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My question is about how to avoid tax hassles on foreign dividends in an IRA. I have a Roth IRA, but I understand that foreign nations will take hefty taxes out of dividends if the company is domiciled there, but the rules vary by country as some have agreed with the USA to keep their taxes on ADRs low. Switzerland may be a country that is difficult for Americans to deal with, but Great Britain is much easier. So I heard one should just put foreign stocks into taxed accounts, but I want more international exposure plus dividends in my IRA. Can I use country specific ETFs that offer dividends to help?

Here's a sample target company on the left, the country from which it originates in the middle, and the iShares country-specific ETF on the right:

GSK (Great Britain) EWU
POT (Canada) EWL
BHP (Australia) EWA
NVS (Switzerland) EWL
BAMXF (Germany) EWG
SNY (France) EWQ
STO (Norway) FILL (Global Energy Producers)
VALE (Brazil) EWZ
SNE (Japan) EWJ
TSM (Taiwan) EWT

Is it correct to say that for a Roth IRA, basically, do not put any specific foreign companies in there if you want avoid both a pretty big chunk taken out in foreign taxes and the possible difficulties involved with applying for a partial refund? Just how involved is the process? Does anyone know the percentage for taxes on the above countries or any agreements with those countries?

Can the problem be avoided by putting the country-specific ETF into the IRA (let's assume it has some of the target company), as the ETF deals with the tax issues of worry – meaning any dividends received from the ETF are free and clear in my account?

While I am on the topic, I should ask if the “ETF hassle-free tax strategy” above may be applied to ETFs of REITS or MLPs in an IRA as well?
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My question is about how to avoid tax hassles on foreign dividends in an IRA. I have a Roth IRA, but I understand that foreign nations will take hefty taxes out of dividends if the company is domiciled there, but the rules vary by country as some have agreed with the USA to keep their taxes on ADRs low. Switzerland may be a country that is difficult for Americans to deal with, but Great Britain is much easier. So I heard one should just put foreign stocks into taxed accounts, but I want more international exposure plus dividends in my IRA. Can I use country specific ETFs that offer dividends to help?

Maybe I'm missing something, but it seems to me that regardless of the machinations you go through the foreign country is going to take its tax bite out of what you eventually get. You may not be paying it directly and have the "ouch" factor of seeing it itemized, but it's being paid for you somewhere along the line.

Information on treaties is in Publication 901.

The reason for keeping foreign investments in a taxable account is that you can take advantage of the foreign tax credit. Since an IRA is a distinct tax-exempt legal entity, there's no tax to apply the credit to.

REITs don't present a problem in IRAs. In fact, IRAs are a good place to keep them since they tend to throw off a lot of ordinary income.

IMO MLP's rarely present a problem in IRAs, but they also lose their tax-free cash cow aspect.

I think that covers everything except

Is it correct to say that for a Roth IRA, basically, do not put any specific foreign companies in there if you want avoid both a pretty big chunk taken out in foreign taxes and the possible difficulties involved with applying for a partial refund?

I have no idea what partial refund you're talking about. Can you clarify?

Phil
Rule Your Retirement Home Fool
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I do have some areas of confusion and thank you for being patient. I have a CPA handling my taxes because I have lived abroad for a number of years, and pay taxes here in this foreign country. Until recently I have not worried about filing in the USA because I would have needed to earn above 70k in US dollars for me to pay taxes in both countries. Incomes are lower here in Asia where I live, but so are expenses, so it has been a good deal.

I had assumed and been told that I could not open a Roth IRA because I was not physically present in the USA. This turned out to be untrue as my CPA said as long as I file, I can have the Roth, and since I intend to return to home sweet home one day I want to build up a nest egg via a Roth. I am about 20 to 25 years from retirement now.

