Nonresident alien taxation

From Bogleheads

Nonresident alien taxation summarizes how the US applies its taxes to a non-US investor (specifically, a US nonresident alien) holding assets such as US stocks, US bonds, US cash deposits, and US domiciled ETFs and mutual funds.

Non-US investors may face both US dividend withholding taxes and US estate taxes, on top of any taxation by their country of residence. There can also be a risk of US gift taxes.

Who is a nonresident alien (NRA)?

If you are an alien (that is, you are not a US citizen), the US considers you to be 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).[1]

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 US tax purposes.

How does the US classify types of income for nonresident aliens?

For nonresident aliens, US source income falls into one of two classifications:

  • Effectively connected income (ECI).[2] This is income received from engaging in a trade or business in the US. Aside from J, F, M and Q visa holders, few nonresident alien investors will receive this type of US income. The US taxes ECI income at regular US graduated income tax rates.
  • Fixed, determinable, annual, and periodic (FDAP).[3] This is, broadly, US source income that is not connected with operating a US trade or business. For example, US bank and broker interest, US stock dividends, rent received, pensions, and annuities. This would be the most common type of income nonresident aliens receive from the US, for example, from directly holding US stocks or US domiciled ETFs. The US taxes FDAP income at either a flat 30% rate or any lower treaty rate, although with some notable exceptions,[4] in particular most interest.

The remainder of this article deals only with fixed, determinable, annual, and periodic (FDAP) income.

Are capital gains taxable for a nonresident alien?

No. The US does not tax nonresident aliens on capital gains from US domiciled ETFs and US stocks. According to IRS Publication 519:[5]

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.

— IRS Publication 519

Also, according to a reply received 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 nonresident.

— Greenback Expat Tax Services Limited

Is interest taxable for a nonresident alien?

Sometimes. Although the US generally classifies US source interest as fixed, determinable, annual, or periodical (FDAP) income,[3] and taxed at a 30% flat US rate, the wide range of exclusions[4] means that in practice the US does not actually tax the most common types of US source interest that nonresident aliens receive, such as that paid by banks, savings and loan institutions, credit unions, and insurance companies.[5][6] This means that holding US treasuries can be a tax-efficient way for you to hold some US assets.[7]

US source interest that does not fall under an exception may be taxable to the US for a nonresident alien. Examples include interest effectively connected with operating a US trade or business, and broker interest on cash deposits held at US brokers. The standard rate is 30%. You may be able to lower or eliminate this if the country you live in has a tax treaty with the US.[8][9]

Are dividends taxable for a nonresident alien?

Yes. The US will withhold tax on the dividends US domiciled ETFs and US stocks pay to nonresident aliens.

Your broker will apply this withholding to dividends paid to you as an investor. Withholding does not apply to capital gains or to interest payments.[6] A part of the dividend a US domiciled ETF pays you may be exempt from nonresident withholding; see below for more. The standard rate is 30%. If the country you live in has a tax treaty with the US, submitting a W-8BEN form to your broker should reduce this rate (usually to 15%).[8][9][note 1][note 2]

Apart from an exemption for some US source 'portfolio interest' income, also discussed below, US withholding tax applies regardless of the actual assets that a US domiciled ETF itself holds.[10] Even if all of the ETF's assets are non-US stocks, the US will still take 30% or lower treaty rate in dividend tax. Holding the same assets in a non-US domiciled ETF eliminates this US tax overhead.

If you live in a country with poor or no US tax treaty coverage, you should strongly consider using non-US domiciled ETFs instead of US domiciled ones, as a way to reduce or even eliminate the US tax you pay on dividends from funds holding stocks.[note 3]

Estimating tax withholding leakage

Other than the tax withholding that shows on your brokerage account's statement, the fund itself has taxes withheld on the dividends it receives. This is usually happens in funds that hold international equities. This withholding reduces the fund's return to investors, but it is mostly invisible unless you look at the annual reports.

Short-term capital gain distributions paid as dividends

A US domiciled ETF that pays a short-term capital gains distribution will generally include this as part of its dividend. For US investors this makes no difference to their tax or other positions.

