Portfolio & Deposit Interest for Nonresident Aliens (NRAs): When U.S.-Source Interest Is Exempt in 2025

Introduction: Why U.S.-Source Interest Matters for NRAs

Nonresident aliens (NRAs) who invest in U.S. bonds, bank deposits, or other debt instruments often worry about the 30% withholding tax on U.S.-source income. However, Congress carved out key exemptions in IRC §871(h) (portfolio interest) and §871(i) (bank deposit interest), making many types of interest income completely exempt from U.S. tax. This favorable treatment encourages foreign investment in U.S. capital markets and banking systems.

General Rule: 30% Withholding on U.S.-Source Interest

By default, U.S.-source interest paid to a nonresident alien is considered Fixed, Determinable, Annual, or Periodical (FDAP) income and subject to 30% withholding tax. This applies to:

• Corporate bond interest (unless exempted).
• Interest on personal loans made to U.S. borrowers.
• Interest paid on other U.S.-source obligations not covered by statutory exemptions.

But in practice, much of the interest that NRAs receive is exempt under the portfolio interest and deposit interest rules.

IRC §871(h): Portfolio Interest Exemption

The portfolio interest exemption is one of the most important benefits for nonresidents investing in U.S. debt. Under IRC §871(h), interest received from certain debt obligations is not subject to U.S. withholding tax if:

• The interest is paid on registered obligations (bonds, notes) issued by a U.S. corporation or government.
• The nonresident provides a Form W-8BEN to certify foreign status.
• The recipient does not own 10% or more of the voting stock of the issuing corporation.
• The obligation is not issued by a bank loan made in the ordinary course of business.

Example: An NRA investing in U.S. Treasury bonds qualifies for tax-free interest under this rule.

IRC §871(i): Bank Deposit Interest Exemption

Another powerful exemption applies to interest on U.S. bank deposits. Under IRC §871(i), NRAs are not taxed on interest earned from:

• Deposits in U.S. banks.
• Savings and loan associations.
• Credit unions.

Example: An NRA who holds $200,000 in a U.S. bank savings account earning 4% interest pays zero U.S. tax on the $8,000 interest earned.

Interest That Does Not Qualify for Exemption

Not all U.S.-source interest is exempt. Examples of interest that remains taxable to NRAs include:

• Interest effectively connected with a U.S. trade or business (ECI).
• Interest received from a 10% shareholder loan (related party debt).
• Contingent interest tied to profits, sales, or cash flow of the debtor.

These amounts remain subject to 30% withholding unless a treaty reduces the rate.

IRS Forms and Compliance for NRAs

To benefit from these exemptions, NRAs must ensure proper IRS documentation is in place:

• Form W-8BEN: Certifies nonresident status to avoid withholding.
• Form 1040-NR: Filed only if other taxable U.S.-source income exists (e.g., rental income, ECI).
• Bank/tax reporting: U.S. banks generally do not issue Form 1099-INT to NRAs but may issue Form 1042-S for FDAP income.

Without a valid W-8BEN, payors are required to withhold 30% even if the interest qualifies for exemption.

Tax Planning Tips for NRAs in 2025

• Use portfolio interest bonds and U.S. Treasuries to maximize exemption benefits.
• Deposit U.S. funds in banks rather than earning interest through related-party loans.
• Review tax treaties for additional exemptions or reduced rates.
• Maintain W-8BEN forms with all brokers and banks to prevent unnecessary withholding.

Conclusion

For individual taxpayers in the USA who manage funds for foreign clients, and for nonresident aliens investing in U.S. markets, the exemptions under IRC §871(h) and §871(i) are critical. They allow NRAs to earn U.S.-source interest income completely tax-free, provided the income qualifies as portfolio interest or deposit interest. Proper compliance with IRS rules, including W-8BEN certification, ensures that NRAs avoid unnecessary 30% withholding and maximize after-tax returns.