Perhaps my confusing stemmed from not understanding to which government I was applying for the refund – the tax credit. I had assumed that if the USA had a tax treaty with a country such as Great Britain, and Britain had withheld taxes on my GSK, then I would be applying to Britain for the refund to get the difference between what I would have paid the US government and what I actually paid the British government. But after re-reading your response (and some of Publication 901) I see that I must be applying to the US government for the tax credit. Ah! Perhaps that is why you said:

“The reason for keeping foreign investments in a taxable account is that you can take advantage of the foreign tax credit. Since an IRA is a distinct tax-exempt legal entity, there's no tax to apply the credit to.”


Now, there are many reasons for keeping foreign investments besides the obvious – you think that company is well-run and will outperform other investment opportunities. Taking the example of NVS and EWL, we have excellent choices of a Swiss Pharma with a deep pipeline that also owns about one-third of Roche. EWL is a hit list of some excellent European companies, including both Novartis and Roche, but also Nestle, Syngenta, UBS, and Credit Suisse in its top ten. This also provides indirect exposure to the Swiss Franc, which has appreciated tremendously of late. As far as Switzerland is concerned, I think neither my regular brokerage account nor my Roth IRA is a “distinct tax-exempt legal entity.”

So I believe the foreign government gets its taxes before the dividends hit my account. If it is an individual company, I thought I might apply for the tax credit, but for the ETFs, I thought iShares or the managing company would have handled it, so dividends received are post tax credit. While I know I can apply for the tax credit in the taxed account, I am asking if it can be done as well in the Roth IRA. Since taxes have already been paid on any income going into a Roth, I do not want to lose anything else to taxes there or have to file paperwork I barely understand. For someone who has a traditional IRA they may accept it from the start.

To try to clarify – if I have enough of an individual foreign stock in my Roth IRA that is putting out $1000 in annual dividends per year, I am worried about taxes from the foreign government on the $1000. For my country, taxes have already been paid going in, so dividends would accrue tax free going forward. So my $1000 stays at $1000. But if it is a French company like TOT, the French government might take out 50% and I would only have $500. Perhaps if it had been BP, the British government would have a more amenable agreement with the USA government, so that percentage would be much lower.

I understand that if those stocks were in my taxed account, and say my tax rate was 30%, then I could apply – I thought that was to the foreign government – for the difference from what was actually withheld, say 50%, and what my government would have withheld, say 30%. So I can get back the 20% with the application for taxed accounts. Now what about IRAs – both traditional and Roth?

Then I try to avoid the problem with ETFs and ask, assuming that either I will not be able to get back any kind of refund on foreign dividend taxes or just like you said – I won’t put foreign dividend producing stocks there in my IRA to begin with – what about the country-specific ETFs? If I put a country specific ETF in my IRA, the foreign country is not going to take tax out of the dividends from the ETF, correct? Now yes, maybe that foreign government has got its cut already through the ETF company, such as iShares, but it does two things, at least – eliminates the need for worrying about paperwork for refunds via the tax credit, and still gets me dividend-producing foreign exposure in the IRA.


The REIT and MLP question should have been done separately in another post, but this sentence of yours confused me a bit:

“IMO MLP's rarely present a problem in IRAs, but they also lose their tax-free cash cow aspect.”

All I could find on Fool.com was an article from early 2013 called “An Investor’s Guide to Master Limited Partnerships.”

But I think your response on MLPs has left out some important information, so let me start with my assumptions: I want to start with a small position in an MLP and then build it up both with additional purchases of shares and by reinvesting dividends. My brokerage account can only be set to an “all reinvest dividends” or “all dividends to cash” mode. With those things in mind, I want to start building up, over a 20 or more year period, a large position in one or two MLPs. However I found out that after $3000 annually, MLP dividend income in Roth IRAs are taxed. That would kill the advantage of compounding, and at some later point I would not want to just sell out or reset the account to “dividends to cash” mode.

I am not sure now where the source of my information is, and if it applies to REITS or not. But this sort of information leads me to believe MLPs may be good for my taxed account, and just OK for my IRA as long as I accept the limitation above.

Thanks for your help and patience!

