Foreign Contractor Payments: Records That Prove the Deduction

Is hiring foreign contractors tax deductible?

Often yes. A business may deduct the ordinary and necessary expenses it pays or incurs to carry on its trade or business, including reasonable pay for personal services actually rendered (26 USC 162). That rule does not turn on where the worker lives, with one exception below. Some costs are capitalized instead of deducted when paid: work that creates or improves a business asset (26 USC 263) and costs paid before the business opens (26 USC 195). An ordinary expense is common and accepted in your field; a necessary one is helpful and appropriate (Publication 583).

The exception is research done outside the US, which includes software development. Those costs are capitalized and deducted ratably over 15 years, starting at the midpoint of the tax year they are paid or incurred, instead of all at once (26 USC 174). The IRS's interim guidance, which regulations may replace, looks to where the work is performed and counts Puerto Rico and US possessions as inside the US (Notice 2023-63). A well-documented invoice for new code written abroad is therefore not deductible in full when paid. See deducting software development done abroad.

The deduction still needs proof. Substantiating what a return claims is called the burden of proof, and it falls on the taxpayer (IRS: Recordkeeping). Information returns and withholding are a separate duty with their own rules: see paying contractors abroad.

A case is not simple if:

• payments ran for years with no contract, invoice or statement;
• a platform moved the money, so your bank statement names the platform, not the person who did the work;
• the money went out in cash, from a personal account or through a payment app, or the worker is a relative or a company you own;
• no tax form was collected or filed for the people paid abroad;
• one contractor works like staff;
• the work is software development done outside the US;
• an IRS letter already asks for support;
• the person or place may be covered by US sanctions.

Gather first: contracts or written scopes, invoices and platform exports, bank, wire and card statements, the delivered work and the emails around it, and a note of where each person worked.

What documents prove the expense if I am audited?

Books that record the payment, backed by documents that show the amount paid and that it was for the business. Federal rules require records sufficient to establish your deductions (26 CFR 1.6001-1), and the law requires no special kind of record except in a few cases (IRS: Recordkeeping). Publication 583 says documents for an expense should show the amount paid and that it was a business expense. It lists invoices, account statements and canceled checks, and it says proof of payment alone does not establish the deduction (Publication 583).

Keep one file per contractor so every point has a document:

For an electronic transfer, Publication 583 says the statement must show the amount, the payee's name and the date the transfer posted. How long to keep the file is in how long to keep business records.

Do I keep the platform's invoice and statement or the freelancer's own invoice?

Keep both when you have both. The IRS names no single required document (Publication 583), so keep what the platform or the freelancer actually issued to you, with the payment record that matches it. Which one carries the weight depends on who your contract is with. Read the platform's or agency's terms to see.

Your bank or card statement names the platform as payee, not the freelancer. It proves the payment but not who did the work. Download platform invoices and statements every month: records that sit only inside an account can be lost if the account closes or access ends.

How do I book payments made through a freelance platform, and do I list the names of those ultimately paid?

Book the payment as the cost of the work it bought, by freelancer or engagement, not as one lump platform expense, and keep each freelancer's name on the line. Paying through a platform changes who appears on the bank statement, not what the cost is.

1. Tie the charge on your bank or card statement to the platform statement for the same period. The totals should match.
2. Split the charge into one line per freelancer or contract, plus a separate line for any platform fee. A fee is the cost of using the platform, not pay for the work.
3. Book each pay line by type of work (next section). Record the freelancer's name, country and contract in the memo or vendor record.
4. File the platform statement and invoices with the bank record.

Keep each person's name on the line: it answers who did the work if anyone asks. Whether a form goes to that person depends on how the platform pays and where the work was done: see which contractors get a tax form and paying contractors abroad.

Where do foreign contractor payments go: contract labor, professional fees or cost of goods sold?

By the kind of work. The payee's country matters only for software development and other research, the last row. Four categories cover most cases, and the first three assume routine operating work, not research or capital work. An invoice can mix them: keep the tasks and amounts separate.

Schedule C line 11 covers payments to people you do not treat as employees for services performed for your business. It leaves out contract labor deducted elsewhere, so each payment is counted once (Instructions for Schedule C). Line 17 is for fees charged by accountants and attorneys that are directly related to operating the business; legal fees to acquire a business asset usually are not deducted but added to its basis (Publication 334). Outside the last row, a developer or designer is generally contract labor even if the books name the account "professional fees".

Forms 1120, 1120-S and 1065 have no contract labor line. Their instructions say to attach a statement listing by type and amount each allowable deduction not claimed elsewhere (Form 1120; Form 1120-S; Form 1065). Keep contract labor as its own account in the books so the statement can show it.

Cost of goods sold is narrower. Publication 334 says labor costs are usually part of cost of goods sold only in a manufacturing or mining business (Publication 334). Corporations and partnerships attach Form 1125-A when they claim it (Form 1125-A). For a service business, see cost of goods sold for a service business.

What do I record about where and how the work was done?

The country, city or region and dates where each person worked, the task, and who directed it. Each entry answers a question that comes up later.

Keep the log as the work happens, as a monthly note in the contractor's file.

How do I record a payment sent in another currency?

In US dollars. Returns are in dollars, and for most US businesses each foreign-currency item is translated at the exchange rate prevailing when it is paid or accrued (IRS: Foreign currency and currency exchange rates).

If the invoice is in dollars, record that amount. For an invoice in another currency, convert it at the rate on the day you pay it, or on the day you accrue it if you book bills before paying them. A difference from what the bank charged is a bank or exchange fee, or, for a bill you accrued first, a currency gain or loss (26 USC 988). On the line, keep the invoice amount and currency, the rate and where you got it, and the dollar amount. Bank fees on a wire are bank charges, not contractor pay. Which rate source to use and the entry are in expenses paid in foreign currency.

