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More investors are willing to go international for their dividends.
Going international can lift your income. Foreign markets can house high-yield stocks. They can offer even more income through currency exchange.
When the U.S. dollar depreciates against a foreign currency, the foreign currency will buy more dollars. A U.S. investor who buys shares of a foreign company that pays its dividend in an appreciating currency can realize higher income in U.S. dollars.
If only opportunities were so straightforward. They rarely are.
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There’s a catch when investing in foreign dividend-paying stocks. The catch involves withholding taxes on dividends. Most countries, including the United States, impose a withholding tax on dividends paid to foreign investors.
The lack of uniformity compounds the complexity. Withholding rates can range from zero, such as for dividends that originate in Brazil and the United Kingdom, up 35% on dividends that originate from Switzerland.
A Swiss company pays a dollar per share in dividends. The U.S.-resident investor may walk away with only $0.65 per share.
Below is a table of the withholding tax on dividends paid to U.S. investors from the more popular foreign-investing destinations.
|Country||Dividend Withholding Tax Rate|
The good news is that Uncle Same offers some relief.
The U.S. Internal Revenue Service (IRS) offers either a foreign tax credit or an itemized deduction for taxes on foreign-stock dividends. It’s no free ride. These tax credits are applicable only to offset taxes paid in the United States. You’ll still pay U.S. income taxes if the stocks are held in a taxable brokerage account.
Investors receiving less than $300 in foreign tax credits can file for the credits directly on Form 1040, if the shares in question are held in a traditional brokerage account and a Form 1099-DIV was received listing the foreign taxes paid. Otherwise, it may be necessary to file Form 1116 in order to apply for the tax credit and attach it to Form 1040.
The bad news is that most states lack a foreign tax credit mechanism. Just like on a federal tax return, the taxpayer scribbles the full amount (untaxed amount) of the dividend income on the state return, even though he or she is receiving the after-tax amount. The dividend is taxed on the state return on the full amount.
If you invest for dividend income through your retirement account, pay particular attention to the withholding tax rates on your foreign investments.
Individual retirement accounts (IRAs), 401(k) plans, and other retirement account holders don’t pay taxes on investment income each year. Therefore, they’re unable to apply the foreign tax credit against their foreign dividends. Thus, any income received in an IRA or 401(k) account from foreign sources will have been reduced by the foreign taxes paid on this income.
There is no way for the account holder to offset those foreign tax payments by using the foreign tax credit or deduction.
Canada is the notable exception. In the case of Canadian dividend withholding taxes, U.S. investors can avoid the tax by holding shares in an IRA or 401(k).
So, account for the withholding tax applied to foreign dividend stocks when investing. Also, factor in the type of account – retirement or regular – in which you will hold the stock. The country and the account can significantly affect your dividend income and yield.
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