Do I withhold tax or issue a 1099 when paying a contractor who works in China?

Generally no. Personal service income is sourced where the work is performed, so work done in China is foreign-source and not subject to withholding or Form 1042-S. With a valid Form W-8BEN, no Form 1099 is required. Any part of the work done in the U.S. is U.S.-source and treated separately.

How much tax do I withhold on interest and royalties paid to a Chinese parent company?

The default rate on U.S.-source interest and royalties is 30%. If the parent provides a valid W-8BEN-E and qualifies under the U.S.-China treaty, IRS Treaty Table 1 shows 10% for interest, royalties and dividends.

When are Forms 1042 and 1042-S due?

March 15 of the following year, so March 15, 2027 for 2026 payments, and payee copies of 1042-S are due the same day. Form 8809 gives a 30-day extension to file 1042-S with the IRS; Form 7004 extends the time to file Form 1042 but not to pay.

What happens if my company forgot to withhold on a foreign payee?

The U.S. payer is the withholding agent and is personally liable for tax it should have withheld, plus interest and possible penalties. A late Form 1042 carries 5% of unpaid tax per month up to 25%, and late or incorrect Forms 1042-S carry per-return information-return penalties.

Does Form W-8BEN-E go to the IRS, and how long is it valid?

No. The payer collects and keeps it before payment. It generally remains valid through the last day of the third calendar year after the year it was signed, for example through December 31, 2029 if signed in 2026, unless a change in circumstances makes it inaccurate.

Paying Foreign Persons: 30% Withholding and Form 1042-S

The short answer

When a U.S. company pays a foreign individual or company, first decide whether the income is U.S.-source. Services performed outside the United States are foreign-source: generally no withholding and no Form 1099. U.S.-source fixed or determinable annual or periodical income (FDAP), such as interest, dividends and royalties, is subject to 30% Chapter 3 withholding unless the payee gives you Form W-8BEN (individuals) or W-8BEN-E (entities) claiming a treaty rate; under the U.S.-China treaty those rates are generally 10%. The payer files Form 1042 and Forms 1042-S by March 15 of the following year and furnishes 1042-S to the payee. Tax you fail to withhold becomes the company's own liability.

Who this applies to

U.S. companies owned from China or doing business with Chinese affiliates: paying a Chinese parent management fees, technical service fees, software or trademark royalties, interest on shareholder loans, or dividends.

It also applies to U.S. small businesses using overseas contractors: designers, developers, customer service or bookkeeping staff working from China; RTP founders who hire a development team back home; restaurants and shops paying foreign service providers.

Step 1: Decide the source of the income

Services are sourced where performed, interest by the payer's residence, royalties where the property is used.

Service fees: Publication 515 says the source of personal service income is where the services are performed, regardless of where the contract was made, where payment is made or where the payer lives. Work a Chinese contractor performs in China is foreign-source; the U.S. company generally does not withhold and files neither Form 1042-S nor Form 1099. If the contractor does part of the work in the U.S., allocate; the U.S. portion is U.S.-source.

Interest: generally sourced by the payer's residence, so interest paid by a U.S. company is usually U.S.-source.

Dividends: sourced by whether the paying corporation is U.S. or foreign.

Royalties: for patents, copyrights, software and trademarks, sourced where the property is used.

Step 2: 30% withholding and treaty rates

U.S.-source FDAP is withheld at 30% by default; a valid W-8 form is what allows a lower treaty rate.

Who is responsible: the U.S. payer is the withholding agent. Publication 515 says a withholding agent is personally liable for any tax required to be withheld, independent of the foreign payee's own liability.

W-8BEN and W-8BEN-E: foreign individuals give you Form W-8BEN; foreign entities give W-8BEN-E. Collect it before payment and keep it; it is not sent to the IRS. A W-8BEN generally remains valid through the last day of the third calendar year after the year signed (signed in 2026, valid through December 31, 2029), unless circumstances change. A treaty claim generally needs a U.S. or foreign taxpayer identification number; for personal services, only a U.S. TIN works.

U.S.-China treaty (IRS Treaty Table 1): interest 10%, dividends 10%, royalties 10%. Without a valid W-8BEN-E you withhold 30%, even if the payee is clearly a Chinese company.

Foreign individuals working in the U.S.: independent services performed in the U.S. are U.S.-source and generally withheld at 30%; an individual who qualifies for a treaty exemption can claim it on Form 8233.

