If you hold U.S. dividend stocks in your IRA or some other types of retirement accounts, you may not have to pay taxes on them until withdrawal. If your IRA or retirement account holds foreign dividend-paying stocks, that’s another story. These dividends may have already been taxed in their country of origin, do you won’t have to pay U.S. taxes on them. But the foreign taxes have already decreased the dividend’s value so receiving a credit or deduction on your income taxes is difficult, if not impossible. While foreign tax credits and deductions are available to some investors, that’s not generally the case when the foreign stocks are held in an IRA.
Form 1099-DIV Dividends and Distributions
If you hold foreign stocks in a taxable, or non-IRA mutual fund account, you will find your portion of any foreign income taxes paid on your Form 1099-DIV, which the mutual fund company sends you in the early part of the following year. The form shows the country or U.S. possession in question, your share of foreign income and the amount of foreign taxes that were paid. That information is found in box 6 on Form 1099-DIV.
Qualifying for the Foreign Tax Credit
Tax credits are better than deductions because they reduce your taxes on a one-to-one basis. That means a $1,000 tax credit saves you $1,000 on your tax bill. A tax deduction, on the other hand, reduces your taxable income only by the percentage of your tax rate. The IRS imposes four conditions for receiving a foreign tax credit:
- The tax is imposed on the taxpayer.
- The taxpayer has either accrued or paid the tax.
- The tax is the legal, actual foreign tax liability.
- The tax is an income tax.
The IRS considers qualified taxes paid to U.S. possessions, such as Puerto Rico, as foreign taxes.
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Foreign Taxes for Which You Cannot Take a Credit
The IRS does not permit taxpayers to take foreign tax credits on certain items, including:
- foreign mineral income
- taxes for which only itemized deductions are allowed
- portions of foreign oil and gas income
- taxes due to foreign tax splitting
The IRA Dilemma
If you hold foreign stocks in your IRA account, you’re out of luck for either the deduction or the credit. Since you aren’t paying tax on that income until you start making withdrawals, the IRS won’t let you take a credit or a deduction on the foreign taxes you've paid. The taxes on those foreign dividends are gone for good. But there's a bright side, at least for those who hold traditional IRAs. Those foreign taxes do decrease the income in your traditional IRA. When you start making withdrawals after the permissible age of 59½, or start taking mandatory withdrawals starting at age 70½, you are only taxed on the net amount you withdraw. If you have a Roth IRA account, however, withdrawals are not taxed at all, and there is no mandatory withdrawal age, so there is no type of benefit derived from making foreign tax payments.