performed inside of the United States.
Review vendor policies and vendor contract templates to see what language is present about restrictions on performing services inside of the United States.
Ensure processes are in place for ongoing monitoring of Form 8233 scenarios well in advance of the invoice payment date.
Start documenting existing and new vendors correctly and holding future payments where not properly documented. Assess if retroactive documentation can be applied to past payments.
Further resources
IRS Form W-4 and Instructions
IRS Notice 1392
IRS Form 8233, Form W-8s, and related Instructions
IRS Form 1042-S and Instructions
IRS Publication 515
IRS Publication 519
IRS Publication 15
IRS Publication 15-T
How can Dune Consultants help?
We can help you in all aspects of implementation and advise your organisation in all of the topics discussed here. Contact us today to discuss at info@duneconsultants.com.
