Foreign Tax Credit-Statutory Withholding Rate vs. Treaty Rate - YouTube

In this YouTube video, we will discuss what to do when you receive a tax document,

such as a 1099-DIV or 1099-INT, that shows foreign taxes paid on the income earned.

For example, you received a Form 1099-DIV that shows you earned $4,000 of dividend income.

The income earned is shown in Box 1a.

Box 6 of the form shows $1,200 of foreign taxes were withheld and paid.

Box 7 identifies the foreign country, in our example, Australia.

Generally, you may claim a foreign tax credit on your U.S. individual tax return for withholding

taxes imposed on the dividend income, but only to the extent you are

legally liable for that tax.

The withholding tax rate is based on the internal tax law of the foreign country, unless a tax

treaty between the United States and that foreign country establishes

a different withholding rate.

Many countries have tax treaties with the United States.

Depending on the treaty, eligible residents or citizens of the United States may be taxed

at a reduced rate, or be totally exempt from certain foreign taxes on various types of

income earned in these foreign countries.

Many tax treaties establish reduced tax rates for dividend and interest income.

By the way, when we say foreign tax paid, as in Box 6 of the Form 1099-DIV, it means

the tax was withheld and then paid over to the foreign country (or a withholding tax).

So how much of the $1,200 foreign tax paid in the example are you legally liable for

and able to claim as a foreign tax credit?

In order to answer that question, you need to first determine if the amount of foreign

tax shown in Box 6 is the appropriate amount of withholding tax imposed on the dividends

earned in that foreign country.

Let's look at the Form 1099-DIV again.

It shows $1,200 of foreign tax paid to Australia on $4,000 of dividend income earned

in that country.

The first question to ask is, "Is there a tax treaty between Australia and the United States

that reduces or even eliminates the normal Australian withholding tax rate on

dividends earned in that country?"

Information on tax treaties and treaty withholding tax rates can be found on the IRS.gov website.

To locate this information, go to IRS.gov.

In the search box near the top right side of the screen, type "Tax Treaty Tables"

and click search.

Tax Treaty Tables – Internal Revenue Service should be the first link that appears on the

list of search results.

Click on this link.

On the next page, scroll down to Table 1 and click it.

Table 1 lists the treaty tax rates for certain types of income earned in these foreign countries.

Column 1 lists the names of the foreign countries with which the U.S. has tax treaties.

For our discussion, focus on the second and third columns, which show interest

and dividend income.

Notice that right next to the rates are alphabetic notations; these represent footnotes

at the end of the table.

This table is a convenient reference because the treaty rates for each country

for the different types of income are shown in one place.

If you need to look up additional information within the treaty itself

for a specific type of income, the table lists the relevant treaty articles.

This table shows the treaty withholding rates from the U.S. perspective, but these rates

are generally reciprocal, meaning the same treaty rates apply to both the United States

and the foreign country on the same type of income earned in these respective countries.

If in doubt, always consult with the tax treaty itself.

To locate a specific treaty article, go to the IRS.gov website and type the name of the

foreign country in the search box.

Australia is the foreign country in our example, so let's type in "Australia."

When the search results appear, look for the link to the tax treaty documents for that country

and click the link.

Multiple documents may appear on the search list for the same country.

Always select the link to the income tax treaty document for the most recent year.

What if the foreign country shown on the Form 1099 is not listed on Table 1?

It could mean the United States does not have a tax treaty currently in effect

with that foreign country.

To be certain, you should look up the tax treaty with the specific

foreign country in question.

By the way, we selected Australia as the foreign country in our example for no particular reason

other than the fact it is the first country listed on Table 1.

If there was no tax treaty between Australia and the United States,

the entire amount shown in Box 6, or $1,200, would be eligible for the foreign tax credit.

But Australia does have a treaty with the United States, and Table 1 shows a lower treaty rate

of 15 percent.

You earned $4,000 of dividend income in Australia, and since the applicable treaty rate is 15 percent,

your legal liability for foreign tax on that income is $600 ($4,000 X 15%).

Therefore, $600 is the amount of foreign taxes eligible for the foreign tax credit,

not the $1,200 shown on Form 1099-DIV.

Let's look at another example.

Instead of a Form 1099-DIV, you have received a Form 1099-INT that reports interest income

earned from a foreign investment.

The interest income is $4,000 and the foreign tax paid is $1,000.

The investment is in Austria instead of Australia.

Again, we selected Austria as the foreign country in this example for no particular

reason other than it is the second country listed on Table 1.

So we go to Table 1 and find the line in the table for Austria.

Instead of looking at the Dividends column, we now look at the Interest column.

In this instance, the treaty rate for tax withholding on interest is zero.

This means the amount shown in Box 6 should be zero because under the tax treaty with

Austria you have no legal liability to pay any foreign tax on the interest income earned

in that country.

Consequently, none of the $1,000 shown in Box 6 can be claimed as a foreign tax credit.

We strongly recommend that you visit the IRS.gov website and review the actual treaty with

the specific foreign country.

By now, you may be wondering why was so much more tax actually withheld and reported on

your Form 1099-DIV or Form 1099-INT when a treaty specified a reduced withholding rate?

And more importantly, what can you do about the amount that was overpaid?

First, if the withholding agent did not verify your status as a U.S. resident or citizen

eligible for a reduced treaty withholding rate, it will withhold at the foreign country's

higher rate based on its internal tax law.

You should contact your financial institution with any questions concerning foreign tax

withholding on income earned in foreign countries.

Note that in certain countries you may be able to provide the withholding agent with

certain forms indicating that you are eligible for a reduced rate of withholding at source

pursuant to a treaty.

Second, if you are not able to timely provide the withholding agent with the required information

to reduce the rate of withholding at source, you may be able to file a tax return with

the foreign country to obtain a refund of the excess withholding tax.

In such a case, you will likely have to demonstrate that you are a "U.S. resident," as defined

by the applicable treaty, and satisfy the requirements for obtaining the particular

benefit provided by the treaty.

The important point to understand here is that withholding taxes in excess of what you

are legally required to pay to a foreign country cannot be claimed as a foreign tax credit

on your individual U.S. income tax return.

In summary, when you receive a Form 1099-DIV or 1099-INT that shows a foreign tax paid

in Box 6 and a foreign country in Box 7, refer to Tax Treaty Table 1 on the IRS.gov website

for a quick reference.

The amount of foreign tax paid that is eligible for the foreign tax credit is based on the

reduced treaty rate (if a treaty exists and you are eligible for its benefit), regardless

of what was actually paid or withheld per Box 6 of the Form 1099.

For more information, go to irs.gov or irs.gov/foreigntaxcredit).