For U.S. expats, foreign dividends must be reported on your U.S. tax return, as the U.S. taxes worldwide income. This guide explains how to handle foreign dividend taxation, including potential credits like the Foreign Tax Credit (FTC) to avoid double taxation. Whether filing on your own or with a professional, understanding these rules helps ensure compliance and maximizes your tax benefits.
What Are Dividends?
The IRC 26 U.S. Code § 316 (a) defines the dividends as:“ any distribution of property made by a corporation to its shareholders”. Dividends are considered as an investment type of unearned income and are treated in the same way as taxable interest and capital gain distributions.
Note: You must report all of your income, both earned and unearned regardless of where in the world it is sourced. Foreign income should be converted and reported on your US expat tax return in US dollars.
Are Foreign Dividends Taxable In The U.S.?
Yes, foreign dividends are taxable for U.S. taxpayers, including both citizens and residents. U.S. tax law requires individuals to report any dividends earned from foreign companies on their tax returns. This applies whether the dividends are reinvested or received in cash, as U.S. taxpayers are taxed on their worldwide income. This means that no matter where the income is generated, it must be included on the U.S. tax return.
When it comes to tax rates, foreign dividends are generally taxed at the taxpayer’s ordinary income tax rate. Unlike dividends from U.S. corporations that often qualify for lower capital gains tax rates, foreign dividends usually do not receive the same preferential treatment.
Can Foreign Dividends Be Qualified?
Foreign dividends can be considered qualified dividends under specific IRS criteria. The following are key factors that determine if foreign dividends receive favorable tax treatment:
Criteria for Qualified Foreign Dividends
- Holding Period: The shareholder must hold the stock for more than 60 days within a 121-day period starting 60 days before the ex-dividend date. This period is vital for eligibility for lower capital gains tax rates.
- Qualified Foreign Corporation: The dividend must come from a qualified foreign corporation, which can meet one of these conditions:
- Incorporated in a U.S. possession.
- Eligible for benefits under a comprehensive income tax treaty with the U.S.
- The corporation’s stock is traded on an established U.S. securities market.
- Exclusions: Certain dividends, such as those from real estate investment trusts (REITs), master limited partnerships (MLPs), and passive foreign investment companies (PFICs), do not qualify.
Tax Consequences
Qualified dividends are subject to lower capital gains tax rates, with a maximum of 20%, depending on the taxpayer’s income. In contrast, ordinary dividends can be taxed at rates as high as 37%.
How Do I Report Foreign Dividends On My US Tax Return?
When reporting foreign income from dividends paid by foreign corporations, U.S. taxpayers must include this income on their Form 1040, following the IRS’s requirement to report all worldwide income, including investment income from abroad. This applies whether the dividends are considered foreign qualified dividends or not.
US Expats may be eligible to claim credits based on foreign income taxes paid by the fund or individual, utilizing the Foreign Tax Credit to alleviate double taxation.
If the total dividend payments and interest income exceed $1,500, you are also required to file Schedule B (Interest and Ordinary Dividends). On Schedule B, you must list all foreign income, including dividends from foreign investments. If the dividends are received in a currency other than U.S. dollars, you must convert the amount using the appropriate exchange rate when completing your tax return.
Additional Filing Obligations For Foreign Financial Assets
U.S. expats who hold significant foreign financial assets, including dividend-paying foreign stocks, may need to file additional forms to ensure compliance with U.S. tax laws:
- Form 8938 (Statement of Specified Foreign Financial Assets): If your total foreign assets, including foreign bank accounts and foreign investments, exceed specific thresholds ($200,000 for single filers living abroad or $400,000 for joint filers), you must file Form 8938 to report these assets to the IRS.
- Foreign Bank Account Report (FBAR): If you have foreign bank accounts and the aggregate value of these accounts exceeds $10,000 at any time during the calendar year, you must file an FBAR (FinCEN Form 114) to report these accounts to the U.S. Treasury Department. Failing to file can result in severe penalties.
These additional reporting obligations ensure that U.S. taxpayers with significant foreign investments remain compliant and avoid penalties for underreporting foreign assets.
Can I Claim A Foreign Tax Credit For Dividends Paid Abroad?
Yes, U.S. taxpayers can claim a Foreign Tax Credit for taxes paid on foreign dividends to avoid being taxed twice on the same income. This includes foreign income taxes paid by mutual funds and individuals, which can be used to claim the Foreign Tax Credit. To do this, you must file Form 1116 with your U.S. tax return, which calculates the credit based on the foreign taxes paid and ensures it applies only to income that is also taxed in the U.S.
The Foreign Tax Credit reduces your U.S. tax liability by the amount of foreign taxes paid, dollar-for-dollar, up to the amount of U.S. tax due on that foreign income. If the foreign taxes exceed your U.S. tax liability, you can carry forward or back the unused portion to other tax years.
For simplicity, if your foreign tax withholdings are $300 or less ($600 for joint filers) and you have a 1099-DIV or 1099-INT, you can claim the credit without filing Form 1116. This credit is an effective way to avoid double taxation on dividends paid abroad.
Related: IRS Form 1116: How to Claim the Foreign Tax Credit (With Examples)
How To Report Foreign Taxes Paid On Dividends?
