Income Calculations for Tax on Foreign Dividends
When you receive dividends from investing in a foreign corporation, you get less money than expected but use a tax maneuver to recover the withheld amount. The foreign government in the country where the corporation is located withholds tax on the dividends. Overseas taxing authorities don’t expect you to voluntarily pay since you live out of their reach on another part of the planet. Their withholding assures that they obtain tax revenue without you filing a foreign tax return. Fortunately, the Internal Revenue Service allows a benefit on your U.S. income tax return for the foreign taxes.
If you’re a U.S. citizen, you owe income tax on dividends paid by corporations based in foreign countries just like dividends received from domestic organizations. The IRS even taxes the foreign dividends of U.S. citizens who live overseas. Unlike dividend-paying U.S entities, a foreign corporation may not report its dividend payments to you and the IRS on a Form 1099. You must still account for the income and pay the tax. U.S. income tax is assessed on the worldwide income of every U.S. citizen as well as foreign citizens who meet qualifications as U.S. residents.
Some foreign citizens living in the U.S. are classified as resident aliens. After someone qualifies as a resident alien, he is taxed on foreign dividends just like a U.S. citizen. Foreign citizens are resident aliens when they meet the “green card” test by having legal authorization to live and work in the U.S. A foreign citizen can also become a resident alien by meeting the IRS test for sufficient number of days present in the U.S. Nonresident aliens are only taxed on their income from U.S. sources. They don’t report foreign dividends to the IRS as taxable income.
Some types of dividends receive special tax treatment. These “qualified dividends” are taxed at a fixed rate that’s lower than the rate assessed on other types of income. You’re charged ordinary income tax on dividends that are non-qualified. The dividends of most U.S. based corporations are qualified dividends. Foreign dividends are eligible for the favorable tax treatment if the foreign corporation paying them is organized in a U.S. possession, operates in a country that has a tax treaty with the U.S. or has issued stock that is registered for trading on U.S. stock exchanges.
Qualified dividend treatment also places restrictions on stockholders as well as the corporations that issue stock. You only have a qualified dividend if you owned the stock for at least 60 of the 121 days preceding the date 60 days before the “ex-dividend date.” Corporations establish an ex-dividend date as the day stockholders must own shares to receive the next dividend. An exception for preferred stock stipulates that qualified dividend recipients must have held their shares for 90 out of 181 days.
Tax Credit or Deduction
When foreign tax is withheld on dividend payments, you’re entitled to a tax credit or deduction if the same dividend income is taxable by the U.S. You get back the amount withheld by the foreign government when you claim a credit equal to the foreign tax on your U.S. income tax return. Tax credits function identically to receiving money for paying your tax liability. A tax deduction is generally less valuable than a tax credit. Deductions reduce your income and the tax calculated from applying a tax rate.
Brian Huber has been a writer since 1981, primarily composing literature for businesses that convey information to customers, shareholders and lenders. Huber has written about various financial, accounting and tax matters and his published articles have appeared on various websites. He has a Bachelor of Arts in economics from the University of Texas at Austin.