Paying wages to overseas employees puts a US company inside two rulebooks at once: the US rules on income tax withholding and social security for the wages it pays, and the employment law of the country where the person actually works. The US side splits cleanly on who the employee is. Wages of US citizens and residents working abroad generally stay inside the federal withholding system, with specific exemptions; wages of nonresident aliens for work performed entirely outside the United States are generally foreign source income and outside it. The local side does not care about either answer: the country where the employee sits expects a local employer, local payroll and local contributions, which is the gap an employer of record exists to close.
US citizens and residents on a foreign payroll
Wages a US employer pays to a US citizen or resident working abroad are generally subject to federal income tax withholding, but the IRS recognizes several exemptions. An employee whose compensation qualifies for the foreign earned income exclusion under section 911 can file Form 673 to have withholding stopped on that portion, though a resident alien may not use Form 673 for this purpose. Withholding is also not required where the foreign country itself mandates income tax withholding on the same compensation, which is exactly the situation created when the person is employed through a local entity abroad. The upshot: how you structure the employment decides which country's withholding machinery runs the payslip.
Nonresident aliens working abroad
For a foreign national working outside the United States, the IRS position is broad: wages earned by nonresident aliens for services performed outside the US, for any employer, are foreign source income and therefore not subject to US federal income tax withholding or reporting. That removes the US side of the problem but leaves all of the local side. The person's own country will require an employer registered there to run payroll, withhold its income tax and pay its social contributions, and a US company wiring gross salary to a personal account abroad is not a payroll; it is an unregistered employment relationship accruing liabilities in the employee's country.
Social security, Medicare and totalization
US social security and Medicare taxes can follow wages abroad. They generally continue to apply when the work is for an American employer, a term the IRS defines to include the US government, US residents, corporations organized under US law and certain partnerships and trusts, and an American employer can extend coverage to employees of a foreign affiliate it holds at least a 10% interest in by agreement on Form 2032, an election that, once in effect on or after mid-1989, cannot be terminated. Where both the US and the employee's country would tax the same work, totalization agreements exist to eliminate dual coverage and dual contributions so that social security taxes are paid to only one country. Whether one covers your case depends on the country pair.
The practical routes to a compliant payroll
Three structures cover almost every case. A local entity of your own with a registered payroll fits a country where you have real scale. An employer of record fits everywhere else: its entity employs the person locally, runs the local withholding and contributions that both rulebooks expect, and invoices you monthly, with verified per-employee pricing shown in this site's index. Treating the person as a contractor avoids payroll only when the relationship genuinely is contracting; using it to dodge employment obligations builds misclassification risk in the employee's country. Whichever route you take, have a tax adviser check the US side for the specific employee, because citizenship, residency and country pair change the answer. Nothing here is tax advice.
Questions people ask about paying wages to overseas employees
Do I withhold US income tax for a US citizen working abroad?
Generally yes if you pay them as a US employer, unless an exemption applies: Form 673 for compensation qualifying for the foreign earned income exclusion, or the case where the foreign country already requires withholding on the same wages.
Do I withhold US tax for a foreign employee working in their own country?
Generally no: the IRS treats nonresident aliens' wages for services performed outside the US as foreign source income, not subject to US withholding or reporting. The employee's own country's payroll obligations still apply in full.
Can we just wire salary from the US and skip local payroll?
Not compliantly, if the person is an employee. The country where they work expects a registered local employer withholding its taxes and paying its social contributions. An EOR provides that employer without you opening an entity.
What stops double social security contributions?
Totalization agreements between the US and specific countries, which the IRS describes as eliminating dual coverage and dual contributions so social security taxes go to one country only. Whether one applies depends on the country; check the pair before structuring the role.