Foreign Stock Ownership and Taxes

There have been more questions lately about foreign stock ownership and taxes. Here's an example. A U.S. citizen sends $10,000 to a brokerage firm in Canada for investing in Junior mining stocks. But he asks himself this question: What kind of corporation should I form in order to minimize capital gains taxes from stocks and to protect my privacy as well?

Once of the first things U.S. investors in foreign securities should consider is both U.S. tax treatment and the tax laws of the foreign country (if they have any).

Canada imposes a tax on capital gains realized by foreign investors. The U.S. tax treatment of foreign company stocks is basically the same as for U.S. stocks, and that is if the stocks are held directly by the taxpayer or through a ‘pass-through’ entity. (Pass-through entities, by the way, include a partnership, S corporation or a U.S. grantor trust.)

So, if a tax is imposed by Canada, the U.S. allows the taxpayer to claim a foreign tax credit to the extent of the U.S. tax on the income subject to tax in Canada.

However, if a U.S. taxpayer forms a foreign corporation, and uses that corporation to invest in securities, the U.S. will treat that entity as a passive foreign investment company (PFIC) and as a controlled foreign corporation (CFC). Generally, U.S. tax treatment of these entities is not beneficial.

In some cases, a foreign corporation or international business company (IBC) that is owned by a U.S. citizen can elect to be treated as a pass-through entity. This election can be made with tax form 8832. If the foreign corporation is owned entirely by one U.S. citizen or entity, then it can elect to be treated as a disregarded entity. Income of disregarded entities would then be reported on form 1040 of an individual or on form 1120 for a corporation.