Capital gains and dividends distribution from IRA to non resident alien

[Mukeshbhaskar]

Hi,

I was working in USA till Sep 2018 and had 401K from my employer. I left USA in Oct 2018 and did not return till now. I rolled over my 401K to IRA in Jan 2019 and in Dec 2020, I asked my IRA custodian to cash out the capital gains and dividends earned in 2020 on my IRA amount instead of reinvesting them. I need to pay taxes on these capital gains/dividends and I believe i will also have to pay 10% additional penalty. I am a non resident alien for 2020 as I was not in USA in 2020. My question is about the tax treatment of these capital gains/dividends that are cashed out to me. Will these be treated as Effectively Connected Income and taxes based on the normal tax slabs or these will be treated as FDAP income and be taxed at the rate of 30% as I am a non resident alien for 2020? Thanks for your time and help.

[MarilynG1]

Unfortunately, TurboTax does not support a Non-Resident Alien Return, so am unable to answer your question about tax treatments for your IRA distribution. 

You can use Sprintax to prepare your return or download forms from the IRS site.

Click this link for more info on Resident and Non-Resident Alien Taxes. 

[dmertz]

Distributions from an IRA such as these, regardless of how the money came to be in the IRA, are taxable as ordinary income.  They do not get capital gains treatment.  The taxable amount of the distribution (the entire amount if you have no after-tax basis in traditional IRAs, which is likely in this case since the traditional IRA is a rollover from a 401(k)) is includible on Form 1040-NR line 4b.  If you were under age 59½ at the time of the distribution, the distribution is also subject to a 10% early-distribution penalty unless you have a penalty exception that applies.

[Mukeshbhaskar]

Thank you very much for your time so my read of your response is that even though I cashed out only the capital gains and dividends of 2020 (and not my original contribution), because it is gains out of IRA, it will be subjected to normal tax rates and not 30% tax rates even though I am a non-resident during 2020. Please clarify if I misunderstood it. 

[dmertz]

I was only commenting that the nature of the money paid out of an IRA is ordinary income rather than capital gains or dividends income and the fact that the gain in value within the IRA resulted from capital gains and dividends from investment within the IRA should be irrelevant.

I'm not particularly familiar with FDAP income or preparing a U.S. Nonresident Alien Income Tax Return, so I'm not able to say whether this income meets the definition of FDAP income.  It might help to use Sprintax to see how Sprintax treats this on your non-resident alien tax return.