Hiring Abroad for a US Startup: EOR, Contractor or Subsidiary

Employer of record vs contractor vs subsidiary: what each means for US startup taxes

A US startup can hire someone abroad three ways: an employer of record (a provider abroad employs the person and invoices you), a contractor (you pay the person or their company for services), or your own entity in that country. On the US side, all three share one rule: pay for development done abroad is foreign research, spread over 15 years (Rev. Proc. 2025-28, section 2.03). The real differences are who employs the person, which US forms follow, and whether the foreign country can tax your company.

A case is not simple when the person sells or signs contracts, when they are a US citizen or green card holder, when you own a foreign entity, or when the country is Canada and payroll crosses the border. Gather the agreement, a written description of duties, the person's work location and days, who signs customer contracts, and every invoice or payment record.

Can a US company hire an employee in another country without an entity there?

US tax law does not stop a US company from employing someone abroad directly; the other country's law decides whether a foreign employer must register, withhold local tax and pay local social contributions there. On the US side, pay to a nonresident alien for services performed outside the US is not wages and is not subject to US withholding (Publication 515). US Social Security and Medicare cover services in the US, or services abroad by a US citizen or resident for an American employer (26 U.S.C. 3121(b)), so a foreign national working abroad is generally outside them.

Direct employment does not avoid the permanent establishment question below, and it puts local payroll duties on your company. For an employee in Canada, see hiring an employee across the border.

Can one employee or contractor abroad create a permanent establishment for our startup?

Yes, one person can be enough, depending on what the person does. The foreign country's law, limited by any income tax treaty with the US, decides whether your company has a taxable presence there; each treaty on the IRS treaty list has a permanent establishment article. The Canada treaty's Article V shows the two usual tests (treaty text):

1. A fixed place of business through which your company's business is wholly or partly carried on, such as an office or branch.
2. A dependent agent: a person acting for your company who has, and habitually exercises, authority to conclude contracts in its name. An agent of independent status acting in the ordinary course of its own business is excluded.

The Canada treaty excludes a place or person used solely for listed activities, such as storing goods or work of a preparatory or auxiliary character for the company. A salesperson who negotiates and signs customer contracts raises the risk more than an engineer who writes code, because the agent test turns on contract authority. The Canada treaty also has a services test: services your company provides in Canada for 183 days or more in a twelve-month period can create a permanent establishment, but only if more than 50% of its gross active business revenue comes from one person's services there, or the services are for the same or a connected project for Canadian customers (consolidated treaty, Article V(9)). Other treaties word these tests differently, and a country without a US treaty applies only its own law; nothing here decides the answer for a particular country.

Does an employer of record remove permanent establishment risk?

Not by itself. An employer of record changes who employs the person, not what the person does for your company. The treaty agent test looks at a person "acting on behalf of" your company with authority to conclude contracts in its name, not at who signs the paycheck. If the person signs customer contracts for you, or works from a place at your company's disposal, the risk can remain. The foreign country's law and practice decide how it treats this arrangement, and that can differ by country.

When does a contractor abroad start to look like an employee?

The foreign country's law decides whether a contractor working there is really an employee, under its own tests. If it reclassifies the person, local payroll tax, social contributions and employment rights may follow, under that country's rules. The US worker-status test matters for people working in the US, or for a US citizen or resident who would be your employee; see contractors who may be employees.

A contractor who works only for you and signs contracts in your company's name may not be an agent of independent status under the treaty, so the permanent establishment test above can apply to a contractor too. For the forms you collect and file when paying a contractor abroad, see paying contractors abroad.

What does our own subsidiary or branch abroad add to the US return?

A subsidiary adds yearly US information returns and a pricing rule; a branch puts the foreign activity directly on your return.

• A foreign subsidiary (a corporation for US tax) that your company controls generally makes your company a Form 5471 filer, attached to its own return and due with it (Form 5471 instructions). Missing it can cost $10,000 per foreign corporation per year. Cash your company puts into the subsidiary is reported on Form 926 when, right after the transfer, it holds at least 10% of the subsidiary (Form 926 instructions). If US shareholders own more than 50% of it, the subsidiary is a controlled foreign corporation, and its profit may count toward the parent's net CFC tested income, the name Public Law 119-21 gave to what was called GILTI. Owning a subsidiary there does not by itself make your US company taxable in that country (Canada treaty, Article V(8)). For the yearly filings, see a US parent of a foreign operating company.
• A branch, or a foreign entity disregarded as separate from your company, is reported on Form 8858 with Schedule M for dealings with it (Form 8858 instructions). Its income and expenses are your company's, and a branch is listed in the treaty as a permanent establishment.

