Special U.S. Tax Rates for Foreign Investors

As part of the 2013 budget negotiations between Congress and the White House over how to close the nation’s deficit, the top tax rate imposed on long term capital gains and qualified dividends was set at 20% plus, under IRC § 1411, a 3.8% net investment income tax for a total for 23.8%.

IRC § 1 defines qualified dividends as dividends received from domestic corporations and qualified foreign corporations.  While short term capital gains and the ordinary dividend tax rate may range from 10% to 39.6%, qualified dividends are taxed at the same rate as long term capital gains, topping out at 23.8%.  Nonresident aliens, however, are exempt from the 3.8% net investment income tax, therefore their top tax rate on long term capital gains and qualified dividends is 20%.

These tax rates are exceptions to the general rule that subject nonresident aliens to a 30% withholding tax on U.S. source income.  The kind of income subject to the 30% withholding is income which is Fixed, Determinable, Annual, or Periodical (“FDAP”).  Amongst others, this includes income from compensation for personal services, interest, pensions and annuities and real property income such as rent but not sale of real property.  Tax treaties may be available to reduce the withholding rate.

Nonresident aliens who spend time in the United States should be sure to track the number of days they are present in the United States as they may trigger tax residency under the substantial presence test and if they spend 183 days or more during the year in the United States, they will be subject to a 30% tax on capital gains.  IRC § 871(a)(2).