Guide to Foreign Tax Withholding on Dividends for U.S. Investors (2024)

Foreign dividend-paying stocks can increase a portfolio's diversification and provide exposure to faster-growing emerging economies.

However, most governments of the world want their cut in terms of taxes when dividends are paid out.

Just as with U.S. dividend tax law, the fine details of how much you have to pay and what forms you need to fill out can be both time-consuming and a source of angst come tax time.

Let’s take a look at foreign dividend withholding taxes as it applies to U.S. investors to see what you need to know about generating overseas dividend income.

What is Withholding Tax on Dividends?

While the U.S. government taxes dividends paid by American companies, it doesn’t impose tax withholdings for U.S. residents.

In other words, each U.S. investor receives the full dividend amount and is responsible for reporting their annual dividends to the IRS each year and paying taxes accordingly.

However, many governments automatically withhold taxes on dividends paid to nonresident shareholders by companies incorporated within their borders.

As a result, U.S. investors owning shares in most foreign companies will see a portion of their dividend payments withheld by their broker. That amount represents the foreign withholding tax on dividends.

Foreign Dividend Withholding Tax Rates by Country

The foreign withholding tax rate on dividends can vary wildly around the world. Here is the foreign tax on dividends by country for some of the largest nations:

S&P Dow Jones Indices maintains a list of withholding tax rates for every country.

Some of the most popular foreign dividend companies, including those based in Australia, Canada, and certain European countries, have high withholding rates, between 25% and 35%.

Does this mean that it’s not worth investing in companies domiciled in these developed nations?

Not necessarily. Thanks to tax treaties between the U.S. and many countries around the world, the actual amount of dividends withheld from U.S. investors is often much less than these headline figures.

Tax Treaties Can Help Ease the Pain but Make for Extra Complexity at Tax Time

In order to avoid double taxation, in which dividend investors are taxed by both foreign governments and the IRS, the U.S. has worked out tax treaties with over 60 nations to reduce the foreign tax paid on dividends.

As a result, most major countries have deals with the U.S. to apply only a 15% withholding tax to dividends paid to nonresident shareholders. Some examples include Australia, Canada, France, Germany, Ireland, and Switzerland.

To receive the lower rate, your broker or asset manager needs to have certain information on file, including a W-9 form which contains a U.S. investor's name, address, and Social Security number.

In our experience, major brokerages such as Vanguard and their custodians automatically file the necessary paperwork with foreign governments to enable their verified U.S. investors to obtain the preferential tax treaty rates for dividends. But it may be worth confirming with your broker.

Besides receiving the lower tax treaty rates on dividends paid by foreign companies, U.S. investors have another lever they can pull to reduce their withholding tax burden.

How to Minimize Your Foreign Dividend Tax Burden

There are two ways to at least partially offset your foreign taxes: a foreign dividend tax credit, or deduction. You need to make the decision about which to use for all of your foreign withholdings in any given year.

In other words, if you want to take a credit for some of your withholdings, than you need to take a credit for all of it, and vice versa. What’s the difference between the two?

  • Foreign Dividend Tax Credit: provides a dollar for dollar decrease in your tax liability
  • Foreign Dividend Tax Deduction: decreases your taxable income so that the actual tax liability reduction is based on your marginal tax bracket

The tax credit is usually the preferred choice, because it can save you more money.

The simplest way to obtain this credit is if your foreign tax withholdings are $300 or less per individual ($600 if filing a joint return), and you have received a 1099-DIV or 1099-INT form from your broker outlining your total foreign tax withholdings.

In this case, you can claim the entire withholding amount as a tax credit, reducing your U.S. tax burden dollar for dollar and effectively eliminating the foreign dividend tax.

The catch is that you can deduct only an amount equal to your total U.S. tax liability in any given year. For example, say your total U.S. tax liability is $10,000 but you had $15,000 in foreign tax withholdings.

In that case, rather than sending you a $5,000 check, the IRS will only let you subtract $10,000 for that year (you owe nothing), and then rollover $5,000 in tax liability reduction into future years, limited to a decade.

Another benefit of this credit is that you can use it in conjunction with your standard deduction, which the majority of Americans take rather than itemizing. In other words, as long as your foreign withholdings aren’t too large, you can use the standard form 1040 to do your taxes.

What if your foreign tax withholdings are above the $300 / $600 level for individuals and couples filing jointly? That’s where things get more complex.

To determine how much of a tax credit you can claim above the $300 / $600 limit you need to fill out form 1116, which gets attached to your form 1040 and has instructions that are 24 pages long.

You have to jump through these extra hoops rather than simply obtain a full foreign tax credit because not all foreign dividends qualify for preferential treatment.

Guide to Foreign Tax Withholding on Dividends for U.S. Investors (1)

Fortunately, many of these exclusions don’t apply to most investors, other than the potential for Puerto Rican stocks, whose dividends aren’t qualified for a credit and must be itemized for a deduction.

However, there is one kind of tax credit disqualification that can affect regular investors and is the main reason why anyone with over $300 / $600 in foreign withholdings must fill out form 1116.