Rob (aka TempoAllegro)
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I do have some areas of confusion and thank you for being patient. I have a CPA handling my taxes because I have lived abroad for a number of years, and pay taxes here in this foreign country. Until recently I have not worried about filing in the USA because I would have needed to earn above 70k in US dollars for me to pay taxes in both countries.

I have delayed responding to this in hopes that someone who knows more than I about international issues would jump in. So maybe when they read some of my wrong statements we'll hear from them.

First, I assume you are a US citizen or permanent resident. I can't find anything that exempts you from filing. In fact, the 1040 instructions explicitly include foreign income even if it's excludable from US taxation. Does your CPA know you're not filing? If so, ask for an explanation of why the 1040 instructions don't apply to you. If not, 'fess up.

I had assumed and been told that I could not open a Roth IRA because I was not physically present in the USA. This turned out to be untrue as my CPA said as long as I file, I can have the Roth, and since I intend to return to home sweet home one day I want to build up a nest egg via a Roth. I am about 20 to 25 years from retirement now.

Well, it seems everyone's wrong, including whoever it was who gave you a physical presence test. If you look at IRS Publication 590 you'll find that your IRA contribution amount is limited to the lesser of $5,500 (2013) or your "taxable compensation." Since the foreign earned income exclusion means that portion of your income isn't taxed, it can't be used as the basis for IRA contributions.

Perhaps my confusing stemmed from not understanding to which government I was applying for the refund – the tax credit. I had assumed that if the USA had a tax treaty with a country such as Great Britain, and Britain had withheld taxes on my GSK, then I would be applying to Britain for the refund to get the difference between what I would have paid the US government and what I actually paid the British government. But after re-reading your response (and some of Publication 901) I see that I must be applying to the US government for the tax credit. Ah! Perhaps that is why you said:

“The reason for keeping foreign investments in a taxable account is that you can take advantage of the foreign tax credit. Since an IRA is a distinct tax-exempt legal entity, there's no tax to apply the credit to.”


Now, there are many reasons for keeping foreign investments besides the obvious – you think that company is well-run and will outperform other investment opportunities. Taking the example of NVS and EWL, we have excellent choices of a Swiss Pharma with a deep pipeline that also owns about one-third of Roche. EWL is a hit list of some excellent European companies, including both Novartis and Roche, but also Nestle, Syngenta, UBS, and Credit Suisse in its top ten. This also provides indirect exposure to the Swiss Franc, which has appreciated tremendously of late. As far as Switzerland is concerned, I think neither my regular brokerage account nor my Roth IRA is a “distinct tax-exempt legal entity.”


OK, I'm lost. I have no idea, nor do I care, what Switzerland thinks about anything. I'm just talking about US tax law, and under that law an IRA of any stripe is a separate tax-exempt legal entity. Your taxable brokerage account is not a legal entity of any sort. It's simply one of your personal assets, the income from which is taxed on your personal return.

So I believe the foreign government gets its taxes before the dividends hit my account.

That's the way I've always seen it work.

If it is an individual company, I thought I might apply for the tax credit, but for the ETFs, I thought iShares or the managing company would have handled it, so dividends received are post tax credit. While I know I can apply for the tax credit in the taxed account, I am asking if it can be done as well in the Roth IRA.

No, for reasons already stated.

Since taxes have already been paid on any income going into a Roth, I do not want to lose anything else to taxes there or have to file paperwork I barely understand. For someone who has a traditional IRA they may accept it from the start.

Sorry, but I don't understand your logic. But no matter. Your conclusion, regardless of how you got there, is wrong.

To try to clarify – if I have enough of an individual foreign stock in my Roth IRA that is putting out $1000 in annual dividends per year, I am worried about taxes from the foreign government on the $1000.

And I keep telling you that regardless of what kind of account you hold that stock in, you're going to pay that foreign tax. If a mutual fund or ETF (also tax-exempt entities) hold the shares, they pay the foreign tax, but nobody in either scenario gets a benefit from the foreign tax credit.

