What Are Foreign Qualified Dividends and How Are They Taxed?

Investing in foreign stocks can provide diversification and growth potential, but it also comes with tax implications. A key consideration for U.S. investors is whether dividends from these investments qualify for lower tax rates. The IRS allows certain foreign dividends to be taxed at the same reduced rates as domestic qualified dividends, but specific conditions must be met.

IRS Criteria for Foreign Qualified Dividends

The IRS sets guidelines to determine whether dividends from foreign corporations qualify for favorable tax treatment. These rules ensure that only dividends from companies with sufficient ties to the U.S. tax system receive reduced tax rates, which can significantly impact an investor’s tax liability.

Corporate Classification

To be considered qualified, dividends must come from a corporation that meets the IRS’s definition of an eligible foreign entity. This includes companies incorporated in a country with a U.S. tax treaty or those whose shares are regularly traded on an established U.S. securities market. The IRS maintains a list of qualifying foreign corporations.

Dividends from passive foreign investment companies (PFICs) do not qualify. PFICs primarily earn income from investments rather than active business operations, such as certain foreign mutual funds and holding companies. Investors in PFICs face complex tax rules, often resulting in higher tax rates and additional reporting requirements.

Applicable Tax Treaties

The U.S. has tax treaties with many countries, which can affect whether a foreign corporation’s dividends qualify for lower tax rates. To receive qualified status, the foreign company must be incorporated in a treaty-partner country or otherwise meet IRS eligibility requirements.

The U.S. Department of the Treasury maintains a list of tax treaties, each with provisions on dividend taxation. Countries like the United Kingdom and Canada have treaties that reduce withholding taxes and make it easier for dividends to qualify. In contrast, dividends from companies in jurisdictions without a treaty, such as Hong Kong or Singapore, may not qualify. These agreements may also allow foreign tax credits to reduce double taxation.

Required Holding Period

Even if a foreign corporation meets other qualifications, investors must hold shares for more than 60 days during the 121-day period surrounding the ex-dividend date. This rule prevents short-term trading strategies aimed at capturing tax benefits.

Additionally, the IRS requires that investors maintain an unhedged position during this period. Using options, short sales, or other strategies to offset risk can disqualify dividends from receiving favorable tax treatment. Failing to meet the holding period rules results in dividends being taxed at higher ordinary income rates.

Dividend Tax Rates

The tax treatment of dividends depends on whether they are classified as qualified or ordinary. Qualified dividends are taxed at the same rates as long-term capital gains: 0%, 15%, or 20%, depending on taxable income.

For 2024, single filers with taxable income up to $47,025 pay no tax on qualified dividends. Those earning between $47,026 and $518,900 are taxed at 15%, while income above that is taxed at 20%. Married couples filing jointly have higher income brackets, with the 15% rate applying up to $583,750 and the 20% rate beyond that.

Ordinary dividends, which do not meet the criteria for qualified treatment, are taxed at the investor’s marginal income tax rate. In 2024, federal income tax brackets range from 10% to 37%, meaning high-income individuals could face significantly higher tax burdens on non-qualified dividends.

The 3.8% Net Investment Income Tax (NIIT) applies to individuals with modified adjusted gross income exceeding $200,000 ($250,000 for married couples filing jointly), increasing the effective tax rate on investment income.

State taxes add another layer of complexity. Some states tax all dividends as ordinary income, while others provide preferential treatment for qualified dividends. California taxes all dividends at rates up to 13.3%, while states like Florida and Texas impose no state income tax. Understanding both federal and state tax implications helps investors structure their portfolios efficiently.

Reporting Requirements

Investors receiving dividends from foreign corporations must properly report this income to the IRS. These payments are typically reported on Form 1099-DIV, issued by brokerage firms.

Foreign dividends may require additional reporting depending on total foreign holdings and whether foreign taxes were paid. Individuals with significant foreign investments may need to file Form 8938 (Statement of Specified Foreign Financial Assets) under the Foreign Account Tax Compliance Act (FATCA). This applies if total foreign financial assets exceed $50,000 for single filers or $100,000 for married joint filers at year-end, with higher thresholds for those living abroad.

If dividends are received from a foreign account rather than through a U.S. brokerage, investors may need to file FinCEN Form 114 (FBAR) if aggregate foreign account balances exceed $10,000 at any point during the year.

Foreign tax credits can help offset U.S. tax liability when foreign taxes are withheld on dividends. Taxpayers can claim this credit using Form 1116, though limitations apply based on the proportion of foreign income to total taxable income. If foreign taxes paid do not exceed $300 for single filers ($600 for married couples filing jointly), the credit may be claimed without filing Form 1116, simplifying the process.

Foreign Withholding on Dividends

Many countries impose withholding taxes on dividends before they reach investors. These rates vary widely, from 0% to as high as 35%. Switzerland, for example, levies a 35% withholding tax on dividends, while the United Kingdom generally does not withhold any tax on dividends paid to non-residents.

Some countries allow reduced withholding rates if investors submit the appropriate tax forms before receiving dividends. The U.S. has treaties with many nations that lower these rates, but claiming a reduction typically requires submitting a tax residency certification, such as IRS Form W-8BEN for individuals or W-8BEN-E for entities.

Failing to provide these forms in advance often results in the maximum withholding rate being applied. In such cases, investors must seek a refund through the foreign tax authority, a process that can be time-consuming. Understanding country-specific withholding rates and filing requirements can help investors maximize their after-tax returns.