Do I withhold tax when paying a software licence fee abroad?
Often, but the answer turns on how the payment is characterised. Royalties leaving the country are withheld at source, and whether a particular software payment is a royalty at all, rather than payment for a copyrighted article or for a service, is what decides the rate and sometimes decides whether tax is due on it. Treaties do not treat software, know-how, trademark and copyright royalties alike. So the work is to characterise the payment against the article that applies to it first, and only then to read off what that article provides.
What is the difference between a royalty and a service fee?
Broadly, a royalty is paid for the right to use something, such as a copyright, a trademark, a patent or know-how, while a service fee is paid for work somebody does for you. The distinction matters because the two are dealt with under different articles of a treaty, with different rates and sometimes different outcomes entirely. Mixed contracts are where this goes wrong. A licence bundled with support, training and customisation may need splitting, and if the agreement puts a single price on the whole thing, nobody can split it afterwards without argument. Price the components separately in the contract.
Does the treaty rate apply automatically or do I need paperwork?
Not automatically. The reduced rate depends on the recipient being entitled to it, and the payer is the one who has to be satisfied of that at the time of payment. That means holding the recipient's eligibility declaration before the money goes out, rather than collecting it at year end when the reporting is being prepared. If the documentation is not in hand, the safe course is to withhold at the domestic rate and let the recipient reclaim the difference, which is slower and generally unpopular. Build the declaration into licence onboarding rather than into the accounts payable run.
Can a treaty exempt royalty payments from withholding completely?
Some treaties exempt particular categories of royalty entirely, which is another reason characterisation is the whole exercise rather than a formality. An exemption reaching one category does not extend to another in the same contract, so a single agreement covering, say, a trademark licence and a know-how transfer can carry different treatment for each stream. Read the article that applies to the specific payment, confirm the recipient qualifies for what it provides, and document how you reached that conclusion at the time. A conclusion reconstructed years later carries much less weight on review.
My licensor invoiced gross, so who bears the withholding?
Whatever the contract says. This is a commercial allocation rather than a tax one, and where the agreement is silent it turns into an argument at the worst possible moment. Many foreign licensors expect to receive the invoiced amount in full, which means the payer is carrying the withholding on top of the fee. Others accept it as a deduction and take credit for it at home, in which case they will want the withholding certificate promptly. Settle the point in the licence, and state whether the amounts are gross or net of withholding, before the first payment falls due.
What happens if we never withheld on past royalty payments?
The exposure sits with the payer, so it is your problem rather than the licensor's, and it does not go away because the licensor has paid tax at home on the same income. The work is to go back over the payments, characterise each one under the article that actually applies, establish what should have been withheld and whether any supporting documentation existed at the time, then disclose on that basis. Doing the characterisation properly often reduces the exposure as well as supporting it, because some payments turn out not to be royalties at all.
Can I claim the child tax credit if I live abroad?
Partly, and the split matters. The non-refundable part can reduce US tax if the child meets the identification requirement in time. The refundable part is calculated on earned income, so excluding your salary with the foreign earned income exclusion removes the very figure it is built on — which is one of the clearest cases where the exclusion costs more than the credit route. Modelling both is the only way to know. See exclusion against credit.
Do expats pay state taxes?
Sometimes — leaving the country does not automatically end a US state's claim. States apply their own domicile tests, and several are slow to accept that domicile has moved while a home, licence, registration or voter record stays behind. A few states have no income tax at all, which removes the question. The federal exclusions do not bind a state, so state exposure has to be reviewed separately from the 1040. See state residency and domicile.
