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Foreign taxes on an IRA investment


Dear Tax Talk,
I accidentally selected a foreign ADR (American Depositary Receipt) stock for the loose change in my IRA, and then Israel withheld 25 percent of the very dividends I selected it for. Can I save my supporting paperwork and later claim a foreign tax credit when I am withdrawing the taxed dividend? -- David

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Dear David,
As you were shocked to find out, your tax-free individual retirement account is all of a sudden paying taxes to a foreign country.

Since an IRA would not traditionally pay taxes, I can't find anything in my research that says you can claim a credit for taxes paid by the IRA. Since the funds are paid to the IRA net of taxes, I don't see where you could later gross up the withdrawal for the foreign taxes paid.

For example, if your IRA earned $100 in dividends, it would have had $25 withheld for foreign taxes. The IRA would then only have $75 available to pay you, which would be your withdrawal. Since you're withdrawing the after-tax amount you couldn't claim the $25 credit.

Alternatively, I don't believe you could say that it was equivalent to a nondeductible IRA, since the U.S. tax may have been higher. I don't think the ADR is an advisable investment and you need to get rid of it.

-- Posted: August 5, 2004




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