However, the US does not tax nonresident aliens on their capital gains. In this case, an ETF should exempt the part of a dividend that is due to short-term capital gains from nonresident alien withholding. For this to occur correctly, the broker needs to be aware that the withholding rate on this payment to nonresidents is less than the standard or treaty rate.

Interest distributions paid as dividends

Where a US domiciled ETF receives US source interest on its holdings, and that interest would not have been taxable to a US nonresident if paid directly, the part of the dividend attributable to this interest is 'portfolio interest'[11] and can be exempted from nonresident withholding.[12] This situation is unlikely in ETFs that hold only stocks, but will be common in bond ETFs, and any mixed-asset ETFs.

Again, for this to occur correctly both the ETF provider and the broker need to be aware of the relevant qualified interest income (QII) regulations.

This exemption is particularly narrow. It does not apply to any non-US source interest or dividends that the ETF receives.[10] This means that a US domiciled ETF containing non-US bonds or non-US stocks suffers the standard 30% or lower treaty rate US tax on dividends. If you had instead held the ETF's assets either directly or through a non-US domiciled ETF, you would have paid no US tax.

TD Ameritrade tax withholding experiment

A test in 2015 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.[note 4][note 5][note 6] MUB holds US municipal bonds, which are tax-exempt from US federal taxes. VXUS holds stocks of non-US companies.[13]

Date Holding activity Amount
03/06/2015 01:07:48 NON-TAXABLE DIVIDENDS (MUB) 1.20
03/06/2015 01:10:05 ORDINARY DIVIDEND (BIV) 1.05
03/06/2015 01:10:05 W-8 WITHHOLDING (BIV) -0.32
03/06/2015 01:10:09 ORDINARY DIVIDEND (LQD) 1.31
03/06/2015 01:10:09 W-8 WITHHOLDING (LQD) -0.39
03/06/2015 01:12:00 ORDINARY DIVIDEND (BNDX) 0.62
03/06/2015 01:12:00 W-8 WITHHOLDING (BNDX) -0.19
03/27/2015 09:38:40 ORDINARY DIVIDEND (VIG) 2.75
03/27/2015 09:38:40 W-8 WITHHOLDING (VIG) -0.83
03/31/2015 02:17:29 ORDINARY DIVIDEND (VTI) 2.54
03/31/2015 02:17:29 W-8 WITHHOLDING (VTI) -0.76
03/31/2015 02:21:56 ORDINARY DIVIDEND (VXUS) 1.58

Is filing a US 1040-NR tax return necessary?

Generally, no. If your broker applies the correct US tax withholding for your home country (so 30% without a tax treaty, or the treaty rate if applicable), your US tax withholding will exactly match your US tax liability. In this case, and provided you have no other taxable US source income, the IRS does not require you to file a form 1040-NR nonresident alien US tax return.[14]

If you supply your broker with a form W-8BEN, this should ensure that they withhold the correct amount of US tax on your dividends.[15] The most common case where US tax withholding is incorrect is where a broker withholds 30% rather than a lower treaty rate. This can occur if you have not provided a W-8BEN, it has expired, or the broker has ignored it. In this case, you can file a form 1040-NR with the IRS to recover the overwithholding. The IRS provides a special "simplified procedure"[note 7] for this.

Are nonresident aliens at risk from US estate taxes?

Potentially, yes. Except for Canada, if you hold US domiciled ETFs or US stocks and your home country does not have a separate estate tax treaty with the US, then on your death 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.[note 8] There is no unlimited marital estate tax deduction for US nonresident aliens, except where the recipient spouse is a US citizen.[16]

Canada does not have a separate estate tax treaty with the US. Instead, the US maintains a single treaty with Canada that combines both income taxes and estate taxes. Under this combined treaty, Canadians receive protection up to the level of the US estate tax exemption allowed to US citizens, the same as the separate US estate tax treaties generally provide for other countries.[17]

