What's the scoop on US taxation of foreign interest?

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By Liz Zitzow - In this article, I learned that British bank NatWest beat the IRS for a tax refund of $66 million. WooHoo!

Basically, the US wanted to tax NatWest’s US branch for items exempt under the treaty. They duked it out for quite a while, but eventually the plucky Brits won.

The incident brought to my mind a common error I see on tax returns. Many US citizens and US residents have an offshore account; usually one opened up during a period when they lived abroad. Often that account is in a country with which we have a tax treaty. In those cases, if there is tax withheld, there is often no deduction or tax credit allowed in the US for the tax withheld – because it shouldn’t have been withheld in the first place. The US only allows a tax crdit for a foreign tax that is actually due. If you pay a tax you don’t owe, you don’t get to take a tax credit for it.

When your client is paying a withholding tax on interest income earned in a foreign country with which we have a tax treaty, you should have them file the appropriate papers with either the bank or the country to get their tax withholding refunded. Most times, this is very easy to do. For example, for a UK-based bank, it is a simple one-page declaration filed with the bank rather than the HMRC (the UK equivilent of the IRS), even simpler than our Form W8-BEN that would be filed in the reverse circumstances for a Brit with an account at a bank in America.

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