When the subsidiary does development for the parent, the parent pays it a service fee that must be an arm's length amount under 26 CFR 1.482-9. Research and development is on the regulation's list of excluded activities, so the at-cost services cost method is not available for it; methods such as the cost of services plus method price it with a markup. A company account abroad may also need an FBAR; see FBAR for company accounts abroad.

Is pay for software development done abroad still deductible right away?

No. Research spending attributable to research done outside the US is spread over 15 years, starting at the midpoint of the tax year it is paid (Rev. Proc. 2025-28), and software development counts as research spending (26 U.S.C. 174(c)(3)). That is so whether you pay an employer of record, a contractor or your own subsidiary. Pay for roles that are not research, such as sales or customer support, falls under the ordinary business-expense rules. For mixed US and foreign teams and the first-year math, see deducting software development done abroad.

What if the person abroad is a US citizen or green card holder?

A US citizen or green card holder stays taxable in the US on worldwide pay, and US Social Security and Medicare can follow them abroad. Under 26 U.S.C. 3121(b), services abroad by a US citizen or resident for an American employer, which includes a corporation organized under US or state law, are covered employment. Where the US has a totalization agreement with the country, the person is generally covered only where they work, unless sent there temporarily; a certificate or statement from the covering country proves the exemption (Publication 54; IRS totalization agreements).

• Employed by your US company directly: US Social Security and Medicare generally apply unless a totalization agreement assigns coverage to the country of work, and federal unemployment tax applies to a US citizen's pay except in a neighboring country that has a US unemployment agreement (26 U.S.C. 3306(c)). You need not withhold US income tax on pay abroad if it is reasonable to believe the employee will exclude it under the foreign earned income exclusion, for example after a signed statement from the employee; a US citizen can use Form 673 (Publication 54).
• Employed by your subsidiary or an employer of record: the answer turns on whether that employer is an American employer. A US company can extend US Social Security to US citizens and residents employed by a foreign affiliate, an entity in which it holds at least a 10% interest, by agreement under section 3121(l) on Form 2032; once made, the agreement cannot be ended (Publication 54).
• Paid as a contractor: see paying contractors abroad for a US person living abroad.

What records should we keep about the person's role and work location?

Keep records that show what the person does, where, and who can bind your company; these decide both the permanent establishment question and the deduction.

Example

These examples are illustrative; figures are in US dollars.

One engineer in Poland through an employer of record

A US startup pays an employer of record $90,000 in the year for an engineer who writes its software in Poland. The startup files nothing for the engineer, who is the provider's employee. The invoices are foreign research spending, spread over 15 years from mid-year: about $3,000 deducted in the first year and $6,000 a year after that. If the engineer only writes code and signs nothing for the startup, an agent test like the one above, which turns on contract authority, points away from a permanent establishment; whether Poland sees any taxable presence is a question for Polish law and the US–Poland treaty.

A sales lead in Canada who signs customer contracts

A US startup engages a sales lead in Canada, first as a contractor and later through an employer of record. Either way, the sales lead negotiates and signs customer contracts in the startup's name. Under Article V(5) of the Canada treaty, this can give the startup a permanent establishment in Canada, so Canada may tax the profit attributable to it. Limiting the sales lead to finding customers while the US team signs changes the facts the treaty test looks at, but not the Canadian filing: soliciting orders in Canada through an agent or employee counts as carrying on business there (Income Tax Act, section 253), and a non-resident corporation that carries on business in Canada files a Canadian corporate return even when the treaty removes the tax (section 150(1)(a)).

Your own subsidiary in India with 10 engineers

A startup's Indian subsidiary employs 10 engineers at a total cost of $400,000. The parent pays the subsidiary a service fee priced on cost plus a markup, for example $432,000 at an illustrative 8% markup; the markup is not a benchmark. The subsidiary pays Indian tax on its profit, the parent files Form 5471 with its return, and the parent spreads the $432,000 fee over 15 years as research done abroad: about $14,400 deducted in the first year.

Different for you?

• The person works in Canada, or crosses the US–Canada border: see hiring an employee across the border, and for options granted to staff in Canada, stock options for employees in Canada.
• Someone abroad signs contracts or runs sales for you, or you own a foreign entity: the permanent establishment and pricing questions need a country-specific review with cross-border tax help.
• You pay contractors abroad: collect the right forms with paying contractors abroad.
• You own a foreign subsidiary: see a US parent of a foreign operating company for Form 5471 and tested income.
• Your developers work in the US and abroad: see deducting software development done abroad.
• Your company is Canadian and hiring its first US worker: see a Canadian business expanding into the US.
• Workers in the US may be misclassified: see contractors who may be employees.
• The company holds an account abroad: see FBAR for company accounts abroad.