U.S. Tax Rules Foreign Investors Should Know

People who live in other countries can invest in U.S. financial markets, even if they aren't U.S. citizens or residents, but they should be aware of the tax obligations they'll face.

Non-U.S. investors can trade U.S. stocks in one of two ways: by opening an account in their home country with a company that offers access to U.S. markets, or by opening one with a U.S.-based brokerage that offers international accounts.

Either way, non-U.S. investors are treated as non-resident aliens ("NRA") for U.S. tax purposes and face different tax laws than U.S. citizens and residents if they invest in U.S. markets. (A non-resident alien is generally defined as any non-U.S. citizen or resident who doesn't hold a permanent resident card and doesn't meet the "substantial presence" criteria of being physically present in the United States for at least 31 days during the current year and at least 183 days over a three-year period, using a weighted formula. If someone is not a U.S. citizen but is living in the country and meets the U.S. tax definition of a U.S. resident, they are generally subject to the same tax laws as U.S. citizens.

NRA investors generally aren't required to pay capital gains taxes on stocks. Interest on bonds from U.S. issuers, meanwhile, usually qualifies for the portfolio interest exemption and is not subject to withholding if the investor has provided a properly completed W-8BEN (see below). But these NRA investors are subject to taxes and withholding on dividends from U.S. stocks and their accounts may be subject to U.S. estate tax at the time of their death.

Here's what else non-U.S. investors living overseas should know about their U.S. tax obligations.

NRA investors in U.S. markets will face tax withholding on U.S. dividend income. Tax is withheld by the brokerage at the time of payment, but the investor may not face a year-end tax bill because the withholding is remitted to the Internal Revenue Service (IRS) on their behalf and filing of a U.S. tax return is generally not required. The statutory tax rate is 30%, but residents of countries that have a tax treaty with the United States may qualify for a reduced rate. To learn more about NRA withholding and tax treaties, see NRA withholding | Internal Revenue Service and the tax treaty tables section on the IRS website.

In response to concerns that non-U.S. investors could avoid dividend withholding by purchasing certain equity-linked instruments, the U.S. Congress enacted Section 871(m), which affects U.S. equity-linked derivatives that give rise to a "dividend equivalent payment." A dividend equivalent payment is considered U.S. income and is subject to withholding, which is performed at the 30% statutory tax rate and is treaty eligible. Brokerages will remit the withholding to the IRS on the account owner's behalf.

There's another withholding rule to account for—1446(a), which covers withholding related to distributions of certain income by publicly traded partnerships (PTP) to their non-U.S. partners. The rate is 37% for non-corporate partners and 21% for corporate partners. As of January 2023, for Schwab One International accounts held by non-U.S. individuals or entities, Schwab withholds an additional 10% of gross proceeds from sales and certain distributions treated as sales of PTP interests under 1446(f). 

When a non-U.S. investor who is a non-resident of the United States dies while holding investments in U.S. assets, their assets are subject to the federal estate tax, with rates ranging from 18% to 40%. Unlike with U.S. citizens and residents, the exemption for these investors is only $60,000. However, the United States has signed estate tax treaties with a handful of countries, including Canada, Japan, and the United Kingdom. Some of those treaties may provide larger exemptions.

Non-U.S. investors who invest in U.S. stocks are required to provide their brokerage with Form W-8BEN to certify their tax status. Without a valid W-8BEN on file, brokerages may withhold 30% from U.S. dividends and interest and a backup withholding rate of 24% on gross proceeds under IRC Section 3406.

The W-8BEN expires on the last day of the third calendar year after the signature date, unless material account information changes, in which case investors would need to submit a new form to the brokerage. Typically, reminder notifications are sent before the W-8BEN expires.

Any non-U.S. investor will be issued Form 1042-S by mid-March for the preceding tax year reflecting any reportable activity. Any U.S. withholding that occurred, along with the income it's attributed to, will be reported on Form 1042-S. This form is available online and is also mailed to account owners who have not opted for paperless delivery. The form is also sent to the IRS and may be shared with the tax authority of the non-U.S. investors' country of residence, depending on applicable information-sharing agreements with the United States. Typically, it is not necessary to file a U.S. tax return, but investors may still be required to report certain income to tax authorities in their home country.

Schwab does not provide tax advice. We suggest investors consult a tax-planning professional regarding their personal circumstances.