What is Withholding Tax on Dividends?
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
- 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.
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
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
- 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
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.
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.
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?
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
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.