US broker deposit interest taxation for NRA

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Topic Author
Lazerr
Posts: 41
Joined: Fri Aug 12, 2022 2:41 pm

US broker deposit interest taxation for NRA

Post by Lazerr »

With US interest rates going up, nonresident aliens may find themselves getting paid deposit interest for their uninvested funds at their brokers. Most prominently, most IBKR subsidiaries (but not IBCE/Hungary) pay their clients 1.83% interest on USD cash above $10k, if their net asset value is over $100k.

I tried getting information from IBKR on how this would be treated regarding US federal income taxes for a nonresident alien receiving this interest. It was not particularly enlightening. You would think they would be able to tell me, as withholding agents...

Maybe somebody here got a little deposit interest for 2017-2020 from IBKR can tell me what happened?

IBKR told me:
  • It is not portfolio interest (which would be exempt from US taxation for all NRA).
  • It is income code 29 (Deposit Interest), which is not the type of interest covered by the tax treaty tables. The tax treaty tables list the withholding rates for income code 01, Interest paid by U.S. obligors-general.
  • Regarding withholding, I was both told that IBKR never withholds taxes on interest and that it is subject to withholding. Nice.
Regarding the withholding, I heard from some NRA users that IBKR did not withhold anything on their deposit interest, but that might still be due to tax treaties. The tax treaty with Germany, for example, says that interest may only be taxed in the country of residence (with exceptions that I do not believe to apply here).

So right now I assume that:
  • The broker deposit interest is not generally US income tax exempt.
  • Tax treaties can still reduce or exempt taxation.
  • You have to read the actual treaty, not the tax treaty tables, to figure it out.
Is that correct? And with that in mind, I wonder what I would have to do, as US nonresident alien and resident of Germany, in the following scenarios:
  1. IBKR withholds 30% income taxes. File 1040-NR to get the money back? Do I have explicitly take a treaty position via form 8833?
  2. IBKR withholds no income taxes, but does not claim a treaty exemption on form 1042-S. The withheld tax would be correct, but for the wrong reason. Does that give me an obligation to file a 1040-NR?
  3. IBKR withholds no income taxes and lists exemption code 04 (Exempt under tax treaty) on the 1042-S. Assuming nothing else makes me file a 1040-NR, this looks like there would be no requirement for me to file. The withholding was correct and exempted correctly.
TedSwippet
Posts: 5181
Joined: Mon Jun 04, 2007 4:19 pm
Location: UK

Re: US broker deposit interest taxation for NRA

Post by TedSwippet »

Lazerr wrote: Sun Aug 14, 2022 1:40 pm IBKR told me:
  • ...
  • Regarding withholding, I was both told that IBKR never withholds taxes on interest and that it is subject to withholding. Nice.
So a Schrödinger brokerage, then. You only get to find out which state the superposition has collapsed into by opening the envelope, email, secure message, or whatever, that contains your form 1042-S. US tax withholding based on quantum mechanics. Classic.

Looking back at my own 1042-S forms, all the interest on them was from money market fund holdings, and shows as income code 01. I don't have anything coded 29, but then, I don't have a Vanguard or any other US brokerage account, just Vanguard US mutual fund only. And my residual US credit union account pays zero interest. No direct experience then. Sorry.
Lazerr wrote: Sun Aug 14, 2022 1:40 pm So right now I assume that:
  • The broker deposit interest is not generally US income tax exempt.
  • Tax treaties can still reduce or exempt taxation.
  • You have to read the actual treaty, not the tax treaty tables, to figure it out.
Is that correct?
It looks like at least one reasonable possibility, out of several, from a user perspective. Although ... my understanding of the withholding tables for NRAs that cite treaty articles is the this was the IRS's full interpretation of the treaty, which seems to imply that they consider 'deposit interest' (whatever that actually is) to be outside the treaty. Although perhaps just not taxable/withholdable under portfolio interest rules? Shrug, basically. It is incredible how much complexification the US can add to something that other countries manage entirely simply.
Lazerr wrote: Sun Aug 14, 2022 1:40 pmAnd with that in mind, I wonder what I would have to do, as US nonresident alien and resident of Germany, in the following scenarios:
  1. IBKR withholds 30% income taxes. File 1040-NR to get the money back? Do I have explicitly take a treaty position via form 8833?
  2. IBKR withholds no income taxes, but does not claim a treaty exemption on form 1042-S. The withheld tax would be correct, but for the wrong reason. Does that give me an obligation to file a 1040-NR?
  3. IBKR withholds no income taxes and lists exemption code 04 (Exempt under tax treaty) on the 1042-S. Assuming nothing else makes me file a 1040-NR, this looks like there would be no requirement for me to file. The withholding was correct and exempted correctly.
On 1, don't know, but I would certainly try it. Chances are that even if it's wrong -- which seems impossible to tell on current IRS "guidance" (hah!) -- the IRS won't pick it up. The alternative is to take a local tax credit, assuming your rate exceeds US tax withheld; waving the IRS interpretation at your local tax authority if necessary. At 30% though, chances are it may not.

