Paying taxes to the US Internal Revenue Service (IRS) is probably not the first thing the average Canadian worries about. We have to pay our own tax collectors, and most of us spend no more than a few weeks in the US each year. When we think of taxes, we understandably think of the Canada Revenue Agency (CRA).
It’s a logical thought, but not always the right one. Although your income taxes are paid to the CRA (unless you move abroad), your investments are different. Dividends often come from stocks in countries other than Canada withholding taxes, which are paid to the tax authorities in the country of the company’s legal domicile.
Most Canadians hold at least a few U.S. stocks – often through index funds – which are subject to a 15% dividend tax. For the most part, these taxes are not optional. Usually your broker deletes them automatically. Once paid, you never hear about these taxes again from the IRS, which handles these matters through financial institutions rather than individuals. Don’t let that fact fool you: You pay taxes to the IRS, more than you probably know.
Can you avoid paying dividend tax to the tax authorities?
After you learned that your US stock dividends will be taxed by the IRS, you probably had one of two reactions:
- “Time to sell my US stocks!” This is understandable, especially with the current US administration being what it is. However, it’s not rational: US markets are home to some of the best companies in the world. You don’t want to miss the action.
- “How can I avoid these taxes?” This is the most rational response. The short answer is that it is possible, but not without limiting your freedom somewhat. Since selling all your US stocks is not a viable solution to the IRS withholding tax, we need to explore your options to avoid/reduce the dividend tax you pay to the IRS.
Moving to a country with lower taxes
One way to avoid paying dividend taxes to the IRS is to move to a country where withholding taxes are lower. An example is Bulgaria; the US charges Bulgarians only 5% to 10% on US-source dividends. Unfortunately, you will probably have difficulty finding a job in Bulgaria, China or another country with a lower withholding tax than ours.
Investing in an RRSP
Another way to avoid paying dividend taxes to the IRS is to invest in an RRSP. US stock dividends are not taxed by the CRA or IRS when held within an RRSP. The same is not true with TFSAs; withholding taxes apply there.
Investing in an RRSP is probably the most realistic way to avoid paying dividend taxes to the IRS. It’s legal. It’s ethical. It does not entail any bureaucratic hassle. Overall it’s a good way to go.
Paying Dividend Taxes to the IRS: Silly Takeaway
Finally, I would like to say that if paying taxes to the IRS bothers you, it would be wise to keep in mind all the great stocks we have here in Canada. If you look at a stock like Fortis Inc (TSX:FTS), you’ll find a lot to love. The company is a regulated utility with near-monopoly status in many jurisdictions. It has a manageable payout percentage (72%). It has 51 years of dividend increases to its name. It’s a solid long-term performer. If you really want to avoid US withholding taxes, getting more names like Fortis in your portfolio is one way to do that. But overall, avoiding US stocks isn’t necessary. With an RRSP and a collection of high-quality U.S. dividend stocks, you can avoid dividend taxes entirely.
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