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Tax Reform impact for non-US citizen property investors - W-8BEN, W-9 which forms to file?

Tax Reform impact for non-US citizen property investors - W-8BEN, W-9 which forms to file?
Ines Zemelman, EA
17 February 2020

Situational analysis

Non-US citizen (Thai Citizen) owns rental properties in the US. These rental properties generate income, which is then deposited into US banks. The US bank has now begun taking backup withholding. What is happening, and what forms does the taxpayer need to complete to reduce withholding?

Summary

 

  1. Bank starts taking 30% backup withholding from interest earned by deposit accounts.
  2. The Taxpayer wishes to avoid backup withholding.
  3. The bank requests to provide form W-8BEN or W-9 in order to stop or reduce backup withholding.
  4. The form W-9 does not apply because the taxpayer is not a US person. The Taxpayer is under the impression that form W-8BEN also does not apply because the rental income they receive from US sources is considered effectively connected income (EIC). Bank informs taxpayers that they should be filing W-8ECI. Is this correct? What should the taxpayer file?

What is the bank withholding tax on? Interest, not rental income.

Albeit the bank deposits, which generate income, come from rental income, the bank is only taking backup withholding from the interests the deposits generate.

Therefore, form W-8ECI is not relevant. The taxpayer should file form W-8BEN and resubmit it annually only changing the date of signing.

W-8BEN and the purpose it serves

A W-8 form is an IRS form that provides foreigners with an exemption from specified US information return reporting and backup withholding. There are a variety of W-8 forms.

The primary purpose of the W-8 form is to indicate to mutual fund companies and brokers that a foreign investor is not subject to standard taxation practices where investment income is not taxed.

Understanding the W-8 Form

Non-resident aliens and Foreign businesses that earn income from one or more US sources utilize the W-8 form. Its purpose is to provide notification that these businesses and individuals will not be taxed traditionally. Resident aliens and US citizens use a W-9 form for certification of tax Identification numbers. Although the W-8 form is an IRS form, it is submitted only to financial companies that request it and not to the IRS. Failure to submit the form as requested can result in a 30% tax withholding and potentially additional penalties.

The Form applies to nonresident alien individuals, foreign entities and exempt foreign persons. The term nonresident alien individual is someone who is neither a US citizen nor a resident. Foreign entities mean  nonresident alien or a foreign corporation, partnership, estate or trust that is not involved in US trade that gains from a deal with brokers or barter exchanges nor has been or plan to reside in the country for more than 183 days.

Variations of the W-8 form

There are several versions of the W-8 form. The most common forms are as follows

  1. W-8BEN - This is the form commonly used. It certifies Foreign status, regarding tax withholding on income. Tax-Free income, as specified by this form, includes interest, dividends, rents, royalties and annuities. The form allows foreigners to claim treaty benefits. The filer must provide certification of residency in the indicated country as well as a tax identification number to receive benefits from a tax treaty between the US and the foreigner's home country.  It is typical for foreigners to be taxed at a rate of 30% on income that is received from a US source.
  2. The W-8 ECI provides certification that a foreign individual’s income is somehow linked to work done in the US. The ECI attached to this form stands for “effectively connected income”. The certification allows the foreign individual to be exempt from the 30% tax rate on the income earned.
  3. In addition to the W-8ECI and the W-8BEN, there is also the W-8 BEN-E form, which is used by the beneficiary foreign businesses with income from the US that claim to be tax residents outside of the US.
  4. The W-8IMY form is for foreign dividends who act as intermediaries rather than acting as beneficiary owners.
  5. The W-8EXP form is for any international organization, foreign government, foreign tax-exempt organizations, foreign central banks of issue, foreign private foundation or government of a US possession that is simply claiming exemption from the Foreign Account Tax Compliance Act.

Form W-8BEN claims treaty benefits on backup withholding. According to the Tax Treaty between the US and Thailand, interest arising in the US and paid to a resident of Thailand is taxed at 15%.

Therefore, by filing this form, the taxpayer will receive a reduction of backup withholding from the default 30% to the treaty benefit 15%. Annual filing of a U.S tax return and properly reporting the interest will not eliminate the backup withholding.

Form Summary

 

Form W-9

 

A US citizen or other US person including a resident alien individual

W-8 ECI

A person claiming that income is effectively connected with the conduct of a trade or business in the US

W-8ECI or W-8IMY

A non-US business or non-US trust (subject to certain exceptions, consult own tax advisors)

W-8IMY

A person acting as an intermediary

Tax Reform & Withholding

In the case of the taxpayer, the amount of interest is less than the personal exemption of $4K. Before this year, U.S. financial institutions were not excessively concerned with small income that would be offset by personal exemption anyway.

This was changed as a result of Tax Reform 2017.

Starting from the 2018 year, there will be no more personal exemption.

Thus, the level of compliance for U.S. financial institutions was increased. With a lack of personal exemption, any amount of US income will become taxable from the first dollar, therefore banks take backup withholding from any income.

Going forward, by filing form W-8BEN, you will bring the amount of backup withholding in line with your actual tax obligations and will not have to seek a refund.

How To Complete the Above Forms

Completing W-9 tax forms for domestic residents

If you are a US citizen residing anywhere, or an individual resident in the US and have been issued a US ITIN, SSN or EIN, please complete IRS Form W-9, using your ITIN, SSN or EIN, and your legal address, Return the completed form, with your signature affixed to your acquiring editor at the press.

Completing W-8BEN tax forms for overseas royalty payments                       

For non-US persons, US law requires that 30 percent be withheld of any regular payment made to individuals who reside elsewhere. An exception is granted to Individuals who reside in countries that have tax treaties with the US and who submit a completed W-8BEN tax form. If the country has a tax treaty with the US and the non-resident submitted a complete W-8BEN, then US income will be taxed according to the requirements of that treaty. If there is no treaty then 30% of US income will be withheld.

Treaties are, for lack of a better word, confusing. Our team can help you navigate these troubled waters and ensure your documents are in order.

Ines Zemelman, EA
founder of Taxes for Expats