Warning: Where an account holder who is a US nonresident alien dies, and there is no US estate tax treaty coverage (or marital deduction for transfers to a US citizen spouse), the US will levy up to 40% estate tax[18] on US assets over the value of $60,000 USD.[19][note 9] This includes US domiciled holdings such as funds and ETFs, as well as cash sums in a US-based brokerage account,[20][note 10] stocks of US corporations, and US IRAs, 401ks, and similar retirement saving accounts,[21][note 11] but excludes cash deposits at a US bank and most directly-held US treasury bonds.[note 12][7][22]
If you are in this situation you should strongly consider using non-US domiciled ETFs instead of US domiciled ones, and if using a US-based broker, ensure that your cash balance does not exceed $60,000. This eliminates the threat of estate taxes for most nonresident aliens, the main exception being nonresident aliens who hold US situated retirement accounts such as IRAs and 401ks.[note 13][note 11]

Even where a treaty protects you from US estate tax, there are still hurdles and delays in accessing US domiciled holdings:[23]

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.

— Charles Schwab, U.S. Tax and Estate Disclosure to Non-U.S. Persons

A US estate tax treaty may protect you from US estate taxes up to or even beyond 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. In particular, the US estate tax treaties with Ireland and South Africa may not offer worthwhile protection from US estate taxes.[24] If you are considering holding US domiciled ETFs and other US situated assets, you should check any applicable US estate tax treaty details very carefully before proceeding. 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; citizenship may also be a factor.[25]

You may face local estate taxes 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.

US estate tax liability calculator

If you do not have coverage from a US estate tax treaty, the following form[note 14] estimates your US estate tax liability for a given level of US situated assets. The result is based on the standard nonresident alien unified credit of $13,000 USD, which gives you an exemption of just $60,000 USD. (If you live in a country with a US estate tax treaty, read the relevant treaty closely to determine your own potential exposure to US estate tax.)

Are nonresident aliens at risk from US gift taxes?

Sometimes. Nonresident aliens do not face US gift tax on gifts of 'intangible property', such as most US domiciled ETFs[note 15] and US stocks,[26][27] even though these assets might be taxable under the US estate tax.

In contrast, gifts of 'tangible property', such as US situated real estate, are potentially subject to US gift tax, even when made between two US nonresident aliens with no other connections to the US. A few US estate tax treaties also cover US gift taxes.

Warning: Even though a cash deposit in a US bank is excluded under the US estate tax, the IRS views cash deposits as 'tangible property' and so subject to US gift tax.[28][29] There is no unlimited marital gift tax exemption for US nonresident aliens, except where the recipient spouse is a US citizen.[30]
If you hold any US cash accounts, you should avoid directly making any gifts of US cash above the minimal US gift tax exemption.

Foreign Account Tax Compliance Act (FATCA) and NRAs

From Wikipedia:[31]

The Foreign Account Tax Compliance Act (FATCA)[32] 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.

— Wikipedia

Regarding non-US clients of a foreign financial institution (FFI) who will not provide the documentation needed for FATCA, from Deloitte:[33]

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.

— Deloitte FATCA FAQs

From Northern Trust:[34]

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).

— Northern Trust, FAQ for Fund Managers

To avoid running into FATCA withholding, use a FATCA-compliant broker where possible, and make sure your W-8BEN form is up-to-date.[15] Most US brokers and larger international ones are FATCA-compliant. If you are investing in US domiciled securities, check with your brokerage firm to confirm this.

