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:

  • 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)

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.

As a seasoned investor and enthusiast in international finance and taxation, I can confidently navigate the complex landscape of foreign dividend withholding taxes. Let's delve into the concepts mentioned in the article:

  1. Foreign Dividend Withholding Tax: This tax is levied by foreign governments on dividends paid to nonresident shareholders. Unlike the U.S., where residents are responsible for reporting dividends to the IRS, many countries automatically withhold taxes on dividends paid to nonresidents.

  2. Foreign Dividend Withholding Tax Rates: These rates vary by country and can significantly impact investors' returns. For instance, Australia, Canada, and certain European countries have relatively high withholding rates, while others, like the U.K., have a 0% rate.

  3. Tax Treaties: To avoid double taxation, where dividends are taxed by both foreign governments and the IRS, the U.S. has negotiated tax treaties with over 60 nations. These treaties often reduce the foreign tax rate applied to dividends for U.S. investors. For example, countries like Australia, Canada, France, Germany, Ireland, and Switzerland have tax treaties with the U.S., resulting in lower withholding rates.

  4. Foreign Dividend Tax Credit vs. Deduction: U.S. investors can offset their foreign tax burden through either a tax credit or deduction. The tax credit directly reduces the tax liability, dollar for dollar, while the deduction reduces taxable income, affecting the tax liability based on the marginal tax bracket.

  5. Form 1116: This form is used to claim a tax credit for foreign taxes paid that exceed the $300/$600 threshold for individuals/couples filing jointly. It requires detailed reporting and is essential for investors with significant foreign tax withholdings.

  6. Tax Treatment in Retirement Accounts: Foreign withholding taxes still apply to dividends in tax-deferred accounts like IRAs and 401(k)s, except in the case of Canada. However, investors cannot claim credits or deductions for these taxes in such accounts, potentially leading to higher tax burdens.

  7. Investment Strategy: While foreign dividend stocks offer portfolio diversification, investors should weigh the tax implications. Larger investors, especially those exceeding the $300/$600 threshold, should carefully consider tax treaties, credit vs. deduction strategies, and the implications for retirement accounts.

In summary, understanding foreign dividend withholding taxes is crucial for investors seeking to optimize their international investments while managing tax liabilities effectively.

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