Nonresident alien taxation

This page summarizes how a non-resident alien (NRA) is taxed when investing in US-domiciled ETFs. Pay attention to the US withholding taxes and US estate taxes.

Who is a non-resident alien (NRA)?
If you are an alien (not a U.S. citizen), you are considered a nonresident alien unless you meet one of two tests. You are a resident alien of the United States for tax purposes if you meet either the green card test or the substantial presence test for the calendar year (January 1-December 31).

In short, if you are not a US citizen or green card holder and have not been in the US for 183 days (calculated over a 3 year period), you are a nonresident alien for tax purposes.

Are capital gains taxable for a nonresident alien?
No. Capital gains from US-domiciled ETFs are not taxable by the IRS. According to IRS Publication 519 :

"A nonresident alien usually is subject to U.S. income tax only on U.S. source income". "If you were in the United States for less than 183 days during the tax year, capital gains are tax exempt unless they are effectively connected with a trade or business in the United States during your tax year."

Also, according to a reply that I got for a paid consultation with Greenback Expat Tax Services Limited:

"Investing in ETFs will not count as effectively connected income and therefore any capital gains from the sale of these will be tax free as a non-resident."

US-domiciled ETFs tax withholding
Tax withholding is applied to dividends paid to you as an investor. It does not apply to capital gains, nor to interest payments. . The standard rate is 30%. This can be lowered (usually to 15%) if your country of residency has a tax treaty with the US, usually by submitting a W-8BEN form via your broker.

Estimating tax withholding leakage
Other than the tax withholding that shows on your brokerage account's statement, the fund itself gets taxes withheld on dividends received. This is usually applicable to funds holding international equities. This number affects us, but is mostly invisible unless you look at the annual reports.

For more information see: Estimating Level I tax withholding paid by US-domiciled funds.

TD Ameritrade tax withholding experiment
A test using a TD Ameritrade account and a selection of US-domiciled ETFs: MUB, BIV, LQD, BNDX, VIG, VTI and VXUS, shows that all had tax withheld at 30% from the dividends distributed, with the exception of MUB and VXUS. MUB holds US municipal bonds (which are tax-exempt from US federal taxes); VXUS holds stocks of non-US companies.



US estate taxes
If your home country does not have an estate tax treaty with the US, you risk becoming liable for US estate taxes. While the US has an extensive network of income tax treaties, only a handful of countries have estate tax treaties with the US.

Where an account holder who is a US non-resident alien passes away, the US will levy up to 40% estate tax on US assets over the value of $60,000 USD. This includes US-domiciled holdings such as ETFs, as well as cash sums in a US-based brokerage account.

"Upon the death of the beneficial owner, the U.S. brokerage firm is forbidden under U.S. tax law from transferring the assets from the decedent’s account until the IRS has concluded its estate tax audit."

A US estate tax treaty may provide protection from US estate taxes to a level equivalent to that allowed to US citizens, but the presence of a US estate tax treaty does not guarantee that this is the case. US non-resident aliens considering holding US domiciled ETFs and other US situated assets should check any applicable US estate tax treaty details very carefully before proceeding. Note that residency is not normally a sufficient condition for using a US estate tax treaty. This type of treaty is generally controlled by domicile, a legal concept that, although it includes residency as one of its components, is different and distinct from residency.

Local estate taxes may apply as well, and in the absence of a US estate tax treaty this can cause double taxation. In addition, some US estate tax treaties do not provide for estate tax credits, and this may also cause double taxation.

Foreign Account Tax Compliance Act (FATCA) and NRAs
"The Foreign Account Tax Compliance Act (FATCA) is a United States federal law that requires United States persons, including individuals who live outside the United States, to report their financial accounts held outside of the United States, and requires foreign financial institutions to report to the Internal Revenue Service (IRS) about their U.S. clients. Congress enacted FATCA to make it more difficult for U.S. taxpayers to conceal assets held in offshore accounts and shell corporations, and thus to recoup federal tax revenues."

Regarding non-U.S. clients of a foreign financial institution (FFI) who will not provide the documentation needed for FATCA:

"Generally, any account holder whose account is at least $50,000 that does not comply with reasonable requests for information necessary to determine whether its account is a United States account will be a "recalcitrant account holder" and will be subject to 30% withholding on withholdable payments and gross proceeds from the sale or disposition of U.S. assets which can produce interest or dividends".

"FATCA withholding also applies to gross proceeds from the sale of U.S. securities, which are excluded from NRA withholding. In addition, FATCA withholding may not be reduced or eliminated by making a treaty claim on a Form W-8. Where an FFI is not FATCA-compliant, full 30% FATCA withholding will apply. When FATCA withholding is required, the withholding agent does not impose withholding under the existing NRA rules. Conversely, where an FFI is FATCA-compliant, FATCA withholding will not apply, and withholding under the existing NRA withholding rules will apply (subject to treaty rates)".

To avoid running into FATCA withholding issues, it's recommended to use a FATCA-compliant broker and make sure your W-8BEN form is up-to-date. Most US brokers and larger international ones are FATCA-compliant. You can confirm by checking with your brokerage firm if you are investing in US-domiciled securities.