Step 1: Determine Eligibility
To report foreign taxes paid on dividends, U.S. taxpayers should first determine if they are eligible to claim the Foreign Tax Credit (FTC). You qualify if you have paid or accrued foreign taxes on income from foreign sources, such as dividends, and the taxes are imposed directly on you as an individual. These taxes must be legal and valid foreign income taxes that are required to be paid.
Step 2: Use Form 1116
In this form, you’ll need to report your taxable foreign income, including dividends, and list the foreign income taxes paid in both the foreign currency and the equivalent in U.S. dollars, using the proper exchange rate. After calculating the FTC for each income category, you will total the credits to determine the amount you can apply against your U.S. tax liability. Once filled out, Form 1116 should be attached to your annual U.S. tax return (Form 1040).
- Part 1: Report your taxable foreign income, including dividends.
- Part 2: List the foreign income taxes paid in both the foreign currency and the equivalent in U.S. dollars.
- Part 3: Calculate the FTC for each income category.
- Part 4: Total the credits.
In some cases, you may not need to file Form 1116 at all. If your only foreign income is passive, such as dividends, and your total foreign taxes paid are $300 or less ($600 for joint filers), you can claim the FTC directly on your tax return without needing to submit Form 1116.
Tax Tip 1
Foreign Earned Income Exclusion can only exclude foreign and earned income. Dividends are a type of unearned income. It cannot be excluded using the FEIE. You can only use the FTC to minimize your tax burden.
To qualify for the FEIE, you must have foreign earned income, your tax home must be in a foreign country, and you must meet one of the following conditions: be a U.S. citizen, a U.S. resident, or a U.S. citizen or resident who satisfies the bona fide residence test or the physical presence test.
Example 1
Amy is a school teacher in Dubai and earns $80,000 annually. She also receives $12,000 in foreign dividend income. Since the United Arab Emirates does not levy income tax on individuals and has no tax treaty with the U.S., her dividends are classified as ordinary dividends, which means she cannot use the FTC to offset her U.S. tax bill. If Amy had paid foreign income taxes, she could potentially claim a Foreign Tax Credit for those foreign income taxes paid.
The best solution for Amy is to claim the Foreign Earned Income Exclusion (FEIE) to exclude her foreign earned income, and then apply the 2023 standard deduction of $13,850 to reduce her taxable income to zero.
Note: The FEIE has some limitations, so this approach might not be the best for everyone. It’s always advisable to consult with a tax professional to determine the optimal strategy for your specific situation.
What would happen if Amy received $20,000 in dividend income?
The standard deduction will exclude $13,850, leaving $6,150 of dividend income to be taxed at ordinary rates. At a 10% tax rate for the first tax bracket, Amy’s U.S. tax liability would be $615.
Example 2
John is a software developer living in the UK. He earns $120,000 annually from his job and receives $5,000 in foreign dividend income from a UK-based company. The UK government withholds 15% tax on his dividends, amounting to $750. Since John is taxed on his worldwide income by the U.S., he needs to report his UK earnings and dividends on his U.S. tax return.
John claims the Foreign Earned Income Exclusion (FEIE) to exclude $120,000 of his UK salary. However, his dividend income is considered unearned income, which is not eligible for FEIE. He can file Form 1116 to claim a Foreign Tax Credit (FTC) for the $750 of foreign income taxes paid on his dividend income, reducing his U.S. tax liability and avoiding double taxation.
Example 3
Maria is a freelance consultant based in Spain and earns $95,000 annually. She also has investments in Spanish stocks, which generated $8,000 in dividends this year. Spain imposes a 19% withholding tax on dividends, meaning Maria paid $1,520 in Spanish taxes on her dividend income.
Maria claims the Foreign Earned Income Exclusion for her consulting income. Since she is eligible to file Form 1116, she can claim a Foreign Tax Credit for the $1,520 in foreign income taxes paid on her dividend income. Because her U.S. tax liability on the dividends is lower than what she paid in Spain, she can fully offset her U.S. taxes and even carry forward any unused portion of the FTC for future years.
Net Investment Income Tax
In addition to regular income taxes, U.S. taxpayers with significant investment income may also be subject to the Net Investment Income Tax (NIIT). This tax applies a 3.8% surtax on the lesser of your net investment income or the amount by which your modified adjusted gross income (MAGI) exceeds certain thresholds: $200,000 for single filers, $250,000 for married filing jointly, or $125,000 for married filing separately. Net investment income includes foreign dividend income, interest income, and capital gains, among other passive income sources. For example, if your MAGI exceeds the threshold and you have foreign dividends included in your investment income, the NIIT may apply, adding an extra tax liability to the dividends you’ve already reported on Form 1040.
Related: Net Investment Income Tax (NIIT) For U.S. Citizen Expatriates
Get Free Expert Tax Advice For U.S. Expats At 1040 Abroad
It’s essential to consult with a tax professional to determine the best tax planning strategy for your specific situation. A professional can help you navigate the complexities of foreign tax credits, foreign earned income exclusion, and other tax benefits, ensuring you maximize your tax savings and avoid double taxation.
At 1040 Abroad, we understand how important it is to get the right tax advice for your specific situation. Navigating the complexities of foreign tax credits, the foreign earned income exclusion, and other tax benefits can be challenging, but you don’t have to do it alone. We offer free tax advice to help U.S. expats make informed decisions and maximize their tax savings while avoiding double taxation. Contact us today, and let our experienced team answer any questions you may have about your U.S. expat tax obligations!
Have An Expat Tax Question? Contact Olivier Wagner at 1040 Abroad.
