NRA and withholding taxes

STCG from mutual funds will have withholding. LTCG should not have withholding. Bank interest has no withholding. Portfolio interest has no withholding. The definition of portfolio interest confuses many brokers as not all bond interest is portfolio interest. Interest from a money market bank account has no withholding. Interest from a money market mutual fund is categorized as a dividend and has withholding.

Rather than getting into the definition of portfolio interest, you can find a pretty good definition in IRS Pub 519 on page 16.

I'm not aware of changes to Sec. 1441 of the Code but see below.

FFIs are Foreign Financial Institutions. There are new reporting requirements and withholding requirements. The reference to Chapter 4 is to the new Code sections 1471 to 1474 that make up Chapter 4 of the Internal Revenue Code. You're asking about a US broker, so I don't see the relevance of FFIs.

This definition of portfolio interest makes no sense to me. Are US Treasury bond interest considered portfolio interest according to pub

519 page 16? Is bank interest tax free according because it is portfolio interest or because of another rule? Is interest from a corporate bond portfolio interest -- looks like no because "Portfolio interest. U.S. source interest income that is not connected with a U.S. trade or business and ..."? What about interest from munis, include private activity bond interest?

Now you know why financial institutions screw up the withholding on NRAs.

You start with the underlying rule that interest is FDAP (Fixed or Determinable Annual or Periodical) income and it is taxable and subject to withholding unless there is an exception buried in the Code somewhere. Bank and credit union accounts throwing off interest are a specific exception in the code. Not portfolio interest.

The simplest way that I have found to explain portfolio interest is to say if the bonds are bearer bonds (not registered) they are subject to withholding unless the bonds were specifically targeted to the foreign market and meet some other rules. If the bonds are registered and you as the owner file your W-8BEN with the payor or agent, it is portfolio interest and not subject to withholding. If the bonds are registered and were targeted to the foreign market they will be considered portfolio interest even if you don't file the W-8BEN. The above includes bonds issued by state and local and federal government.

The bonds have to have been issued after 7/18/84.

There are a few exceptions. E.g. a 10% owner.

I thought Capital gains is exempt from withholdings. So why the STCG distributions is subject to withholdings? [The previous brokerage, some years back, did not withhold on STCG distributions.]

I was confused. I was thinking of the Foreign Account Tax Compliance Act of 2009 ("FATCA") [that you referenced below] that applies to payments made to either foreign financial OR non-financial entity where there might be U.S. owners -- in which case there will be withholdings on interest, dividends and sales proceeds -- unless those entities enter into an agreement with IRS. Those provisions do NOT apply to NRAs.

So, I don't understand why this brokerage firm is telling me that they will withhold on interest, etc.

Did you give them a W-8BEN? If you did.... they should not be withholding on the items I mentioned.

Yes. I guess I have to go back to them.

Thanks, Alan.

How can you be a 10% owner of state or local or federal government?

How about distributions from MLPs? They are technically not dividends.

TIA

The MLP should specify what kind of distribution you are getting. It could be capital gain, return of capital, interest etc., depending on what it is on the MLP books.

___ Stu

Legally or effectively?

Seth

Here's my confusion. The quote from publication 519 says

BEGIN QUOTE

Portfolio interest. U.S. source interest income that is not connected with a U.S. trade or business and that is portfolio interest on obligations issued after July 18, 1984, is excluded from income. Portfolio interest is interest (including original issue discount) that is paid on obligations:

END QUOTE

income because it is connected with a US trade or business. That leaves on US bonds, muni bonds. And no-one can be a 10% shareholder of the government (in theory at least), so the paragraph later does not make sense.

BEGIN QUOTE

Portfolio interest does not include the following types of interest.

• Interest you receive on an obligation issued by a corporation of which you * own, directly or indirectly, 10% or more of the total voting power of all classes * of voting stock.

END QUOTE

"Connected with a US trade or business" refers to the taxpayer's trade or business, not that the bond is issued by a US corporation.

Ira Smilovitz Leonia, NJ