Investing in foreign stocks involves many costs. One of the costs is the taxes paid to foreign governments on dividends earned by US investors. Such dividend withholding taxes can be huge for some countries such as Switzerland and while others such as Singapore do not withhold taxes.

While paying a substantial portion of dividends earned as taxes to a foreign state, it is possible to claim some or all of the taxes paid in US tax returns. An investor may be either to claim a credit or itemize as deductions. However taxes paid for stocks in certain qualified retirement accounts cannot be claimed at all. Hence it is wise to hold foreign stocks especially ones that are high dividend payers in taxable accounts.

Many investors may wonder whether to take a deduction or credit for the taxes paid to foreign countries. An article by Rande Spiegelman at Charles Schwab explains the ways to claim foreign taxes paid. From the article:

Deduction or credit?

Once you have verified the amount you’ve paid in foreign taxes, you’ll want to make sure to claim it on your U.S. taxes. The key question is whether to take an itemized deduction for the foreign taxes you paid or a tax credit. Each has its advantages and disadvantages, depending on how you approach your tax filing.

Deduction. If you already make itemized deductions using Schedule A of Form 1040—for example, by deducting mortgage interest or charitable contributions—then taking a deduction for foreign tax payments might be the easier way to go. An itemized deduction can reduce your tax bill by lowering your taxable income.

Credit. Claiming a tax credit for foreign taxes can give you more bang for your buck by providing a dollar-for-dollar reduction of your actual tax bill. Consider that hypothetical $200 in foreign taxes again. A credit could reduce your U.S. tax liability by the full $200, assuming you’re eligible for the entire amount. Taking a tax credit seems like the obvious choice, right?

Unfortunately, the foreign tax credit has a few limitations. First of all, if you pay more than $300 for the year in foreign taxes (or $600 if married and filing jointly) and you want to claim a tax credit, in general you must fill out Form 1116. The form can be complicated, although most mutual funds and brokers include the necessary information in their year-end tax statements.

You could also face a cap on the size of your credit depending on how your foreign income and taxes stack up against your U.S. income and taxes. In short, your foreign tax credit cannot be larger than your total U.S. tax liability.

For example, imagine you earned $1,000 from your foreign investments and paid $350 in taxes overseas. Now let’s assume that the U.S. tax bill on the same income would have been $250. Your maximum credit would be $250.

Source: Lost in Translation, Charles Schwab

The entire article worth a read for investors who are new to international investing.

Here are a few points to remember regarding foreign dividend withholding taxes:

• UK does not deduct withholding taxes for US investors. However dividends from UK REITs will be subject to taxes.
• Canadian stocks are best held in retirement accounts as dividends are waived for such accounts.
• Dividends paid out by Canadian REITs are subject to withholding taxes.
• Investors should not hold dividend stocks from countries such as Switzerland, Germany, France, etc. in retirement accounts as all the taxes paid cannot be recovered in any way.
• While a few emerging countries like India do not charge taxes on dividends paid out to foreign investors, most others like Chile, Brazil, Colombia, etc. withhold taxes on dividends.