Hi,

This question is regarding 30% mandatory withholding of IRA distributions to a foreign person (returned to India).

1) If a non-resident alien withdraws from his IRA (before 59.5), I understand that the plan custodian should withhold 30%. Can the NRA file 1040NR and get refund if he is liable to pay less than 30% tax (including 10% penalty)?

Example: NRA withdraws 10000 from IRA. He has to pay a 10% penalty of 1000. IRA custodian withholds 3000. When the NRA file 1040NR, s/he determines that the tax + penalty he is liable to pay is 1600. Will IRS refund (3000 - 1600) = 1400?

2) Would the effectively connected income be taxed differently from capital gains/interest in the IRA? How is the ECI and gains segregated on withdrwal? In the above example how will they determine what portions is capital gain?

3) If the NRA (India resident) file W8-BEN, will that reduce the tax on the interest/capital gains through some tax treaty?

Regards
Sri

Yes. If in fact the 30% withholding exceeds combination of the tax liability and the 10% Early Withdrawal Penalty, then you can recover the difference as a refund by filing Form 1040NR at the beginning for the year following the date of the IRA withdrawal.

Thanks AtlantaTaxExpert.

Is IRA distribution considered as Effectively Connected Income and only subject to graduated tax rates?

Going through Pub 519, it is not clear if the gain/dividend portion of the IRA will be taxed at flat 30% rate for a NRA (this is what I tried to ask in questions 2 & 3 but did not use the right terms).

Regards
Sri

With regards to whether IRA distribution is considered Effectively Connected Income, I found the following info.

Section IRC 864(c)(6) (R2) talks about treatment of certain deferred payments to a non-resident. The language in the clause is modifying the clause of IRC 871(b)(1).

My understanding of the above clauses is that IRA distribution to a NRA is considered effectively connected income and subject to graduated tax rates. So, no flat 30% tax on the gain/dividend portion.

Please correct me if I am wrong.

Regards
Sri

You are correct in assuming you are subject to graduated tax rates.

Thanks AtlantaTaxExpert.

Glad to help!

Dear Sri (and Atlanta tax expert),

Your argument in post #4 looks convincing to me, but, researching this question further, many people seem believe that a 30% flat rate, instead of a graduated rate, applies.

I would be interested to hear whether, since your original discussion, you have any new first-hand experience, or indirect knowledge of whether, in practice, the IRS is willing to follow your argument.

Regards,

--Benno

Sorry Benno. I did not have to withdraw from IRA. So no first-hand experience on the above argument yet.

But, some countries have treaty with US by which IRA distribution can be treated as pension payment (if periodic withdrawal and not lump sum distribution) and taxed only in the country of residence of the Non Resident and not by US. See if that option applies to you.

Benno,

The graduated rates apply; I do these type of returns all of the time, and I know when the 30% flat rate applies and when the graduated rates apply.

For you, the graduated rates apply because the IRA is considered deferred compensation.