Form W-8BENs for expatriates

This Week's Question

This week's episode is a mashup of several question that have come up.

Once I have successfully expatriated, I want to keep my bank account, IRA, 401(k), brokerage account, etc. open in the United States. What paperwork is required and how will I be taxed?

Short Answer

Form W-8BEN. That is what you give the financial institution. It is pretty easy unless you want to reduce your U.S. income tax from the default 30% to a lower number (like zero).

Why Withholding, Why Form W-8BEN

Once you expatriate, you are a nonresident alien from the perspective of the U.S. tax system.

As a general principle the system wants to collect tax on money before it flows from the United States to someone outside the United States. The (logical) fear is that you, as a nonresident, may (heh) not choose to pay U.S. income tax if the IRS cannot reach out and touch you.

The financial institution is in control of the money before it flows out of the United States. The government puts the burden on the financial institution to collect the tax. If the financial institution screws up, it must pay the tax.

The IRS has a small Bible of regulations that tell a “withholding agent” (a U.S. person or institution who has a nonresident's money and the power to pay it to the nonresident) what to do. The regulations also have a number of rules that tell the withholding agent “if you do THIS, you are safe.” Safe harbors – that's what these rules are called in tax jargon.

One of those safe harbors is “If you get Form W-8BEN from someone and you have no reason to think they are lying, you can rely on it and not get penalized as a withholding agent if it turns out you screwed up.”

Every bank, pension plan administrator, and sane withholding agent therefore demands Form W-8BEN.

The Easy Part of Form W-8BEN

The easy part of Form W-8BEN is Part I. This is all about you. The only hard part of Part I are the questions (Line 5 and 6) about tax identification numbers.

Line 5 asks you for your U.S. tax identification number. Since you have a Social Security Number, enter it here. There is no ambiguity about this.

Line 6 asks you for your foreign tax identification number. Unfortunately, in the Brave New World of FATCA the reality is that soon you will have multiple sets of tender, loving bureaucrats who know everything about you. If you have a number, you are required to enter it here.

Lines 5 and 6 are not really difficult to do. The long term implications are just hard to accept: 100% of your life is transparent to two governments, who can do with you what they will. Brave New World, etc.

Why Form W-8BEN Matters To You

In order to show you why Form W-8BEN is important to you (and to persuade you to do the necessary work in filling out Part II), here is a quick summary of the tax results you can expect as a nonresident alien.

Interest Taxed at Zero

The default rule is that bank interest is taxed at zero in the United States. Giving Form W-8BEN to a bank will ensure that all interest earned on your U.S. bank account is tax-free. (Note that in Part I you told the USA where you live and what your foreign tax identification number is – now Uncle Sam can tell your home government all about the money you have in the United States).

You do not need to fill in Part II to achieve this result.

Capital Gain Is Not Taxed

Capital gain (short term and long term) is not taxable (for non-real estate investments, anyway). You want the financial institution to have Form W-8BEN in hand so they report the capital gains correctly, and do not impose backup withholding tax on the gross proceeds of your stock sales.

You do not need to fill in Part II to achieve this result

Default 30% Tax

The main reason why you want to use Part II of Form W-8BEN is to reduce your U.S. income tax bill. The general rule is that dividends, pension payments, IRA distributions, and other types of U.S. income will be taxed at a flat 30%.

Part II of Form W-8BEN is where you give the financial institution the information they need – then they know they are in a safe harbor and can withhold zero (or at least an amount less than 30%) of tax on payments to you.

Part II

Part II is where you have to do some actual work. The result (if you do the work correctly) is that you can reduce U.S. taxation from a flat 30% to a lower number, possibly zero. This is done by using an income tax treaty.

Is There a Treaty?

The first thing to do is check to see whether you live in a country that has an income tax treaty with the United States. If there is no income tax treaty, then you cannot use Part II to reduce the U.S. income tax imposed on income you receive from U.S. sources.

Part II, Line 9

After you find your country, and the treaty, you will need to complete Part II properly. For this example, I am going to pretend that you have a normal investment account at Charles Schwab, and in that account you have stocks and bonds. You want to use the income tax treaty between the United States and your home country to achieve that result.

Let's use a resident of Germany as an example. The particular item of income we are working with is dividend income.

Line 9 is easy. Enter “Germany” in the blank, assuming of course that it is true that you are a German resident.

Part II, Line 10 - Find the Treaty Article

Line 10 requires you to do a bit of research to find the relevant portion of the income tax treaty between the United States and Germany that discusses taxation of dividends.

Find the income tax treaty page for Germany on the IRS website. You will see there is an income tax treaty from 1989.

