Nonqualified Intermediary and U.S. Tax Withholding
Learn the U.S. tax implications of investing via a nonqualified intermediary, including how to manage withholding and recover potential tax overpayments.
A nonqualified intermediary (NQI) is a foreign financial institution, like a bank or broker, that holds U.S. securities for its non-U.S. clients. These entities are “nonqualified” because they have not entered into an agreement with the Internal Revenue Service (IRS) to assume primary tax withholding responsibilities. An NQI acts as a pass-through entity, holding assets and processing transactions for its foreign customers.
When a foreign investor buys U.S. stocks or bonds, they often use a financial institution in their home country, which may be an NQI. This institution holds the securities in its own name at a U.S. custodian on behalf of the investor. The NQI is part of a payment chain that moves investment returns from the U.S. to the foreign owner, and its nonqualified status dictates how U.S. tax obligations are handled.
Tax Withholding and Reporting Obligations
Income earned by non-U.S. persons from U.S. sources is subject to a specific tax regime for Fixed, Determinable, Annual, or Periodical (FDAP) income. Common examples include dividends from U.S. corporations and certain types of interest. The default U.S. tax rule requires the payer to withhold tax at a flat 30% rate before sending the funds to the foreign recipient.
Because an NQI does not have a “Qualified Intermediary” (QI) agreement with the IRS, it cannot reduce the 30% withholding rate itself. The responsibility for applying the correct tax rate falls to an upstream U.S. withholding agent, which is a U.S. bank or broker holding the NQI’s account. The NQI’s role is to provide client documentation to this U.S. agent, which allows the agent to perform the required withholding.
The NQI must provide the U.S. agent with Form W-8IMY, “Certificate of Foreign Intermediary,” to declare its status. Along with this form, the NQI must pass along client information, either through individual W-8 forms or a pooled withholding statement. If the NQI fails to provide adequate documentation, the U.S. agent must apply the full 30% withholding rate to all payments, even if an investor is eligible for a lower treaty rate.
Required Documentation for Investors
Foreign investors using an NQI must provide correct documentation to lower the U.S. tax withheld on their investment income. The primary document is Form W-8BEN, “Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Individuals).” This form is submitted to the NQI, which forwards its details to the U.S. withholding agent, certifying the investor is not a U.S. person and is the owner of the income.
To complete Form W-8BEN, the investor must provide specific personal information that helps the U.S. withholding agent verify their foreign status. This includes:
- Full name
- Country of citizenship
- A permanent residence address outside the United States
- U.S. taxpayer identification number (TIN), if applicable, and a foreign tax identifying number
Form W-8BEN also allows investors to claim benefits under an income tax treaty between their country of residence and the United States. In Part II of the form, an investor certifies their country of tax residency. They must also identify the treaty article that allows for a reduced withholding rate and state the specific rate they are claiming.
Investors should complete Form W-8BEN accurately and provide it to their NQI when opening an account or before receiving U.S. source income. The form can be downloaded from the IRS website. It remains valid for the year it is signed and for the three following calendar years, after which a new form must be submitted.
Understanding Tax Forms Received
After the tax year, an investor who received U.S. source income through an NQI will receive Form 1042-S, “Foreign Person’s U.S. Source Income Subject to Withholding.” This form is issued by the U.S. withholding agent who paid the tax to the IRS, not the NQI. It serves as the record of income earned and tax withheld.
Form 1042-S details the gross income paid to the investor, the tax rate applied, and the total U.S. federal tax withheld. It will show whether the standard 30% rate was applied or if a lower treaty rate was used based on the investor’s Form W-8BEN.
Form 1042-S should be distinguished from the Form 1099 series, which reports income paid to U.S. persons. Form 1042-S serves a similar function but is exclusively for income paid to non-resident aliens who have certified their foreign status.
Filing for a U.S. Tax Refund
If the tax withheld on Form 1042-S is more than what is legally owed, an investor can file a U.S. tax return to claim a refund. This can happen if the full 30% rate was applied instead of an applicable lower treaty rate, sometimes due to a delay in processing Form W-8BEN.
To claim a refund, the investor must file Form 1040-NR, “U.S. Nonresident Alien Income Tax Return.” Using the information from Form 1042-S, the investor reports the U.S. source income received and the federal income tax that was withheld.
A copy of Form 1042-S must be attached to the completed Form 1040-NR. The IRS uses this to verify the income and withholding amounts on the tax return. Without the attached Form 1042-S, a refund claim will likely be delayed or denied.
The completed Form 1040-NR and attached Form 1042-S must be mailed to the IRS address specified in the form’s instructions. The filing deadline is June 15 for non-resident aliens not receiving wages subject to U.S. income tax withholding. After the IRS processes the return, any approved refund is sent to the investor.