UK consultants are exempt from tax withholdings on any portions of their payment which are reimbursement expenes. Taxes should be withheld only on service fees which are only performed in the US as oppose to the UK. Is this true?

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On the matter of expense reimbursements, withholding and reporting are not required if the expense reimbursement is made under an accountable plan—i.e. the expenses are fully accounted for and documented. For the definition of an accountable plan, see IRS Pub 463, page 29, available here: http://www.irs.gov/pub/irs-pdf/p463.pdf.

Reportability and withholding on payments for services applies to U.S.-source income. So payments made to a U.K. consultant for services performed for you in the U.K. would not be U.S. source income and not reportable. Regarding U.S. source income, see IRS Pub 1187, page 64, “Amounts Subject to Reporting on Form 1042-S,” available here: http://www.irs.gov/pub/irs-pdf/p1187.pdf, and “Source of Income” in IRS Pub 515 – Withholding of Tax on Non-resident Aliens and Foreign Entities, page 15, available here: http://www.irs.gov/pub/irs-pdf/p515.pdf.

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