If there is no employee-employer relationship between you and the person for whom you perform services, your compensation is subject to the 30% (or lower treaty) rate of withholding. However, if you are engaged in a trade or business in the United States during the tax year, your compensation for personal services as an independent contractor (independent personal services) may be entirely or partly exempt from withholding if you reach an agreement with the Internal Revenue Service on the amount of withholding required by entering into a Central Withholding Agreement. Also, the final payment to you during the tax year for independent personal services may be entirely or partly exempt from withholding if you are engaged in a trade or business in the United States during the year and you file the forms and provide the information required by the IRS.
The final payment of compensation for independent personal services:
- may be completely or partially exempt from withholding at the statutory rate.
- does not apply to wages paid to an employee.
- must be paid to a nonresident alien who was engaged during the tax year in the conduct of a U.S. trade or business.
- is available only once during a nonresident alien individual's tax year.
- applies to the last payment of compensation, other than wages, for personal services rendered in the United States that the individual expects to receive from any withholding agent during the tax year.
Obtaining the Final Payment Exemption
To obtain the final payment exemption, the nonresident alien, or the alien's agent, must file the forms with the IRS and provide the information required by the Commissioner or his delegate. This information includes, but is not limited to, the following items:
- A statement by each withholding agent from whom amounts of gross income effectively connected with the conduct of a U.S. trade or business have been received by the alien individual during the tax year. It must show the amount of income paid and the amount of tax withheld. The withholding agent must sign each statement and include a declaration that it is made under penalties of perjury.
- A statement by the withholding agent from whom the final payment of compensation for personal services will be received showing the amount of final payment and the amount that would be withheld if a final payment exemption is not granted. The withholding agent must sign the statement and include a declaration that it is made under penalties of perjury.
- A statement by the individual that he or she does not intend to receive any other amounts of gross income effectively connected with the conduct of a U.S. trade or business during the current tax year.
- The amount of tax that has been withheld (or paid) under any other provision of the Code or regulations for any income effectively connected with the conduct of a U.S. trade or business during the current tax year.
- The amount of any outstanding tax liabilities, including any interest and penalties, from the current tax year or prior tax periods.
- The provision of any income tax treaty under which a partial or complete exemption from withholding may be claimed, the country of the individual's residence, and a statement of sufficient facts to justify an exemption under that treaty. The alien individual must provide the statement to the IRS, signed and verified by a declaration that it is made under the penalties of perjury, that all the information provided is true, and that to his or her knowledge no relevant information has been omitted.
If satisfied with the information provided, the Commissioner or his delegate will determine the amount of the nonresident alien individual's tentative income tax for the tax year on gross income effectively connected with the conduct of a U.S. trade or business. Ordinary and necessary business expenses may be taken into account if proved to the satisfaction of the Commissioner or his delegate.
The Commissioner or his delegate will provide the nonresident alien with a letter addressed to the withholding agent, stating the amount of the final payment of compensation for personal services that is exempt from withholding, and the amount that would otherwise be withheld that may be paid to the individual due to the exemption. The amount of pay exempt from withholding cannot be more than $5,000. The nonresident alien individual must give two copies of the letter to the withholding agent and must also attach a copy of the letter to his or her income tax return for the tax year for which the exemption is effective.