It is human nature to organize things (unless you’re a teenager, where disorganization is often king). Likely, you have a special sock drawer dedicated solely to your socks, and you have a little box below your dashboard you refer to as your glove compartment (where, ironically, you don’t keep your gloves). Maybe it should be renamed to the napkin compartment. I digress.
Like your sock drawer and glove compartment, your tax status’ are no different, they too have clear labels and categorizations. In a brokerage firm, most accounts fall into one of three overly broad categories: retirement, domestic, or foreign. Resident aliens and permanent residents (green card holders) follow the same tax laws as U.S. citizens, so they fall under domestic reporting. Retirement accounts include IRAs, 401(k)s, and many others. And foreign accounts are held by non-resident aliens.
U.S. Dividend Income
If you are a non-resident alien wanting to trade U.S. stocks, this article is for you. As a non-resident alien, you are subject to Chapter 3 withholding. When investing in a U.S. security, any dividend income received is subject to withholding. This withholding is withheld by your broker at the time of payment. You will not have a year-end tax bill due since the withholding is remitted to the IRS on your behalf when the income is deposited into your account. The statutory tax rate is 30%; however, certain countries have entered into a treaty with the U.S. and you may qualify for a reduced rate if you are eligible and have claimed the exemption on an IRS Form W-8BEN. To learn more about tax treaties, explore the tax treaty tables section available on the IRS website.
Non-U.S. Dividend Income
Dividend income received from non-U.S. securities may already have the country of incorporations tax deducted before the income is received. The net amount is distributed to your account; additional U.S. withholding is not applicable.
In response to concerns that non-U.S. investors could avoid dividend withholding by purchasing certain equity linked instruments, U.S. Congress enacted a new withholding regime titled Section 871m. The regulations impacts in scope (delta/substantial equivalence test) equity linked derivatives which give rise to a “dividend equivalent payment”. This will primarily impact options for TD Ameritrade clients. While no income payment is actually received, the “dividend equivalent payment” is considered deemed income and is subject to withholding. The withholding is performed at your current dividend rate and is treaty eligible. Your broker will remit the withholding to the IRS on your behalf.
Tax Reporting – Form 1042-S
As a non-U.S. investor, you will be issued a Form 1042-S by mid-March for the preceding tax year on any reportable activity. Any U.S. withholding that occurred, along with the income it is attributed to, will be reported on Form 1042-S. This form is available online and is also mailed to your current mailing address on record. Additionally, the form is sent to the U.S. IRS, which then delivers the form to the Tax Authority of your country of residence. Typically, no U.S. tax filing is necessary; however, you may be required to report certain income earnings to your country.
Non-U.S. investors are required to provide their brokerage firm with a complete and valid IRS Form W-8BEN to certify their tax status. This form expires three calendar years after the signature date, unless material account information changes causing the form to become invalid prematurely. Without a valid W-8BEN on file, Internal Revenue Code Section 3406(a)(1)(B) will require TD Ameritrade to begin federal backup withholding at a rate of 28% on all taxable dividends, interest, sales proceeds (including those from options transactions), and other reportable distributions credited to your account. Notifications are sent prior to your W-8BEN expiring to remind you that new paperwork is needed.
The U.S. stock market is one of the pillars of our country’s economic system, and U.S. citizenship is not a requirement to trade U.S. securities; however, identifying the different forms and policies which apply to non-U.S. taxpayers who trade U.S. securities are important to understand. Just like organization in your sock drawer can be a beneficial part of your daily routine, a healthy dose of organization in your approach to trading U.S. securities as a non-U.S. citizen can go a long way in making the process smoother from start to finish.