Foreigner Interest Income

[STEPHAN]

Florida.

A friend of mine is a German Citizen living in Denmark. She does not live in the US and has no SSN and no Tax ID.

From a divorce, he has an account of $250,000 here. She wants me to use these funds for a real-estate financing instead of a mortgage. I am willing to pay her 4%.

Does she have to pay taxes on the interest in the US?

 

[quincy]

Florida.

A friend of mine is a German Citizen living in Denmark. She does not live in the US and has no SSN and no Tax ID.

From a divorce, he has an account of $250,000 here. She wants me to use these funds for a real-estate financing instead of a mortgage. I am willing to pay her 4%.

Does she have to pay taxes on the interest in the US?

Who has an account of $250,000? “He” or “she?”

Why are you paying your friend 4%?

Clarification would be nice.

 

[Taxing Matters]

Florida.

A friend of mine is a German Citizen living in Denmark. She does not live in the US and has no SSN and no Tax ID.

From a divorce, he has an account of $250,000 here. She wants me to use these funds for a real-estate financing instead of a mortgage. I am willing to pay her 4%.

Does she have to pay taxes on the interest in the US?

So this would be loan of the $250,000 to you on which you'd pay 4% interest? And would this loan be a mortgage (i.e. secured by the property you'll be buying) or an unsecured loan?

 

[STEPHAN]

She got the money from a sale of a property at the time of the divorce. Taxes were paid. The money is on an account at a US bank.

She will give me a loan of $250,000. I will pay her 4% interest.

She will not get a mortgage. I will use it for a real estate deal. I will pay her back after 12 months. She will get monthly interest payments.

 

[Taxing Matters]

She got the money from a sale of a property at the time of the divorce. Taxes were paid. The money is on an account at a US bank.

She will give me a loan of $250,000. I will pay her 4% interest.

She will not get a mortgage. I will use it for a real estate deal. I will pay her back after 12 months. She will get monthly interest payments.

This is a payment of U.S. source interest to a nonresident alien for which no exemption under the Internal Revenue Code (IRC) applies. Thus, unless a treaty exemption applies (more on that later) this is taxable income to your friend and would be taxed at a flat 30% rate. Assuming that this real estate deal is part of a trade or business that you conduct you would have the obligation to withhold 30% of each interest interest payment and forward that money to the IRS. She would then get a credit for that withheld tax on her tax return (Form 1040-NR). You would file Form 1042-S to report your payments of interest to her and remit with the withheld tax. There are significant penalties for failure to file the Form 1042-S and in addition if you fail to withhold when you are required to withhold you can be personally liable for the amount you failed to withhold. You will also need to have her complete a Form W-8BEN. It's important for you to keep that form with your tax records.

Depending on the details of her residence arrangements, she is likely either considered tax resident in Denmark or in Germany. If she can claim tax residence in either country she may be able to claim exemption from US tax on the interest based on the tax treaties that the U.S. has with those two countries. If she claims exemption based on the treaty on the W-8BEN and assuming you have no reason to know she isn't entitled to that exemption then that would excuse you from doing with the withholding but you would still have to file the Form 1042-S to report the payments you made to her.

Read the instructions for the two forms for all the details of what you need to do. Also, information on withholding obligations for those making payments to foreign persons is found in IRS publication 515. Information for her on her obligations for US tax can be found in IRS publication 519.

The German Tax Treaty and Denmark Tax Treaty explain how interest is treated if she is considered a resident of Germany or Denmark respectively. Both treaties work the same way, which is that if she is a resident of Germany or Denmark for Treaty purposes then only Germany or Denmark may tax that interest income.

 

[STEPHAN]

Thank you so much Taxing Matters! I really appreciate your help!