Foreign Dividend Paying Stocks in Your IRA

The great benefit of IRA accounts is that your taxes on dividends and capital gains are deferred (or nonexistent in the case of Roth IRAs).

Foreign stocks that pay dividends, depending on their country of origin, often have their dividends taxed in the foreign country. Suppose the company pays a dividend of $1 per share, you own 100 shares, and the foreign country has a 15% tax on dividends. When you receive the dividend in your account, you'll get $85 rather than $100. This is because of the foreign tax.

If you own foreign shares in a regular account, these foreign taxes are deductible or can be used to take the foreign tax credit. However, if you hold the shares in an IRA account, foreign taxes aren't deductible or eligible for the foreign tax credit. So, in the example above, in a regular account you can deduct the $15 or get a $15 credit (depends on certain factors), but in an IRA you can't.

In certain situations, it may be advantageous to hold foreign dividend paying stocks in a regular account rather than an IRA. However, as you're not paying any US taxes on income in your IRA, you're not subject to the double taxation that the deduction and credit are designed to rectify. Either way you're paying taxes. Without the deduction or credit, you would be subject to double taxation in a regular account. This isn't the case in an IRA. For this reason, I won't worry about having ADRs in my retirement account.

Here is a great article on the foreign tax deduction and credit.