WSJ Ask an Expert: Tips for U.S. Expats: Using Foreign Credits to Avoid Double Tax on Investment Income
The Wall Street Journal invited Creveling & Creveling to be part of a panel of experts for personal finance on its WSJ Expat site. The following article originally appeared on the WSJ site and has been shared with permission:
As Americans living overseas know, U.S. citizens and green-card holders must pay U.S. tax on their worldwide income, no matter where they live or are considered tax residents. In recent years, the introduction of the Foreign Account Tax Compliance Act has dramatically increased the requirements for tax reporting. While the new reporting requirements are burdensome to say the least, the good news is that by making full use of foreign tax credits, you can lower your U.S. taxes due while avoiding paying double tax on foreign investment income.
Most U.S. expat taxpayers are already using U.S. tax breaks on their income from foreign salaries to help lower their overall tax bill. These include the foreign-earned income exclusion and foreign housing deduction or allowance. However, U.S. expats are not always taking advantage of foreign tax credits that may be available for non-salary income such as on investments.
For example, if you're a U.S. expat with a foreign bank or brokerage account, or a shareholding in a foreign company, chances are you are receiving interest or dividend income from your foreign investment and that you pay foreign tax on the income. The taxes may be paid in an annual tax filing in your country of residence, or they may be withheld or netted off the income at source. In other words, there might be a third country involved, the country where the investment paying the dividend is actually located. For Americans overseas, that third country might get first dibs on taxing the income, followed by the country of residence, and then the U.S. But with treaty protection, Americans should only have to pay a total tax of the highest rate of the three countries involved, not three times the tax, which sometimes happens. In some cases, the tax isn't explicitly shown in a transaction, and some expats may not even realize there was already tax withheld.
What you need to know is that the final foreign tax that you owe on the foreign income, adjusted for any double taxation treaties, can be used as a foreign tax credit to reduce your U.S. tax liability. Here are some examples:
- As a tax resident of Thailand, your bank paid you net interest income on your account after withholding a 15% tax. The 15% withheld is considered your final tax owed in Thailand. By filing Form 1116-Foreign Tax Credit, you can apply the Thai tax withheld as a foreign tax credit against any U.S. tax that might be owed on the same interest income.
- As a tax resident of Hong Kong, you own shares in Nestlé, a Swiss company, through an international brokerage account. When Nestlé pays a dividend, according to Swiss law, a 35% tax is initially withheld at source, which in this case would be Switzerland. However Hong Kong does not charge its residents tax on investment income earned overseas and under the double tax treaty between Hong Kong and Switzerland, a lower Swiss tax rate applies, typically around 15%. You can first reclaim a portion of the taxes withheld by requesting a refund in Switzerland. Next, you can use the remaining final tax as a foreign credit on Form 1116 against the U.S. dividend tax you owe. Since Nestlé is a listed company, the U.S. tax rate on qualified dividends would apply.
- As a tax resident of the United Arab Emirates, you receive dividends from a Singapore business that you partly own. Singapore withholds 15% tax on dividends. The U.A.E. does not tax residents on overseas investment income and there is no double-taxation treaty between the U.A.E. and Singapore, so 15% is the final tax owed. You can use the 15% tax withheld as a foreign tax credit against U.S. taxes owed by filing Form 1116.
- Through a U.S. brokerage account you purchase exchange traded funds that invest in shares in foreign companies. On its year-end 1099 in box 6, your U.S. broker reports "Foreign Tax Paid" by the ETFs, which is the foreign tax withheld at source on the dividends paid by the foreign stocks in your ETFs. By filing Form 1116 you can apply the foreign tax paid as a credit against the U.S. tax you would owe on the foreign dividend income. Note that to use the foreign tax paid as a credit on your annual U.S. filing you cannot own the foreign ETFs in a 401(k), IRA or other U.S. tax-advantage accounts, which might be either U.S. tax-deferred or tax-free accounts.
For many expat Americans who earn overseas investment income, savings from these credits can add up to hundreds or even thousands of dollars in a single tax year alone. If you haven't been making full use of foreign tax credits to save on your U.S. tax bill, now is the time to start.
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About Creveling & Creveling Private Wealth Advisory
Creveling & Creveling is a private wealth advisory firm specializing in helping expatriates living in Thailand and throughout Southeast Asia build and preserve their wealth. The firm is a Registered Investment Adviser with the U.S. SEC and is licensed and regulated by the Thai SEC. Through a unique, integrated consulting approach, Creveling & Creveling is dedicated to helping clients cut through the financial intricacies of expat life, make better decisions with their money, and take the steps necessary to provide a more secure future. For more information, visit www.crevelingandcreveling.com.