How to Offset Taxes on International Stock Dividends

Donald Jay Korn for Financial-Planning.com writes: Despite their high payouts, international stocks and funds can come with big tax bills, but there are ways to offset those hefty levies.

There is no denying the appeal of foreign equities. The dividend yield on the stocks as of mid-September in the MSCI EAFE Index are more than 3%, while the average for stocks in the S&P 500 is under 2%.

“We see dividend-paying stocks outside the U.S. as being attractive now,” says Jonathan Brodsky, managing director of investment management firm Advisory Research in Chicago. “In addition, companies in Japan and Korea could be announcing meaningful increases in their dividend rates in the coming years. Governments there have indicated they will introduce measures to generate higher payouts to shareholders.”

TAX TRAPS

But there are potential tax traps.

“The home country may require companies to withhold some of the dividend for taxes before releasing the payments to foreign investors,” Brodsky says.

For example, if a foreign company pays a $1,000 dividend to an American shareholder and that company is based in a country that requires 15% withholding, the cash flowing to the investor would be just $850.

TAKING CREDIT

Fortunately, there are ways to offset those taxes that effectively have been paid to a foreign government, thus avoiding double taxation.
Here are a few:

• Take an itemized deduction. This simple method delivers only a partial payoff. A $150 deduction, for instance, saves $60 in tax for a client whose effective marginal tax rate is 40%. In addition, high-bracket clients may lose some tax benefits from itemized deductions under a new tax law here.
• Take a foreign tax credit on Form 1040. With a $150 tax credit, the tax savings is $150. However, taxpayers can take this easy step only if they have paid no more than $300 in foreign tax on dividends and interest ($600 for couples filing jointly). There are a few other hurdles to clear, too.
• File IRS Form 1116. An individual who has paid more than $300 or $600 in foreign tax must file this form, which can be complicated, in order to claim the tax credit. 

“With regard to foreign tax withheld, our clients generally take the tax credit,” says Martin James, a CPA/PFS president and managing member of Martin James Investment & Tax Management in Mooresville, Ind.

Michael Eisenberg, a CPA/PFS and founder of Eisenberg Financial Advisors in Los Angeles, agrees, adding that mutual fund companies and brokerage firms have been very good about reporting the foreign tax withheld, making it easier to prepare Form 1116. “These firms have been showing it on the year-end 1099 forms that report dividend and interest income so it is easy to spot and pick up,” he notes.

James points out that many taxpayers will take this credit for federal purposes and then forget to take it on their state income tax return, if the state allows, so advisors should follow up with clients who have foreign dividend income.

75% of accountants say real-time view of client’s finances would yield better financial advice

Karen Stern, CPA for St. Louis Biz Talk writes: What if consistent communication with your external accountant could improve business operations and give you the management information you crave? Seventy five percent of accountants say that having a real-time view into their client’s finances would enable them to provide better financial advice, according to a recent survey by Xero, a small business accounting software developer. Xero surveyed a group of accountants to find the most common mistakes business owners make when it comes to their finances. Results showed that the most common mistake was talking with their accountants only during tax time. Other most common mistakes included:

1. Not fully understanding their tax obligations

2. Not having real-time insight into their finances (i.e., not keeping financial records up to date)

3. Neglecting to set up a cash flow forecast

4. Not linking their financials to business goals

Using cloud-based accounting systems that offer a real-time view into the financial health of an organization, CPAs and accountants are able to offer critical information and guidance for businesses to grow their businesses more profitably. Only 5 percent of accountants said that 100 percent of their clients are using online accounting services, while 20 percent said that between 75 and 99 percent of their clients are using such services, and 24 percent said that between 50 and 74 percent of their clients are using online accounting services.

Online, on-demand financial reporting facilitates the availability of up-to-date critical information. This technology also allows the integration of software, such as web-based time tracking, bill payment, job costing, billing and collections. In addition, automation allows for faster and cheaper data input.

These management accounting systems allow organizations to maintain constructive communication with their accountants year-round as they manage their tax liability, optimize deductions, maximize tax planning and help strategize for growth. According to 44 percent of the accountants polled, small business owners should be in touch with their financial adviser at least once a month, while 21 percent of the survey respondents indicated it should be once a week.

Jamie Sutherland, president of Xero U.S., said that another significant finding was how small businesses can work with their accountant to avoid some of the pitfalls around deductions. He added that 75 percent of the survey respondents indicated that faulty deductions are causing audits, so ”working with an accountant to make sure you’re taking correct deductions from your financials will alleviate the possibility of an audit.”

The most common mistakes businesses make that could trigger an audit by the IRS include excessive deductions to income, misclassifying their workforce (as in employee vs. independent contractor), home office deductions and mixing business and personal expenses in deductions.

“The thing that comes up frequently is around mixing personal and business deductions,” Sutherland said. “There’s a gray line there. If you’re going on vacation and some of your expenses are for business and some are personal, you need to be clear about exactly what is business related.”

Meanwhile, small businesses often overlook some deductions, including out-of-pocket expenses, depreciation, automobile expenses (such as gas, parking and tolls), expenses associated with hiring new employees and office improvements.

Small businesses and service businesses, in particular, have a lot to gain by employing cloud-based management accounting intelligence tools and working consistently with their CPA or accountant in order to grow their organizations. Outsourcing these accounting services is a cost-effective strategy benefiting businesses of all sizes.