Deducting The Foreign Tax Associated With Dividend Income From A Foreign Company

Posted on: 20 December 2016


Many individuals diversify their portfolio holdings by investing in companies based in other nations. U.S. tax filers who receive dividend income due to their stock ownership in foreign companies may be eligible to take a tax deduction for taxes paid to a foreign government.

You may directly own shares in a foreign company, or you might have ownership in a mutual fund that has investments abroad. Either way, it is likely that your dividend income received from a foreign company is slightly reduced by taxes paid to the home country of the business. Your share of taxes paid to the taxing authority of the other country can be determined by examining your yearly earnings summary.

Form 1099-DIV

After the close of each tax year, you should be provided with IRS Form 1099-DIV by your broker or your mutual fund provider. Form 1099-DIV contains a specific entry box designated for reporting each shareholder's portion of taxes paid to a foreign tax authority. If there is an entry in the designated box, you may be able to utilize the amount of foreign tax paid as a tax deduction.

The Foreign Tax Credit

The intent behind some tax rules is to prevent the double taxation of income. A deduction for foreign taxes paid may be taken as either a tax credit or an itemized deduction. For many tax filers, the credit is more effective since a credit is a direct reduction in tax. In contrast, an itemized deduction simply lowers taxable income before calculating tax.

Form 1116

The Foreign Tax Credit is typically claimed on IRS Form 1116. There is a specific entry line on Form 1040 on which to enter the credit calculated on Form 1116. The foreign tax credit may be entered directly on Form 1040, without the inclusion of Form 1116, for individuals that meet all of the following requirements.

  • All of the foreign income is passive, such as dividends and interest
  • Both income and tax are reported on a qualified statement such as Form 1099-DIV
  • The foreign tax is not more than $300 for individuals or $600 for a married couple

The foreign tax credit is not refundable, which means that it is useful only to the extent it reduces the amount of tax otherwise payable. If used as an itemized deduction, foreign tax paid is entered along with other taxes on IRS Schedule A. Contact an accountant, such as those found at Vlasac John M & Co, for assistance in deducting foreign taxes paid.