How are foreign stocks taxed?

Many countries levy a withholding tax on dividends paid to foreign investors. Rates vary widely by country, and treaties with the US often reduce the standard domestic rate for US holders.

Your broker receives the net amount and passes it on. The gross dividend and the tax withheld both appear on your 1099-DIV, so the amount you actually received is smaller than the dividend reported as income.

You are taxed by the US on the gross dividend, not the net. Without relief that would be double taxation, which is what the credit exists to prevent.

The credit offsets your US tax dollar for dollar by the foreign tax paid, up to the US tax attributable to that foreign income.

Below a threshold amount of foreign tax, and where the income is passive, it can generally be claimed directly on your return without a separate form. Above it, Form 1116 is required and the calculation becomes more involved.

A credit is worth more than a deduction, because it reduces tax owed rather than taxable income. You can elect a deduction instead, which is occasionally better in specific circumstances, but the credit is usually the right choice.

Inside a 401(k), IRA or HSA there is no US tax on the dividend, so there is no US tax to credit the foreign withholding against.

The withholding still happens. It is simply lost, permanently, with no way to recover it. On an international equity fund that can be a fraction of a percent of the holding every single year.

This is the clearest argument in the tax code for holding international equity in a taxable account rather than a sheltered one, and it runs directly against the usual instinct to shelter everything possible.

An international fund or ETF passes the foreign tax paid through to you and reports it on the 1099-DIV, so the credit works the same way.

A fund is required to have a sufficient proportion of its assets in foreign securities to pass the credit through at all. A global fund holding mostly US stocks may not.

Some international dividends will also fail the qualified dividend test, because not every foreign issuer meets the qualifying criteria, so the qualified percentage on an international fund is often lower than on a domestic one.

Selling a foreign stock at a profit produces an ordinary US capital gain, long-term or short-term by the usual holding period rules.

Most countries do not withhold on capital gains for non-resident portfolio investors, so the double taxation problem is largely confined to dividends.

Currency movements are embedded in the dollar gain rather than reported separately for ordinary shareholdings, since your basis and proceeds are both measured in dollars.

Most US investors hold foreign companies through American Depositary Receipts, which trade on US exchanges and settle in dollars.

ADRs typically carry a depositary service fee, deducted from dividends or charged periodically. It is a cost rather than a tax, it is not creditable, and it is easy to miss because it never appears as a line item you approve.

Withholding still applies to the underlying foreign dividend, so an ADR carries both the fee and the withholding.

Holding foreign stocks through a US broker creates no additional reporting duty beyond your normal return.

Holding assets in an account at a foreign financial institution can trigger separate reporting requirements above certain thresholds, entirely distinct from income tax and with their own deadlines and penalties.

That is a compliance question rather than a tax one, and anyone with accounts outside the US should confirm their position with a tax professional.

Dividend classification, holding periods and the foreign tax credit are covered in IRS Publication 550. The foreign tax credit is described in IRS Topic 856. Walnut is informational and is not an investment adviser. This guide is educational and not personalized tax or investment advice; anything with a tax consequence is worth confirming with a tax professional.