Foreign investments

How are foreign investments taxed?

To the first-time investor, an overseas business can seem like a big tax gain – a way to make money while flying under the radar of the Internal Revenue Service. There is only one problem: The IRS will notice it when you try to transfer your income to a US bank. If you are investing overseas, the IRS is on you and, in most cases, the country where your investment actually came from. So while you may feel fanciful as everyone makes money on foreign investment like some sort of railroad baron, you are also in the unenviable position of being taxed twice.

The exact amount of tax you owe – and to which entity – varies widely from country to country. Fortunately, however, it is easy to determine if any foreign taxes have been withheld from your investment. When you receive your 1099, box 6 will tell you what has already been withheld for foreign tax. And if a foreign country has taxed you, the United States gives some relief in the form of a credit or a deduction. Which one to take depends on your situation.

If you plan to itemize your deductions (instead of taking a standard deduction), you might find it worthwhile to simply add foreign tax as the old regular deduction. It’s a simple way to do it, but it’s not necessarily the biggest savings, and it doesn’t help at all if you don’t detail it. Instead, you might prefer to take the foreign tax credit, which is calculated by how much you would be taxed in the United States, multiplied by a percentage.

If the foreign tax is more than your US tax, the maximum credit you can get is the amount of US tax. If the US tax is more than the foreign tax, you can claim the entire foreign amount as a credit and pay the balance to the IRS. In all cases, you will need to complete IRS Form 1116, Foreign Tax Credit.

Thus, in general, foreign investments are taxed by both the foreign country and the United States. But depending on your income and your tax liability, you might only end up paying once.

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