On 2, no 1040-NR as I see it. The general rule is that if withholding equals tax liability, no 1040-NR required. It doesn't matter how that situation arises; pure chance or carefully resolved fine tuning through the treaty, both the same.

And 3, clearly the cleanest case.

Don't you feel real buzz of excitement to see what unholy combination IBKR eventually settles on? Maybe we should start a sweepstake on it.
Topic Author
Lazerr
Posts: 41
Joined: Fri Aug 12, 2022 2:41 pm

Re: US broker deposit interest taxation for NRA

Post by Lazerr »

From asking other IBKR users, I am assuming no income taxes would be withheld. At this point I've also heard more often that IBKR does not withhold taxes on interest. So most likely, no taxes would be withheld. I would find out after about one month, because IBKR tells you how much interest is accrued, paid out or withheld.
TedSwippet wrote: Mon Aug 15, 2022 6:23 am It looks like at least one reasonable possibility, out of several, from a user perspective. Although ... my understanding of the withholding tables for NRAs that cite treaty articles is the this was the IRS's full interpretation of the treaty, which seems to imply that they consider 'deposit interest' (whatever that actually is) to be outside the treaty. Although perhaps just not taxable/withholdable under portfolio interest rules? Shrug, basically. It is incredible how much complexification the US can add to something that other countries manage entirely simply.
I was told it is not portfolio interest, so that exemption does not apply. Now the interesting thing is, outside of portfolio interest or a tax treaty, there are not many exemptions by law: https://www.law.cornell.edu/uscode/text/26/1441

This lists 5 exemptions from withholding:
  1. Portfolio interest, It's not that, according to IBKR.
  2. Original issue discount. It's not that either.
  3. Unknown owner. No, they check your identity as you sign up.
  4. Bonds. Maybe, but probably not. I don't see any note of my money being put into bonds in my US account. For the stock yield enhancement program, I do.
  5. Section 871(i)(2). Maybe that? IBKR does give out loans on a very technical level.
The only withholding exemption that I could see apply is number 5, which happens to be tax exempt. So now I see two options:
  1. IBKR know what they are doing, but leave customer support in the dark. The interest is tax free.
  2. IBKR are incorrectly not withholding taxes. But you would think that the IRS would have noticed by no, considering IBKR do file a 1042-S.
I am trying to find out more from support, but I fully expect that I'll have to chat up IBKR users come 2023 and ask what's in their 1042-S.
TedSwippet wrote: Mon Aug 15, 2022 6:23 am Don't you feel real buzz of excitement to see what unholy combination IBKR eventually settles on? Maybe we should start a sweepstake on it.
Well, this interest could be a significant help to my investment strategy in my future, if IBKR does not mess it up (with honorable mention to the IRS). So I would say I am much more anxious than excited.
Topic Author
Lazerr
Posts: 41
Joined: Fri Aug 12, 2022 2:41 pm

Re: US broker deposit interest taxation for NRA

Post by Lazerr »

Minor update: It appears the interest is not subject to withholding, regardless of the residence of the recipient. That implies it is not a tax treaty thing, but an exception under the US tax code.

As to what exception is used, not even IBKR seem to know. Nice.
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