Treaties are updated by “Protocols”. Germany and the United States updated the income tax treaty in 2006 with a Protocol (warning: PDF). You will want to look there for your answer. On page 4 of that official PDF you will see “ARTICLE IV” of the Protocol deleted the old Article 10 of the treaty and replaced it with an entirely new Article 10. This deals with the taxation of dividends and is the current agreement between the two countries about how dividends are taxed.

• Article 10(1) says that dividends can be taxed by the recipient's home country. You live in Germany. You knew that. You know your Apple dividends will be taxed in Germany.
• Article 10(2) says that dividends can also be taxed in the paying corporation's home country. This means that the United States can tax the dividends paid by Apple as they are being paid out to a resident of Germany.
• Article 10(2)(b) limits the amount of tax that the IRS can take to 15%. This is better than the default 30%, at least.

For the purpose of Part II, Line 10, we have now identified Article 10(2)(b) as the relevant treaty clause that reduces your U.S. income taxation on dividend income from U.S. corporations. I assume that the other situations (requiring 10% or 80% stock ownership) do not apply to this situation. You are unlikely to own 10% or 80% of a corporation through an account at Charles Schwab.

Part II, Line 10 - Filling In the Blanks

Filling in the blanks on Form W-8BEN, Part II, Line 10:

• Put “10(2)(b)” in Line 10, at the far right blank.
• On the second line, it asks you for the correct tax rate. Put 15% in there.
• At the end of the second line, it asks you to identify the type of income. Write “dividends” in there.
• Finally, the IRS wants an essay answer for why you meet the terms of the treaty article. This is silly, redundant, and of no nutritional value to the IRS at all. So we cheerfully do it! Write in here “I am a resident of Germany receiving dividends from U.S. corporations.”

Practical Realities

Aside from signing the form and giving it to Schwab, you have dealt with the tax stuff.

The bigger practical question (and this is still an evolving unknown) is whether any U.S. financial institution will want to continue doing business with you after you cease to be a U.S. citizen or green card holder. The trend is not encouraging. More and more U.S. financial institutions are declining to do business with nonresident aliens – and that includes you, someone who expatriated.

It's not that they don't love you. Of course Merrill Lynch loves you, in its own special way. They want you gone because you are expensive and risky. You carry tax risks along with you (what if their systems fail and they screw up withholding)? You carry “know your customer” risks. (Yes, I know that you had an account with us for the last 20 years, but can you really document the source of funds as being from your job as a school teacher? Are you really sure that you didn't make that money selling trafficking AK-47s in North Africa during your summer breaks?)

And mostly you carry securities law risks. If Merrill Lynch allows you – a citizen and resident of Germany – to buy and sell stock, there is a risk that German securities regulations might catch them unawares, and Merrill Lynch would find themselves facing stiff fines in Germany for those violations.

As a result, it is much easier and cheaper to kick you out of the system.

Banking (cash money in a bank) appears to be no problem with U.S. banks. I have seen many banks open accounts for nonresidents.

Webinar for Noncovered Expatriates

I am doing a webinar for noncovered expatriates – normal people who give up U.S. citizenship or green cards. It will have four major areas that I cover, because these are the problematic ones for regular people who expatriate.

• The expatriation-year tax return. This is a “dual status” tax return and preparing it properly bedevils all of us. I will walk you through how it is prepared, how to allocate income to the time you were a citizen and the time you were a nonresident, and in general I will dive as deeply into nuts and bolts as time will allow.
• The certification test. This is the only thing that can trip up a noncovered expatriate and make him or her a covered expatriate. I will talk about how you go through your prior year tax returns to assess your risk here (or, alternatively, heave a happy sigh, knowing that you are safe).
• Retirement plans and Social Security. These are typically the most complicated assets that noncovered expatriates hold, and the rules are complicated. I will walk you through the paperwork you need to know about, and how the payouts you receive will be taxed after expatriation.
• Life afterwards. Today's email is a little taste of this topic. If your life after expatriation continues to have elements of USA in it (you are receiving Social Security, you own real estate in the USA, your children are citizens, etc.) you will need to know how to handle all of that with miminum stress.

Go to the signup page for more information or email me if you have questions.

The objective is to make you smart enough on these topics to do your own expatriation. Or, if you choose to hire someone to help you (oh, maybe us?) you will be an intelligent shopper and you will be able to tell whether the person offering to do your tax returns has the necessary skills or not.

Disclaimer

You know the story by now. This is not tax advice and I am not your lawyer.

Burning Questions?

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Phil.