What if the contractor never sent an invoice?

You can still support the payment, but build the file now. An invoice is not the only proof: the law requires no special kind of record, and the test is whether documents show the amount paid and that it was for the business (Publication 583).

1. Ask the contractor for an invoice that describes the work and the dates. Keep the request and the reply, and record the date you received it. Never date it earlier.
2. Pull the payment record: the wire confirmation or statement line with the payee's name, amount and date.
3. Keep the delivered work and the emails that set up and accepted it.
4. If no invoice comes, write a dated memo: who, what work, when, how much, how paid, and where the proof is. Mark it as written later by you.

Payments with none of this for years are in "Different for you?" below. A lost receipt is covered in lost receipts for business expenses.

When does a long-term freelancer look like an employee in my records?

When the records show you control what the person does and how, pay on a fixed pattern, and the relationship is open-ended and central to the business. The IRS weighs three groups of facts, behavioral, financial and type of relationship, and no single factor decides. A person working remotely is an employee under the common-law rules (the IRS's usual test) if you can control what is done and how, even if the worker chooses to work remotely (IRS: Independent contractor or employee).

If you treat an employee as a contractor and have no reasonable basis for it, you may be liable for employment taxes for that worker. With a reasonable basis, relief also requires that you filed the required information returns consistently with your treatment of the worker (IRS: Independent contractor or employee). US social security and Medicare tax covers work done in the US and, abroad, only a US citizen's or resident's work for an American employer (26 USC 3121(b)). The law of the worker's country is a separate question. See contractors who may be employees and hiring employees abroad for a US startup.

Should I check sanctions before I pay someone abroad?

Yes, as good practice: before the first payment and again from time to time. The duty behind it is the law: US sanctions apply to every US person, including US-incorporated businesses and their foreign branches (OFAC FAQ 11).

Two kinds of rule matter. Some programs broadly prohibit most transactions involving a country or region. Others block named people and companies on OFAC's List of Specially Designated Nationals and Blocked Persons (the SDN List), and US persons may not deal with them wherever they are (OFAC FAQs). A company owned 50% or more, directly or indirectly and in total, by blocked persons is itself blocked, even if its name is not on the list (OFAC FAQ 401).

1. Search the contractor's name, and the company name if there is one, in OFAC's Sanctions List Search tool.
2. Check where the contractor works, down to city or region, against OFAC's list of sanctions programs. Some programs cover a region inside a country, so a country name alone may not be enough.
3. Save a dated copy of the result in the contractor's file. OFAC says sanctions programs may change frequently and that it is important to check its website regularly, so repeat the search later.
4. If a name or place matches, do not pay until the match is cleared. The search tool uses fuzzy matching, so a hit may be a false match, but dealing with a blocked person's property is prohibited. Get sanctions advice or ask OFAC.

Example

These examples are illustrative and use US dollars.

Three freelancers through a platform

A sole proprietor pays three freelancers in the Philippines, Ukraine and Brazil US$18,000 for the year through a freelance platform: US$8,000, US$6,000 and US$4,000. The card statement names only the platform. Each month the owner matches the card charge to the platform statement and splits it into one line per freelancer. The US$600 of platform fees for the year is booked separately. Each freelancer's file holds the contract, the platform invoices and the delivered files. All three do routine services, with no research, software or capital work, so the US$18,000 goes to contract labor on Schedule C, line 11.

A developer paid by wire with no invoice

A corporation wires US$5,000 to a developer in Poland. There is no invoice. The owner asks for one that describes the work and its dates, files it with the date received, and keeps the wire confirmation, the delivered code and the scoping emails. The owner logs the country and dates, runs the developer's name through the OFAC search tool and saves the result. Because the developer is writing new code outside the US, section 174 may apply: the cost would then be capitalized and amortized over 15 years instead of booked as contract labor. Otherwise it is contract labor, listed by type and amount on the statement of other deductions.

A bookkeeper abroad who works like staff

A corporation pays a bookkeeper in Kenya US$5,000 a month, US$60,000 a year, for three years. The file shows fixed weekly hours, company email and software accounts, the same amount every month and no invoices. These records point toward employment under the IRS groups above, in each of the three years. The owner reviews classification now. If the bookkeeper is not a US citizen or resident, US social security and Medicare tax does not apply to work done in Kenya, and Kenya's rules are a separate question.

Different for you?

• Payments abroad ran for years with no contracts, invoices or statements: which records can be rebuilt, and how earlier years should be categorized, are judgment calls. Start with rebuilding books from bank statements and get help rebuilding the records.
• You paid in cash, from a personal account or through a payment app, or paid a relative: the payment record and the proof of real work are both harder to show. Read paying subcontractors in cash and bring what exists to get the records sorted.
• An IRS letter or audit asks for support: the response date on the letter controls. Read IRS audit of a small business and get help assembling the file.
• One contractor works like staff: see contractors who may be employees and bring the contract, payment history and work log to have the records reviewed.
• Forms for earlier years were missed: see late contractor and employee tax forms, and bring the payment history to bookkeeping help.
• You pay developers or researchers abroad: the log of where each task was done is what the 15-year rule turns on, and how earlier years were treated is a return question. Read deducting software development done abroad and bring the contracts and work log to have the costs organized by task and place.
• You need the W-8, 1099 or withholding answer: read paying contractors abroad.
• Receipts or invoices are lost: see lost receipts for business expenses.
• A search shows a possible sanctions match: pause the payment. Whether it is a real match is a sanctions question, not a bookkeeping one; start from OFAC's sanctions programs page.