In a decision that surprised many international tax advisors, on Oct. 23, 2023 the U.S. Court of Federal Claims ruled in Christensen v. United States, No. 20-935T that Matthew and Katherine Kaess Christensen, American citizens living in France, could claim a foreign tax credit (FTC) against the net investment income tax (NIIT) assessed on their U.S. federal income tax return. U.S. citizens living abroad and their advisors are hopeful that this may be a significant move towards reducing the double taxation they’ve faced since the 2010 enactment of the NIIT under the Affordable Care Act.
Prior attempts by Americans living abroad to offset the NIIT with FTCs had failed. Citing language in Article 24(2)(a), which is common to a number of tax treaties, the Internal Revenue Service argued that FTCs could only be claimed against income described in Chapter 1 of the Internal Revenue Code. Because the NIIT had been introduced under a new Chapter 2A of the of IRC, and was referenced as an “Unearned Income Medicare Contribution Surtax,” courts had agreed that it couldn’t be offset by FTCs.
However, the Christensens argued for relief under a different provision of the U.S.-France Income Tax Treaty. Article 24(2)(b) of this treaty doesn’t contain the language requiring FTCs to be used “in accordance with the provisions and subject to the limitations” of the IRC. (IRC Sections 27 and 901(a) are particularly problematic, as they restrict FTC claims to Chapter 1 taxes.) Based on this, the U.S. Court of Federal Claims agreed that the Christensens could claim a treaty-based FTC to offset the NIIT on their foreign-source passive income—income on which they had already paid French income taxes.
The impact of this decision could be far reaching. Tax advisors have already noted that the language in Article 24(2)(b) of the U.S.-France Treaty is like that in other U.S. income tax treaties, (for example, United Kingdom, Germany and The Netherlands) while some Canadian experts have already found similar provisions in the U.S.-Canada income tax treaty. Further, as international tax experts view treaties with renewed scrutiny, some have suggested attacking the NIIT based on language in the social security totalization agreements between the United States and a number of other countries.
However, for Americans living abroad and their advisors seeking to claim FTCs against their NIIT on their future U.S. federal income tax returns, a few caveats are in order. The relevance of the Christensen case for each taxpayer depends on the specific language in the income tax treaty with their foreign country of their residence. As the saying goes, if you’ve seen one U.S. income tax treaty, you’ve seen one U.S. income tax treaty. Although there’s commonality in many respects, they aren’t uniform.
And accountants have already noted that there may be practical challenges to actually claiming a FTC against NIIT, as the various IRS forms needed to do so don’t currently provide for this.
Finally, although it could be argued that the Christensen decision, supported by Article 24(2)(b) of the U.S.-France income tax treaty, doesn’t conflict with prior IRS wins in which taxpayers had sought to claim a FTC under Article 24(2)(a), this latest case represents a difference between the opinions of the Tax Court and that of the U.S. Court of Federal Claims. So it may open the door for further litigation if the IRS appeals and/or more taxpayers contest the IRS’ position.
For the immediate future, US citizens living outside the United States who wish to have the right to reduce their NIIT by claiming a FTC for taxes already paid to their foreign country of residence, but who don’t want to risk being the next IRS test case, may want to seek protective claims to retain the right to refunds depending on future developments.
Joan Crain is a global wealth advisor based in The Villages, Fla.