A few months ago, I opened a TD Ameritrade account to invest in US index funds because I believe this would help me achieve my financial goals faster. I have been buying Vanguard ETFs regularly since and plan to hold these investments for a long time.
I’m also glad to say that my TD Ameritrade post received a lot of feedback from my readers and some of you were able to successfully open accounts while some were not due to restrictions set by the government of your country of residence.
After sharing with you how to open an online brokerage account to invest in the US, I think the next logical topic to tackle is taxation on US stocks investments of non-resident aliens or NRAs.
Before I go on, I want to clarify that I am not an expert in US tax laws. It’s still best to consult with professional tax advisers.
What I’m trying to do is to attempt to put information out there and start a conversation on a topic that is not usually covered by personal finance blogs. Personal finance bloggers that write about cross-border stock investments are very rare. So those of us who want to invest in the US stock market as NRAs should band and try to learn this thing together.
Having said that, this post is a product of exhaustive research based on available online resources. This post is also informed by my years of reading about investing in the USA as well as by my former job in a multinational business intelligence provider.
This post assumes that the investor is (1) an individual, (2) an NRA, and (3) is not engaged in business or trade in the USA. A person is considered a non-resident alien if they fail to meet the following tests:
As a general rule, people are taxed in the country where the income is earned. If you earned income in the US, you have to pay income taxes in the US. This is true even if you are not a citizen or a resident of that country.
But for our purposes, we have to put a distinction between:
- Dividend income; and
- Proceeds from the sale of stocks and securities
These two kinds of incomes are treated separately by the Internal Revenue Services (IRS).
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TAXATION ON DIVIDEND INCOME
Dividend payments are considered Fixed or Determinable Annual or Periodical Income or FDAP (p.25 of IRS Publication 515 2019). FDAPs are among the income classes subject to Chapter 3 withholding.
Chapter 3 withholding is the term for a set of regimes that require withholding taxes for income from US sources. This means that dividends are subject to withholding tax, even if the beneficial owner is a foreign person.
So who will collect the withholding tax? The IRS requires the withholding agents to withhold taxes (p.3 of IRS Publication 515 2019).
A withholding agent is an entity that has control, receipt, custody, disposal, or payment of an amount subject to chapter 3 withholding. In our case, the online brokerage is the withholding agent. If you trade with TD Ameritrade, the withholding agent is TD Ameritrade. Withholding agents are personally liable for any tax required to be withheld.
Withholding is done at the time when the payment was made, whether or not there is an actual transfer of cash or other property (p.3)
Please note that the tax liability of a foreign person and the liability of the withholding agent to withhold taxes are separate.
Dividend Income Withholding Rate
Most types of US derived income earned by a foreign person is subject to a 30 percent tax rate. This may be overridden if your country and the US signed a bilateral income tax treaty setting a different tax rate for dividends.
In the case wherein your country signed a tax treaty with the US and you were not able to claim treaty status through a W-8 BEN form, the withholding agent should withhold not more than 30 percent of the gross income.
See this list to check if your country signed a tax treaty with the USA: United States Income Tax Treaties – A to Z. You need to carefully read if you are covered by a tax treaty, especially if you’re an expat living in or from a third country.
Like for example, you’re a Filipino living in Japan who invests in the US. Some tax treaties only apply to citizens and residents while some only cover citizens.
INCOME FROM THE SALE OF STOCKS
For the tax implication on the sale of stocks, I found this guide (which is actually for prospective private equity investors who want to keep their names out of US public records). It gave a clear explanation on the treatment of of how income from stocks or securities trading is to be treated.
Section 864 (b)(2)(A)(1) and (2) of the IRS Code state that the phrase “trade or business within the United States” does not include the following:
- Trading in stocks or securities through a resident broker, commission agent, custodian, or other independent agent;
- Trading in stocks or securities for the taxpayer’s own account, whether by the taxpayer or his employees or through a resident broker, commission agent, custodian, or other agent, and whether or not any such employee or agent has discretionary authority to make decisions in effecting the transactions.
You may remember that Chapter 3 withholding only applies to US source income. Since trading in stocks or securities is not considered “trade or business within the United States” it is not subject to withholding tax.
This means that NRAs are not subject to capital gains tax when they sell their US public stocks.
This does not mean, though, that you don’t pay taxes for the sale of stocks because you still do and if you don’t pay your tax liabilities, you may end up in deep shit.
Check the laws and regulations of your country of residence or citizenship regarding taxation on cross-border public stock investment. Each country has its own set of regulations.
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This post is part of my series on cross-border investing
Post 2 (this post): Taxation on US Stock Investments of Non-Resident Aliens