Tax Withheld on Foreign Dividends?
April 11, 2013 3:43 PM Subscribe
Last year, I bought shares in Royal Dutch Shell (RDS.A), because I like the $3.44/share dividend they pay, making it a good place to park spare investing cash. (That is, I don’t really care about the share price, if only up to a point, as long as my investment is yielding 5.32% annually.)
Foreign tax is withheld on the dividend payments, which I get back by claiming the total as a foreign tax credit on my federal tax return.
What I don’t understand is, when foreign tax is withheld, who is withholding it? Am I correct in assuming that it is an IRS-mandated withholding, and that by claiming the credit the withholding is canceled out?
Any comments addressing my “spare investing cash” strategy also invited.
The foreign tax withheld here isn't going to the IRS, it is going to the foreign country concerned (for RDS.A, I believe it is the Netherlands, but your 1099-DIV should say for sure). That tax is paid to the foreign government because you likely owe them some amount of tax on the dividends, and they don't think you're particularly likely to pay up voluntarily as someone living on the other side of the planet with no ties to their country. Since you're not going to be filing a Dutch tax return anytime soon, the withholding makes sure that the Netherlands get their tax revenue without any action on your part.
So Shell (or an agent who handles such things) takes out the withholding and pays it to the Dutch government on your behalf before you get your dividend. Instead of having to go to the Netherlands to get any money back, you can take the US foreign tax credit and have your US tax bill reduced by, ideally, the same amount you paid in tax to the Netherlands. Since this is US tax law we're talking about, some restrictions apply, and you might not be able to get the full amount back, especially if you have an especially high or low income or the stock is held in a tax-advantaged retirement account.
You should note that there are some additional options with RDS's two share classes, about which Seeking Alpha nicely discusses the tax differences. The distinction is particularly useful if you become subject to the AMT, which can reduce your foreign tax credit.
posted by zachlipton at 5:14 PM on April 11, 2013 [1 favorite]
So Shell (or an agent who handles such things) takes out the withholding and pays it to the Dutch government on your behalf before you get your dividend. Instead of having to go to the Netherlands to get any money back, you can take the US foreign tax credit and have your US tax bill reduced by, ideally, the same amount you paid in tax to the Netherlands. Since this is US tax law we're talking about, some restrictions apply, and you might not be able to get the full amount back, especially if you have an especially high or low income or the stock is held in a tax-advantaged retirement account.
You should note that there are some additional options with RDS's two share classes, about which Seeking Alpha nicely discusses the tax differences. The distinction is particularly useful if you become subject to the AMT, which can reduce your foreign tax credit.
posted by zachlipton at 5:14 PM on April 11, 2013 [1 favorite]
As a general rule, any investment which yields a higher return than you would get investing in treasury bonds or in a savings account is worthwhile - in the US yields on savings are at historic lows, and because of inflation you actually lose money if you let it sit in a savings account or T-bills. However, if you are not putting your shares in an IRA, tax has to be taken into consideration and subtracted from your returns to give you an accurate picture of your net gains. Here's another Seeking Alpha article about tax implications of ADRs.
Something else to consider for non-IRA investments is that your tax rate on gains is much lower if you hold your shares for at least a year. Dividends are taxed at a different rate, but that's only for qualified dividends (many ADRs do not qualify, and sometimes their dividends are considered ordinary income by the IRS). If you invest in a solid company with a proven dividend track record, and if you reinvest your dividends in more shares rather than taking it in cash, your yield on your dividends is compounded (usually quarterly, or whenever the dividend is paid). Compound interest is a very powerful investment tool over time. Also, you're correct- the share price itself is mostly irrelevant. What matters is gains, yield, tax rates, etc.
The main problem I see with your current approach is that you didn't understand the tax implications of your investment before you put your money at risk. All investment carries risk. Understanding and mitigating or managing risk is the key to investing. Also, you really do want to take into consideration how much hassle certain types of investments will be, not only for initial research, but also the work you will have to do later when filling out your tax forms (or how much you will have to pay someone else to do it). Some investments will give you slightly better returns than others but sometimes have outright Byzantine layers of taxes involved from numerous countries, states, municipalities, etc (many funds have these issues). The hassle may or may not be worth it to you, even for larger potential gains, but in any event it's always worth taking the time to research thoroughly any investment before putting your money on the table, and to understand your objectives and strategies as an investor and how any particular company would fit into that strategy and help meet your objectives, and most importantly, what's your plan if your investment loses value - if you don't know, don't put your money at risk!
It's not as hard as it sounds (as long as you're not being unrealistic about your goals), but if you don't do the work you will get slapped around by the market sooner or later. Depending on how much money you have at risk, that could be a seriously painful lesson, so instead learn to mitigate your risk as much as possible by doing your homework and following an investment strategy and plan. Honestly, if you do the basic research by looking at the balance sheet and financial and earnings history of the company, you'll be way ahead of the vast majority of people who manage their own investments, and even those who pay others to do it for them.
posted by krinklyfig at 6:28 PM on April 11, 2013 [1 favorite]
Something else to consider for non-IRA investments is that your tax rate on gains is much lower if you hold your shares for at least a year. Dividends are taxed at a different rate, but that's only for qualified dividends (many ADRs do not qualify, and sometimes their dividends are considered ordinary income by the IRS). If you invest in a solid company with a proven dividend track record, and if you reinvest your dividends in more shares rather than taking it in cash, your yield on your dividends is compounded (usually quarterly, or whenever the dividend is paid). Compound interest is a very powerful investment tool over time. Also, you're correct- the share price itself is mostly irrelevant. What matters is gains, yield, tax rates, etc.
The main problem I see with your current approach is that you didn't understand the tax implications of your investment before you put your money at risk. All investment carries risk. Understanding and mitigating or managing risk is the key to investing. Also, you really do want to take into consideration how much hassle certain types of investments will be, not only for initial research, but also the work you will have to do later when filling out your tax forms (or how much you will have to pay someone else to do it). Some investments will give you slightly better returns than others but sometimes have outright Byzantine layers of taxes involved from numerous countries, states, municipalities, etc (many funds have these issues). The hassle may or may not be worth it to you, even for larger potential gains, but in any event it's always worth taking the time to research thoroughly any investment before putting your money on the table, and to understand your objectives and strategies as an investor and how any particular company would fit into that strategy and help meet your objectives, and most importantly, what's your plan if your investment loses value - if you don't know, don't put your money at risk!
It's not as hard as it sounds (as long as you're not being unrealistic about your goals), but if you don't do the work you will get slapped around by the market sooner or later. Depending on how much money you have at risk, that could be a seriously painful lesson, so instead learn to mitigate your risk as much as possible by doing your homework and following an investment strategy and plan. Honestly, if you do the basic research by looking at the balance sheet and financial and earnings history of the company, you'll be way ahead of the vast majority of people who manage their own investments, and even those who pay others to do it for them.
posted by krinklyfig at 6:28 PM on April 11, 2013 [1 favorite]
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posted by Admiral Haddock at 4:53 PM on April 11, 2013 [1 favorite]