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Understanding How the U.S. Taxes Foreign Dividend Payments: Doug’s Quiz Corner

Posted by Doug Hutchinson | CFA®, Director of Research and Trading
April 13, 2018

What is the foreign tax withholding?How Do Tax Credits and Tax Deductions Work for Foreign Dividend Payments?

Your friend Emily made an investment in the stock of a company that is based outside of the U.S. This investment was made in her taxable individual account. She received $100 in dividends for this stock (net of foreign tax withholding) last year. She had no other investments in companies outside the U.S.

For her U.S. taxes, Emily believes that she can get a tax credit or a tax deduction on the foreign dividend income. She isn't certain if she will end up owing U.S. taxes on this foreign dividend though.

A Tax Credit is the amount of money that a taxpayer is permitted to subtract from taxes owed. Tax credits reduce the actual amount of tax owed.

A Tax Deduction is a reduction in tax obligation from a taxpayer’s gross income. These can be the result of a variety of events over the course of the year and are removed from the taxpayer’s taxable income (adjusted gross income) which lowers overall tax liability.

What advice would you give Emily?

  1. Emily is likely to be able to take a tax credit. She should take the tax credit (if eligible) and will likely not owe any additional taxes to the U.S.
  2. Emily is likely to be able to take a tax deduction. She should take the tax deduction (if eligible) and will likely not owe any additional taxes to the U.S.
  3. Emily is likely to be able to take a tax deduction. She should take the tax deduction (if eligible). However, she is likely to owe additional taxes to the U.S.
  4. Emily is not likely to be able to take either a tax credit or tax deduction. She is likely to owe additional taxes to the U.S.

Solution:

1. is probably the best answer.

It is likely that Emily is eligible for either a tax credit or a tax deduction. Emily can take the tax credit which will reduce her actual tax due. In other words, if she had a $20 credit, that means she will owe $20 less in taxes.

On the other hand, a tax deduction of $20 means she is only taking $20 multiplied by her tax rate off her tax bill. If she was in the 25% tax bracket, for example, she would only save $20 x 0.25 = $5.

This all becomes more complicated if Emily paid more than $300 in foreign taxes in a given year. If she paid $300 or more in foreign taxes she would have to complete an additional tax form and the tax credit and tax deduction rules become more complex. Fortunately, in this example Emily has less than $300 in foreign taxes.

Lastly, Emily has to meet certain eligibility requirements to be eligible for the credit or deduction and U.S. taxpayers cannot take a tax credit or deduction on foreign income from certain countries.

Either way, Emily should consider working with a tax professional and/or a financial planning professional to help her with her tax needs and help her meet her financial goals.

 


The information presented by WrapManager, Inc. is general information only and does not represent tax or legal advice, either expressed or implied. You are encouraged to seek professional tax advice for income tax questions and assistance. WrapManager, Inc. does not advise on any income tax requirements or issues.

This quiz is intended for informational and illustrative purposes only. This material is not intended to be relied on as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The information presented is general information that does not take into account your individual circumstances, financial situation or needs, nor does it present a personalized recommendation to you. The information and opinions contained in this material are derived from sources deemed reliable, are not all-inclusive and are not guaranteed as to accuracy.

The information presented by WrapManager, Inc. is general information only and does not represent tax or legal advice, either expressed or implied. You are encouraged to seek professional tax advice for income tax questions and assistance. WrapManager, Inc. does not advise on any income tax requirements or issues.

 

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