Many Americans overseas invest in foreign markets, but U.S. tax rules for dividends from foreign corporations can be tricky. Understanding when these dividends are qualified is vital, as taxes on such dividends are lower then the standard rates.
When Are Dividends Qualified from Foreign Corporations?
In order for dividends to be qualified, they must meet the following 3 conditions:
Holding period: The investor must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. The ex-dividend date is the cutoff date on which new buyers of the stock will not receive the upcoming dividend.
Dividends not listed with the IRS as those that do not qualify: The IRS specifically identifies some dividends that cannot be treated as qualified, regardless of other criteria. These often include dividends paid by entities such as real estate investment trusts (REITs), master limited partnerships (MLPs), and certain other regulated investment entities.
Paid by a U.S. company or a qualified foreign company: In order to be a qualified foreign corporation at least one of the following conditions need to be met:
The company is incorporated in a US possession.
The company is eligible for the benefits of a comprehensive income tax treaty with the United States.
The company is readily tradable on an established securities market in the United States.
Examples
David, a U.S. citizen, owns a private company in Germany, a country with a tax treaty with the U.S. His company does well and pays him dividends. These dividends are considered "qualified" because, despite the company being private, it's based in a country that has a tax treaty with the US. As a result, David benefits from a reduced tax rate on his dividends.
Jessica, a U.S. citizen, invested in a company in Myanmar and received dividends. Her dividends aren't "qualified" because the company is neither incorporated in a U.S. possession nor eligible under a U.S. tax treaty, as Myanmar doesn't have one with the U.S. Also, the company's stock isn't tradable on U.S. markets. As such, none of the conditions for her dividends to be taxed as "qualified" under U.S. law are met. This situation means Jessica's dividends are taxed at her normal income rate, which is higher than the rate for qualified dividends.
What Types of Dividends Are Spacifically Excluded From the Catagory of Qualified Dividends?
Dividends paid on deposits with mutual savings banks, cooperative banks, credit unions, U.S. building and loan associations, U.S. savings and loan associations, federal savings and loan associations, and similar financial institutions.
Dividends from a corporation that is a tax-exempt organization or farmer’s cooperative during the corporation’s tax year in which the dividends were paid or during the corporation’s previous tax year.
Dividends paid by a corporation on employer securities held on the date of record by an employee stock ownership plan (ESOP) maintained by that corporation.
Dividends on any share of stock to the extent you are obligated (whether under a short sale or otherwise) to make related payments for positions in substantially similar or related property.
Payments in lieu of dividends, but only if you know or have reason to know the payments are not qualified dividends.
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