A Guide to Managing Contractor Payroll for Your International Organization

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In today's world, where outsourcing has become the norm, managing people around the globe can be very challenging. Today we talk about the process, outline pitfalls to avoid, and insights to take advantage of when managing independent contractor payroll for your organization.

What is an Independent Contractor?

Contractors are a flexible option for businesses that need to hire temporary staff to cover short-term projects. They are often employed by large international organizations, such as law firms because they can be deployed across multiple countries and regions. 

Contractors are typically hired for specific projects or assignments with a clear start and end date for the work. They may be paid hourly or on an annual salary basis but don't receive any benefits from their employer. If an employee meets all three criteria below, they are likely considered an independent contractor:

  • They perform services outside of the company's place of business. This could mean working from home or elsewhere in the community.
  • They provide the tools and equipment necessary to perform their work. This includes software and other technology needed to complete assignments (e.g., laptops).
  • They have control over when and where they work. They should be able to take breaks whenever needed without asking permission first.

The contractors are paid per hour or project and must file taxes as self-employed individuals. Your employees are a critical part of your organization's success, but you may still be uncertain about managing independent contractor payroll and taxes. The classification is important because it dictates how they're paid and how much you need to withhold from their paychecks.

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Repercussions of Misclassification

Employees are often misclassified as contractors. This may happen when employers want to avoid the administrative and financial burden of payroll and benefits that come with full-time employment. However, there are repercussions of misclassification that can cost your organization a lot of money. The IRS has laid down penalties of misclassification as bullet points:

  • If you fail to withhold and pay employment taxes on wages paid to an employee, you may be subject to a penalty equal to these unpaid amounts. The penalty is charged for each month or part of a month that you underpay employment taxes during the calendar year.
  • Suppose you willfully fail to withhold or pay employment taxes. In that case, the penalty is 100% of the amount not withheld or paid (determined without any information about whether or not such failure is due to reasonable cause).
  • Tax penalties for misclassifying employees as independent contractors are steep. If you're audited by the IRS and your company has misclassified workers, you could face fines of up to $1,100 per misclassified worker for each year that you've done it.
  • If your company is found to have misclassified workers, it could  be sued by employees who were improperly classified as independent contractors.

Independent Contractor Taxes

When you hire an independent contractor, you are responsible for paying them. The IRS also expects you to withhold and pay income taxes, social security taxes, and Medicare taxes on their behalf.

Form 1099 (US-based independent contractor taxes)

In the United States, independent contractors must pay self-employment taxes on any income they receive from their work as a contractor. You need to withhold income tax from each payment you make to them (similar to how employees' wages are taxed). You then forward this money along with your portion of FICA (Social Security) tax payments (15.3 percent) to the IRS monthly via the Electronic Federal Tax Payment System (EFTPS).

This form reports income from independent contractors whose clients have not issued a W-9 document. It reports income paid out during the year and must be issued by January 31st. The IRS requires employers who give more than $600 in payments to non-employees during one calendar year to provide them with this form.

Form 1099 (contractor paid through a third party)

If your company pays a contractor through a third party such as a payroll service or accounting firm, the third party will issue a Form 1099-MISC (Miscellaneous Income) at the end of the year. This form reports income paid to contractors who are not employees and will include any expenses reimbursed by the employer.

In Canada and the United States, payments made from one company to another are considered taxable income for both parties involved — even if they don't include payroll deductions or withholdings from their paychecks. If an individual is paid through a third-party agency or another intermediary (like an LLC), they may need to file their income tax return with their local government authority.

Form 1042 (non-US contractors)

Form 1042 is used for all nonresident alien contractors who do business in the United States and pay U.S.-source income. It is used by U.S. employers or payers (corporations or individuals) as part of their withholding obligation under U.S. tax law and international tax agreements (such as double taxation treaties).

The following information must be reported on Form 1042:

  • Name, address, TIN, and SSN or EIN (if applicable) of nonresident alien contractor
  • Amounts paid during the year (including bonuses, commissions, or other payments)

Form 1042 is an annual information return that you must file if you have withholding agents (such as a staffing agency) who withhold tax from nonresident alien employees. The form contains information about these employees and includes their Social Security numbers so that the IRS can match them with their W-2s.

Tips to Manage International Contractor Payroll

Independent Contractor Agreement

Ensure that you have an independent contractor agreement with each of your contractors. This will help you avoid issues with the IRS or other government agencies. You can find sample separate contractor agreements online, but make sure that the one you use complies with your country's laws and regulations.

Use Payroll Software  

If you have an international organization with multiple contractors, it is essential to use payroll software to manage their paychecks. The payroll software will keep track of all their earnings and deductions, which helps reduce errors and improve accuracy.

This software can also be used to withhold taxes from their paychecks so that you don't have to deal with collecting taxes from each contractor individually. If they are paid hourly, it can also calculate overtime hours automatically so that they don't have to do this themselves.

Hire a Payroll Service Provider  

If your organization has more than 20 employees, hiring a payroll service provider may be better than handling everything internally. Suppose you're not comfortable dealing with the complexities of managing international independent contractor payroll.

In that case, hiring a payroll service provider might be an option for you instead of hiring an accountant or lawyer specializing in this law area. If you hire an outsourced payroll service provider, they can do everything for you, including:    

  • Processing payments.
  • Keeping track of employee hours worked.
  • Calculating and issuing payments.

Employer of Record (EOR) 

The EOR is the entity that will pay your remote employees in other locations. It's highly essential to partner with a globally present EOR like Skuad, before hiring any employees. Your EOR services provider will take care of all employment and compliance matters, payroll setup and periodic payment of salaries.

This way, companies can save a lot of time in setting up their overseas entities and understanding the ever changing compliance requirements. Importantly, for the companies to focus on their core matters, they should partner with an EOR who will take over the employment legal liability and payroll processing for your remote employees.

Wrapping Up

Companies are hiring overseas workers to save money, increase profits, and even stay competitive. This guide serves as a starting point for international companies who want to take the next step into the global economy but who are daunted by the prospect of cross-border payments.

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