© by Theodore "Ted" Kleinman, CPA

Non-resident aliens can hold investments in the United States quite easily. A "non-resident alien" is the U.S. government's name for a citizen of a country other than the U.S. who also lives outside the U.S. The only thing non-resident aliens have to be concerned about if they have U.S. investments is taxation.

For example, if a non-U.S. national works in the U.S. for some period of time and amasses a nice portfolio of stocks while here, that person can hang on to the portfolio forever, no matter whether they continue to live in the U.S. or not. But they will have to continue to deal with the U.S. tax authority, the IRS.

Thanks to the U.S. Congress, the tax laws are complicated, and a resident or nonresident alien might have to look carefully before finding a tax advisor who understands all the issues. Here's an overview.

In the years when you are considered a non-resident for tax purposes (basically, the years when you spend in the US less than 183 days; the actual rule is a little more complex, and takes prior years into account; see IRS publication 519 for details), you file your US tax return on form 1040NR, instead of regular 1040 (EZ, A), and pay tax on your investment income according to special rules:

• No tax on capital gains. This means that a brokerage or a mutual fund should withhold nothing when you sell shares. With respect to mutual funds, long-term capital gain distributions are exempt as well.
• No tax on bank interest.
• No tax on portfolio interest. It's not always easy to figure out interest on what bonds qualify as "portfolio interest", though. Some brokerage firms are confused on this issue, unfortunately.
• 30% flat rate tax on dividends. Generally this includes dividend and short-term cap gain distributions by mutual funds. A tax treaty with your country of residence may reduce this rate.
• 30% flat rate tax on interest that neither is paid by a bank nor qualifies as "portfolio interest." A tax treaty with your country of residence may reduce this rate.
• No personal exemption or deductions can be applied against investment income (which is, technically, "income not effectively connected with your US trade or business").

If you are a non-resident for the tax purposes in a given year, but spend 183 days or more in the country, your capital gains are also subject to the 30% flat tax. This is a fairly rare but possible situation.

Note also that money-market mutual funds pay dividends, while a money-market bank account pays interest, for the purposes of 1040 NR. Tax treaties are very important. If the individual's country of residence has an agreement (tax treaty) with the US government, those rules pretty much supersede the standard rules set by the Internal Revenue Code. In particular, they often reduce the tax rate on interest and dividend income.

While you are a non-resident alien, you are supposed to file Form W-8BEN (it replaces older Forms W-8 and 1001) with each of your mutual funds or broker every 3 or 4 years, so that they will automatically withhold tax from your investment income. Since you have to indicate your country of residence for tax purposes on this form, the investment income payor will know what tax treaty, if any, applies. In the spring, the payor will send you a form 1042-S reporting your income, its type, and the tax withheld.

If Forms W-8BEN have been filed and the appropriate tax has been withheld, you won't need to send any money to the IRS with your 1040 NR in April; in fact, you won't even need to file 1040 NR at all if you don't have other US-source income. Note also that as a non-resident you will not be eligible to claim standard deduction, or to claim married status, or file form 1116 (foreign tax credit).

None of this discussion applies to resident aliens or to US citizens resident abroad. Once you are considered a bona fide resident of the U.S., the tax rules that apply to U.S. citizens also apply to you.

Theodore "Ted" Kleinman, CPA is a Certified Public Accountant with 20 years diversified business experience, who specializes in international taxation preparation and planning. His public accounting experience includes auditing, tax planning and preparation, and management advisory services in diversified industries from real estate development and construction to manufacturing, service, and professional corporations.

Theodore "Ted" Kleinman, CPA Main | Authors Row Main | Home