See also

Notes

  1. At the time of writing, the US maintains income tax treaties with Australia, Austria, Bangladesh, Barbados, Belgium, Bulgaria, Canada, China, Cyprus, Czech Republic, Denmark, Egypt, Estonia, Finland, France, Germany, Greece, Iceland, India, Indonesia, Ireland, Israel, Italy, Jamaica, Japan, Kazakhstan, Latvia, Lithuania, Luxembourg, Malta, Mexico, Morocco, Netherlands, New Zealand, Norway, Pakistan, Philippines, Poland, Portugal, Romania, Russia, Slovak Republic, Slovenia, South Africa, South Korea, Spain, Sri Lanka, Sweden, Switzerland, Thailand, Trinidad & Tobago, Tunisia, Turkey, Ukraine, United Kingdom, and Venezuela.
  2. The US terminated its tax treaty with Hungary, effective 1st Jan 2024 for dividend withholding tax. For more, see: "United States' Notification of Termination of 1979 Tax Convention with Hungary". US Treasury. July 15, 2022. Retrieved September 12, 2022. Also: "Announcement Regarding the Effective Date of Termination of the United States-Hungary Tax Treaty" (PDF). US Treasury. December 29, 2023. Retrieved January 1, 2024.
  3. The countries with poor US income tax treaties, ones that provide a US dividend tax rate that is above the 15% US/Ireland tax treaty rate, are Greece, Pakistan, Trinidad and Tobago, India, Israel, Philippines, Tunisia, and Turkey.
  4. The lack of US withholding tax on VXUS dividends seems to contradict the predictions. It was expected that the US would withhold dividend taxes on this US-domiciled fund. One possible explanation is that the dividend in question was actually payment of short-term capital gains. This type of dividend is exempt from US withholding when paid to a nonresident alien. Forum member "furion" confirms that at least one brokerage considers VXUS subject to US tax withholding, in Bogleheads forum post: "Re: Question about a Bogle wiki article". 2 Jul 2016, viewed 12 Apr 2020.
  5. Also unexpected is that the LQD and BIV dividends were all withheld at 30%. These ETFs hold only bonds, and so their dividends should be all QII, making them exempt from nonresident withholding.
  6. BNDX holds only non-US bonds, and so will not benefit from the QII exemption.
  7. The use of "simplified" here is a relative term. You should also expect a long wait for any refund from the IRS.
  8. At the time of writing, the US maintains estate tax treaties with Australia, Austria, Canada, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan, Netherlands, South Africa, Switzerland, and the United Kingdom. The estate tax treaties with Ireland and South Africa may be deficient in important areas.
  9. For example, a nonresident alien in a country without a US estate tax treaty and who held US domiciled ETFs valued at $500,000 on death would face a US estate tax liability of $142,800, and so lose 28.56% of their assets. In comparison, a US citizen with the same holdings at the same level would pay no US estate tax at all.
  10. Using a non-US subsidiary of a US brokerage or a non-US brokerage does not necessarily protect against US estate tax. For example, Interactive Brokers state that USD cash in an account held at Interactive Brokers UK is 'US situs', meaning that it is at risk from US estate tax. However, it was also confirmed that USD cash held at Interactive Brokers IE is NOT US situs and therefore not subject to US estate tax. US stocks, US-domiciled ETFs, US bonds etc held at IBIE are US situs assets though. See: Bogleheads forum post: "Re: Which cash-like investment to choose in IB (EU) for 6-12 months?", daviddem. March 21, 2023.
  11. 11.0 11.1 Nonresident aliens cannot directly open US IRAs, 401ks, and similar accounts. They might however hold on to these types of accounts when opened during a past period of US residency or citizenship, and they can also inherit them.
  12. Treasury bills and other bonds of 183 days or less in duration are considered US property for US estate tax purposes, leaving them at risk from US estate tax.
  13. For US IRAs, 401ks, and similar accounts, nonresident alien investors without estate tax treaty coverage who hold them might consider taking early withdrawals to further reduce US estate tax exposure.
  14. The tax tables for this form are taken from Wikipedia, derived from IRS Form 706 instructions, as referenced by Form 706-NA.
  15. US domiciled ETFs structured as US corporations are probably safe from US gift taxes, a consequence of the general exception for US stocks. This exception may however not apply to ETFs structured differently, for example limited partnerships.