No Form 1099: a foreign person who provides a valid Form W-8 is exempt from Form 1099 reporting and backup withholding.

Step 3: Deposits and filings

Deposit withheld tax on schedule, and file Forms 1042 and 1042-S by March 15.

Deposits (EFTPS or IRS Direct Pay)

Under the Form 1042 instructions: if undeposited tax is $2,000 or more at the end of a quarter-monthly period, deposit within 3 business days; if $200 to under $2,000 at month-end, deposit by the 15th of the next month; if under $200 for the year, pay with Form 1042 or deposit by March 15. Deposits must be made through EFTPS or IRS Direct Pay.

Returns

Form 1042-S: one per payee per income type, filed with the IRS and furnished to the payee by March 15. Form 8809 gives an automatic 30-day extension to file with the IRS.

Form 1042: the annual return, due March 15. Every withholding agent required to file Forms 1042-S files it, whether or not tax was withheld. Form 7004 extends the time to file, not to pay.

E-filing: if you file 10 or more information returns in total during the year (1042-S, 1099 and W-2 combined), Forms 1042-S and 1042 must be e-filed. Financial institutions must e-file regardless.

Related-party reporting: a U.S. corporation that is 25% or more foreign-owned also reports service fees, royalties, interest and other transactions with foreign related parties on Form 5472. The penalty for not filing is $25,000 per form.

Penalties

Under-withholding: the company pays the tax it should have withheld, plus interest. Late Form 1042: 5% of unpaid tax per month, up to 25%; late payment: 0.5% per month, up to 25%.

Late or incorrect 1042-S: information-return penalties for returns due in 2027 are $60 per return if up to 30 days late, $130 if filed by August 1, $340 after August 1 or not filed, and $690 with no maximum for intentional disregard.

A simple example

Simplified: ignores Chinese tax, currency and state tax.

A North Carolina company, 100% owned by a Chinese parent, pays the parent in 2026: $100,000 for technical support performed in China, $50,000 for a software license used in the U.S., and $20,000 of loan interest. The parent provided a valid W-8BEN-E claiming U.S.-China treaty benefits.

Service fees: performed in China, foreign-source; no withholding, no 1042-S.

Software license: U.S.-source royalty; withhold 10%, or $5,000, so the parent receives $45,000.

Interest: U.S.-source; withhold 10%, or $2,000.

Total withholding is $7,000, deposited through EFTPS on schedule. By March 15, 2027 the company files Form 1042 and two Forms 1042-S and gives copies to the parent. All three payments go on the company's Form 5472.

Without the W-8BEN-E, the royalty and interest would be withheld at 30%, or $21,000; the $14,000 shortfall would be the company's liability.

Common mistakes

Withholding 30% on everything paid abroad. Services performed outside the U.S. are generally not U.S.-source.

Issuing Form 1099-NEC to foreign contractors. With a valid W-8, no 1099 is required; reportable U.S.-source FDAP goes on 1042-S.

Applying the 10% treaty rate without a W-8 form. No valid W-8BEN or W-8BEN-E means 30%, and the payer owns the shortfall.

Calling every related-party payment a "service fee." The label does not decide the character. A charge for technology or trademarks used in the U.S. may be a royalty, and amounts should be arm's length under section 482 and reported on Form 5472.

Skipping Form 1042 because nothing was withheld. If 1042-S is required, so is 1042.

What to do and when

Before signing or the first payment: classify the income and its source; collect W-8BEN or W-8BEN-E and check the treaty and TIN lines.

At each payment: withhold at 30% or the treaty rate and deposit on schedule.

At year-end: total payments per foreign payee and check which W-8 forms expire on December 31.

March 15, 2027: file 2026 Forms 1042 and 1042-S and furnish payee copies; extend with Form 8809 (1042-S) or Form 7004 (1042) if needed.

With the corporate return: file Form 5472 for transactions with foreign related parties.

How YCL can help

For U.S. companies owned from China and businesses with overseas contractors, we classify payments and their source, collect and review W-8BEN and W-8BEN-E forms, compute withholding and deposits, and file Forms 1042, 1042-S and 5472. See our cross-border withholding service.

For the full process, see our guide: Form 1042-S and withholding on payments to foreign persons. If you are setting up a U.S.-China structure, see our U.S. subsidiary guide.

YCL Accounting & Consulting is a multi-state CPA firm serving clients across the U.S. in English and Chinese, led by co-founder Gloria (Chenchen) Liu, CPA. You can start with a free 15-minute consultation.