For my country, taxes have already been paid going in, so dividends would accrue tax free going forward. So my $1000 stays at $1000. But if it is a French company like TOT, the French government might take out 50% and I would only have $500. Perhaps if it had been BP, the British government would have a more amenable agreement with the USA government, so that percentage would be much lower.

OK, I'm lost again. Is "my country" the US? If so, you don't understand how the taxation of dividends works. See Publication 550 for an explanation.

I understand that if those stocks were in my taxed account, and say my tax rate was 30%, then I could apply – I thought that was to the foreign government – for the difference from what was actually withheld, say 50%, and what my government would have withheld, say 30%. So I can get back the 20% with the application for taxed accounts. Now what about IRAs – both traditional and Roth?

Taxable account: that's not how it works. See Form 1116. IRAs: no credit, no matter how many times you ask.

Then I try to avoid the problem with ETFs and ask, assuming that either I will not be able to get back any kind of refund on foreign dividend taxes or just like you said – I won’t put foreign dividend producing stocks there in my IRA to begin with – what about the country-specific ETFs? If I put a country specific ETF in my IRA, the foreign country is not going to take tax out of the dividends from the ETF, correct?

Beats me, but I have no idea why they wouldn't.

Now yes, maybe that foreign government has got its cut already through the ETF company, such as iShares, but it does two things, at least – eliminates the need for worrying about paperwork for refunds via the tax credit, and still gets me dividend-producing foreign exposure in the IRA.

The foreign tax credit isn't all that complicated, as you'll see when you look at Form 1116.

The REIT and MLP question should have been done separately in another post, but this sentence of yours confused me a bit:

“IMO MLP's rarely present a problem in IRAs, but they also lose their tax-free cash cow aspect.”

All I could find on Fool.com was an article from early 2013 called “An Investor’s Guide to Master Limited Partnerships.”

But I think your response on MLPs has left out some important information, so let me start with my assumptions: I want to start with a small position in an MLP and then build it up both with additional purchases of shares and by reinvesting dividends. My brokerage account can only be set to an “all reinvest dividends” or “all dividends to cash” mode. With those things in mind, I want to start building up, over a 20 or more year period, a large position in one or two MLPs. However I found out that after $3000 annually, MLP dividend income in Roth IRAs are taxed.


I'd love to know where you found that out, because I've never heard of that rule. IF, and that's a big IF, your IRA receives more than $1,000 of "unrelated business income" in a year it must file a return, but that doesn't mean that a specific MLP will yield the type of income that creates this liability. You were right. If you want to pursue a discussion of MLP's, start a new thread.

Phil
Rule Your Retirement Home Fool
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Dear Sir:

I wonder how you would have felt at receiving such a reply as the one you just gave?
A few quotes may help you understand:

I say there is no darkness but ignorance. - Shakespeare
A fool thinks himself to be wise, but a wise man knows himself to be a fool. -Shakespeare
Our doubts are traitors and make us lose the good we oft might win by fearing to attempt. -Shakespeare


So I know I am messed up about foreign dividends and taxes, and I will just go to the IRS web site and read forms 901, 590, 1116, and the instructions to 1040 very carefully. Last I heard, the IRS was just fine with me (no pun intended), but I doubt I’ll ask questions ‘round here too soon again.

Have you heard this one about lawyers?

Lawyers are the only persons in whom ignorance of the law is not punished. - Jeremy Bentham

Perhaps there should be a corollary for errant CPAs:
“Accountants are the only persons in whom ignorance of the tax laws are not fined”?

You spanked me pretty hard, but all in good fun. At this point I think I will just avoid dividends, and avoid the tax board! Good luck to all.

TempoAllegro
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Tempo,

I have read through some of this confusing mess. Phil gave you some good, detailed answers. Here is the short version:

1. Taxes withheld from dividends paid to stock, mutual funds or ETFs held inside any type of tax-advantaged account, IRA/401k/403b/etc, are lost money to you. If you own an ETF, the ETF has the tax withheld and pays you the remainder.

2. If you hold these items in a taxable brokerage, you file for the tax credit on your US tax return.

Gene
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