Federal Circuit: No Treaty-Based Foreign Tax Credit Against the NIIT

The Federal Circuit Court of Appeals held that the U.S. income tax treaties with Canada and France do not permit a foreign tax credit against the U.S. net investment income tax (NIIT). The decisions reverse two taxpayer victories in the Court of Federal Claims and remove the principal authority for a position that U.S. citizens abroad may have taken or preserved by protective claim.

NIIT Credit Relief Limited

Paul Bruyea, a U.S. citizen resident in Canada, and the Christensens, U.S. citizens resident in France, each sold assets abroad, paying foreign tax on the gain, as well as the 3.8% NIIT. They both claimed a foreign tax credit against the NIIT, arguing that it was double taxation, for which the respective tax treaties provide relief. While the IRS disallowed the credits, the Court of Federal Claims ruled for the taxpayers in 2023 and 2024.

The Federal Circuit, however, reversed the Court of Federal Claims in both cases and ruled for the government. The court held that the placement of the NIIT outside Chapter 1 of the Internal Revenue Code puts it beyond the scope of the credit regime. The court noted that the treaties are bound by that limitation, as they only grant the credit “subject to the limitations” of U.S. law.

The court rejected the taxpayers’ argument that the language in both tax treaties only limits the computation of the credit, not its overall application. It also rejected their fallback argument that the separate credit provisions written for U.S. citizens residing in the treaty country are exempt from that limitation.

The Impact of this Ruling

This language is taken from the U.S. model treaty text and appears throughout the U.S. treaty network. The ruling is broader than the tax treaties for Canada and France. The Tax Court reached a similar conclusion in Toulouse v. Commissioner, and a district court did so under the U.S.-South Korea treaty in Kim v. United States. The taxpayers may still seek rehearing or Supreme Court review.

The ruling establishes that foreign tax credits are not available against the NIIT. U.S. citizens, residents, estates, and trusts with foreign income that constitutes net investment income will owe the tax to the extent their income exceeds the applicable statutory thresholds, with no offset for foreign taxes paid.

Taxpayers who claimed the credit against NIIT, preserved that position by a protective claim, or intend to rely on it for planning, should review their position now. Eide Bailly’s International Tax practice is advising U.S. citizens abroad and U.S. taxpayers with foreign investments on the effect of these decisions. Contact us to review your exposure and planning alternatives.