References

  1. "Determining an Individual's Tax Residency Status". IRS. Retrieved June 11, 2023.
  2. "Effectively Connected Income (ECI)". IRS. Retrieved Jun 22, 2022.
  3. 3.0 3.1 "Fixed, Determinable, Annual, Periodical (FDAP) Income". IRS. Retrieved Jun 22, 2022.
  4. 4.0 4.1 "Nonresident Aliens - Exclusions From Income". IRS. Retrieved Jun 25, 2022.
  5. 5.0 5.1 "Publication 519, U.S. Tax Guide for Aliens" (PDF). IRS. Retrieved July 25, 2020.
  6. 6.0 6.1 "Publication 515 - Withholding of Tax on Nonresident Aliens and Foreign Entities" (PDF). IRS. Retrieved July 25, 2020.
  7. 7.0 7.1 "Nonresident aliens: U.S. estate tax on treasury bills". Free Online Library. Retrieved July 16, 2022.
  8. 8.0 8.1 "NRA Withholding". IRS. Retrieved July 25, 2020.
  9. 9.0 9.1 "Tax Treaty Tables". IRS. Retrieved May 27, 2019.
  10. 10.0 10.1 Jeffrey M. Colon. "Foreign Investors in U.S. Mutual Funds: The Trouble with Treaties, p. 487". Fordham. Retrieved May 26, 2019.
  11. "Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities". IRS. Retrieved August 6, 2020.
  12. "Permanent U.S. Withholding Tax Relief for Non-U.S. Investors in U.S. Mutual Funds". K&L Gates. Retrieved May 23, 2019.
  13. "Publication 515, Income subject to withholding, Withholding of Tax on Nonresident Aliens". IRS. Retrieved April 3, 2015.
  14. "About Form 1040-NR, U.S. Nonresident Alien Income Tax Return". IRS. Retrieved February 13, 2020.
  15. 15.0 15.1 "About Form W-8 BEN, Certificate of Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities)". IRS. Retrieved January 12, 2023.
  16. "Don't Fall Victim to This Devastating U.S. Estate Tax Trap". Creative Planning. Retrieved January 8, 2024.
  17. "Canada - Tax Treaty Documents". IRS. Retrieved August 9, 2020.
  18. "Estate and Gift Taxes for Nonresident Aliens". Congressional Research Service. June 2, 2014. Retrieved August 7, 2020.
  19. "Estate tax in the United States". Wikipedia. Retrieved July 25, 2020.
  20. "Estate taxation of a nonresident alien" (PDF). JPM Financial Services. Retrieved July 25, 2020. (Archived December 15, 2022, at the Wayback Machine)
  21. "Financial Planning For Foreign Nationals in the U.S." Creative Planning. Retrieved July 27, 2022.
  22. "U.S. Treasury bill is includable in nonresident alien's estate". Tax Notes. Retrieved July 16, 2022.
  23. "U.S. Tax and Estate Disclosure to Non-U.S. Persons" (PDF). Charles Schwab. Retrieved July 25, 2020.
  24. "United States Estate and Gift Tax - An Overview for Foreigners Investing in the United States" (PDF). Kohnen & Patton LLP. Retrieved February 13, 2020.
  25. "Estate, Gift, and Generation-Skipping Transfer Tax Treaties" (PDF). SMU Law Review. 1983. Retrieved August 1, 2020.
  26. "U.S. Gift Taxation of Nonresident Aliens". Kerkering, Barberio & Co. Retrieved August 8, 2020.
  27. "Gift Tax for Nonresidents not Citizens of the United States". IRS. Retrieved August 8, 2020.
  28. "U.S. Estate and Gift Planning for Non-Citizens". SGR Law. Retrieved May 9, 2021.
  29. "Gifts of cash by nonresidents are surprisingly taxable". HodgenLaw PC. Archived from the original on October 27, 2020.
  30. "Frequently Asked Questions on Gift Taxes for Nonresidents not Citizens of the United States". IRS. Retrieved January 8, 2024.
  31. "Foreign Account Tax Compliance Act". Wikipedia. Retrieved July 25, 2020.
  32. "Foreign Account Tax Compliance Act". IRS. Retrieved July 25, 2020.
  33. "FATCA Frequently Asked Questions (FAQs) - Bullet 39" (PDF). Deloitte. Retrieved July 25, 2020.
  34. "FAQ for Fund Managers - Bullet 9, page 6" (PDF). Northern Trust. Archived from the original (PDF) on March 10, 2013. Retrieved June 11, 2023.

Further reading

External links