If you are a US-based entrepreneur or a startup looking for outsourcing projects to an offshore company, it is very common to have concerns regarding any tax implications that can occur in the process.
Many companies provide services in various sectors like logistics, automobiles, pharmaceuticals, e-commerce, real estate, business processing management, etc. When it comes to outsourcing software projects for these sectors, it can also vary.
These projects include websites, educational portals, productivity apps, or projects that target eCommerce services like a multi-vendor marketplace or projects that solve complex problems like location-based instant delivery systems, chatbot software that simulates conversations with human users, etc.
In most cases, companies will either hire a team of expert developers or ask a local development agency for outsourcing their work. By outsourcing projects, companies can save a lot of your time.
Outsourcing is a way that enables enterprise companies to share any types of business operations with external vendors or offshore outsourcing companies. The benefits of these outsourcing solutions can be either long-term or short-term.
The major advantage of outsourcing to an offshore company is that you will get your job done at an affordable rate with high quality. It helps you to focus on major activities of your company and it can improve the management skills and productivity of your firm.
Tax Implications in the USA for outsourcing work overseas
If your organization is situated in the United States, you are allowed to outsource any services that entail the creation of Non-Physical Assets (intangible assets) or the development of software projects.
However, before outsourcing any software development projects, several implications must be considered.
US firms, whether they generate money in the US or from a foreign entity, must pay a 35% tax. If the corporation’s gains from other nations do not return to the United States, it is not required to pay US taxes on the matter.
Individual (employee) taxes and corporation taxes are the two types of taxes.
However, as proof of an individual’s or company’s non-US tax status, you must hold a document known as W-8BEN or W-8BEN-E in either case
In case of not collecting this withholding certificate, you may be compelled to withholding taxes on the gross amount of payments imposed by the company for their services. Let’s check two cases.
1. You’re paying for a foreign person directly
When you submit a 1042 form, and you can withhold a 30% amount unless the person provides you a W8 and tax id.
2. You’re paying for a Non-U.S person living outside the country
In the case of a non-U.S. person, the income he makes from a U.S. company or service provider doesn’t qualify the “U.S. source income” as per the IRS rule. So, here you don’t need to worry about withholding or providing tax forms for U.S. taxes.
Tax on Outsourcing Software Projects: General Rules
According to the rule, a person who makes payment U.S. source income to a foreign person must withhold the proper tax amount.
The U.S. tax code called Foreign Tax Credit allows American based companies to take away the amount they have paid for foreign countries.
The advantage of outsourcing to a country like India is that India has a great pool of engineers and also other resources at affordable rates.
Consider that the company is American based and has a branch in India, and they are paying foreign taxes to the IRS, then the main branch can deduct the amount while they pay in America.
See what are the things to consider to start an offshore development center.
What is the Purpose of an IRS W-9 Form?
IRS Form W-9 is for individuals or one who owns a business when they are working as a freelancer or independent contractor. It is required for a company or associations that organized under U.S. laws.
You need to request vendors to fill out the W-9 form so that you can prepare your 1099-MISC form to report the payments you make to them. It is your responsibility to get a W-9 form from the contractor and keep a copy of it. And it’s not necessary to send the form to the IRS.
If you are an independent contractor and you fill out a W-9 form before working for a company, here you are not considered as an employee.
The differences between an independent contractor and an employee are precise. But independent contractors have more control over the task completion, with no benefits like employees do.
When you have sent a W-9 form to the client, in the future, you may get a 1099 tax form from the person or company that pays to you, and it only reports your gross payments. This is similar to the W-2 form of an employee.
In 1099 you had to include all your gross income since it becomes taxable like an employee’s wage. If you fail to report the income and pay tax, you may receive a lot of penalties, and it will increase your owe amount.
Software Outsourcing Tax- Conclusion
So after hearing the experts’ advice and making some necessary evaluations, we can safely conclude that legally you don’t have to report taxes in the USA.
Outsourcing to an American based company can reduce many tax implications and also makes the development cost affordable and effective.
In Armia Systems, our major verticals are automotive, business services, eCommerce, education, food & beverage, marketplaces, social networking, transportation, and logistics, etc.
Our domain expertise is in mobile/web development cloud services, quality assurance, IoT, etc. And we have experts in technologies like Android, Angular, Cloud, iOS, MongoDB, NodeJS, PHP (LAMP), React Native, Ruby on Rails, etc.
Armia Systems is a U.S. based company with our own offshore development center. So you can engage us for any services or development of your software projects without worrying about international tax laws.