Any withheld dividends on stocks that you held for less than 16 days during the 31-day period that begins 15 days before the ex-dividend date are considered unqualified dividends that will decrease the total amount of foreign tax credit you can claim.

Can Foreign Tax Withholding on Dividends Be Avoided in IRAs and 401Ks?

Given the complexity of foreign withholding taxes, investors might think that owning these shares in a tax-deferred account might be a way to avoid the paperwork hassle.

However, that’s not usually the case since most nations (aside from Canada) still withhold taxes in retirement accounts.

Due to the tax-sheltered status of IRAs and 401(k)s, the IRS doesn’t allow you to take any credits or deductions for foreign withholdings for these accounts. In other words, you could be facing the loss of up to 35% of your dividends, with no beneficial U.S. tax liability offset.

The bottom line is that for tax-sheltered accounts, investors may want to make sure they only own U.S. stocks or companies domiciled in nations that have 0% withholding rates.

Closing Thoughts on Dividend Withholding Tax

Owning foreign dividend stocks can provide some benefits for building a diversified portfolio, but larger investors (those who face foreign withholdings above the $300 / $600 limit) will want to do research and be careful about which companies they buy.

We generally prefer to invest in U.S. multinationals to gain exposure to faster-growing international markets and avoid many of the accounting and tax headaches that can come from investing in foreign companies directly.

Foreign dividend-paying stocks can be a valuable addition to a portfolio as they can increase diversification and provide exposure to faster-growing emerging economies. However, it's important to understand the concept of foreign dividend withholding taxes, especially for U.S. investors.

What is Withholding Tax on Dividends?

Withholding tax on dividends refers to the taxes that are automatically withheld by foreign governments on dividends paid to nonresident shareholders by companies incorporated within their borders. Unlike the U.S. government, which does not impose tax withholdings for U.S. residents, many governments around the world automatically withhold taxes on dividends.

Foreign Dividend Withholding Tax Rates by Country

The foreign withholding tax rate on dividends can vary significantly from country to country. Here are some examples of foreign tax rates on dividends for some of the largest nations:

  • Australia: 30%
  • Canada: 25%
  • China (Mainland): 10%
  • France: 25%
  • Germany: 26%
  • Ireland: 25%
  • Japan: 20%
  • Mexico: 10%
  • Netherlands: 15%
  • Switzerland: 35%
  • U.K.: 0%
  • U.S.: 30% (for nonresidents)

Please note that these rates are subject to change, and it's always a good idea to consult the most up-to-date information from reliable sources like S&P Dow Jones Indices, which maintains a list of withholding tax rates for every country.

Tax Treaties Can Help Reduce Withholding Taxes

To avoid double taxation, the U.S. has established tax treaties with over 60 nations. These treaties aim to reduce the foreign tax paid on dividends by U.S. investors. As a result, most major countries have agreements with the U.S. to apply a lower withholding tax rate to dividends paid to nonresident shareholders.

For example, countries like Australia, Canada, France, Germany, Ireland, and Switzerland have tax treaties with the U.S. that allow for a reduced withholding tax rate of 15% on dividends. It's important for U.S. investors to ensure that their broker or asset manager has the necessary information on file, such as a W-9 form, to take advantage of these preferential tax treaty rates.

Minimizing Foreign Dividend Tax Burden

There are two ways to offset foreign taxes on dividends: a foreign dividend tax credit or a deduction. The choice between the two depends on individual circ*mstances and should be made for all foreign withholdings in a given year.

  • Foreign Dividend Tax Credit: This provides a dollar-for-dollar decrease in tax liability.
  • Foreign Dividend Tax Deduction: This decreases taxable income, resulting in a reduction in tax liability based on the individual's marginal tax bracket.

The tax credit is generally the preferred choice as it can save more money. U.S. investors can claim the entire withholding amount as a tax credit if their foreign tax withholdings are $300 or less per individual ($600 if filing a joint return) and they have received a 1099-DIV or 1099-INT form from their broker outlining the total foreign tax withholdings.

If foreign tax withholdings exceed the $300/$600 limit, individuals will need to fill out Form 1116, which is attached to Form 1040. This form helps determine the tax credit that can be claimed above the limit. It's worth noting that not all foreign dividends qualify for preferential treatment, and some exclusions may apply.

Foreign Tax Withholding in Tax-Deferred Accounts

For tax-sheltered accounts like IRAs and 401(k)s, most nations (except Canada) still withhold taxes on dividends. The IRS does not allow credits or deductions for foreign withholdings in these accounts. Therefore, investors may want to consider owning only U.S. stocks or companies domiciled in nations with a 0% withholding rate to avoid the loss of dividends in tax-sheltered accounts.

In conclusion, while foreign dividend stocks can offer benefits for portfolio diversification, it's crucial for larger investors to research and carefully consider the companies they invest in, especially if they face foreign withholdings above the $300/$600 limit. Investing in U.S. multinationals can provide exposure to international markets while avoiding some of the accounting and tax complexities associated with investing in foreign companies directly.

Guide to Foreign Tax Withholding on Dividends for U.S. Investors (2024)

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