Potential NIIT Relief for International Taxpayers
A recent ruling in 2023 by the U.S. Court of Federal Claims allowed U.S. citizens living in France to offset the net investment income tax (“NIIT”) using the foreign tax credit (“FTC”) for taxes that are paid in France. This outcome is different from a previous court case on this same issue. The IRS has appealed the ruling leaving taxpayers in limbo waiting on the final decision regarding the relationship between the NIIT and FTC.
What is the NIIT?
The net investment income tax is a tax on investment income, which is imposed on taxpayers who are U.S. citizens or residents as well as trusts and estates. This tax is imposed on taxpayers with more than $250,000 of modified adjusted gross income, who are filing married filing jointly, and $200,000 of modified adjusted gross income, who are single. This tax was implemented in conjunction with the Affordable Care Act in 2010.
What is the FTC?
The foreign tax credit is a tax credit which can be used to offset federal income tax dollar for dollar. The FTC allows taxpayers to use taxes paid in a foreign country to decrease their U.S. tax liability. This credit has been around since 1918, right after World War I.
How are these two related?
Since the FTC offsets Federal income tax, one would assume that it could be used to offset the NIIT. The NIIT is a Federal income tax after all. However, due to Reg, 1.1411-1(e), this is strictly disallowed. This disallowance came into question when wording from a treaty between the U.S. and France, which was written in 1994, was used to claim an FTC to offset the NIIT. Article 24 of this treaty has wording which could allow for the NIIT to be decreased by the FTC.
The first taxpayer to claim this was a French resident with U.S. Citizenship, Toulouse.
Toulouse v. Commissioner
This court case originated in 2013 when Toulouse attempted to offset her NIIT liability with her FTC. Her tax return was flagged for a math error, and the IRS informed her that she would have to pay the full amount of her NIIT. After much discussion, Toulouse went to court over the issue. The final ruling of this case was that under Article 24(2)(a) of the U.S.-France treaty, Toulouse was not allowed to use her FTC to offset her NIIT liability. The reason the court gave for this was that Article 24(2)(a) states, “...subject to the limitation of the law of the United States,” meaning that U.S. domestic law would prevail. As a result of this case, the matter seemed to be settled. The FTC could not reduce the NIIT.
Christensen v. United States
This 2023 court case was very similar to that of Toulouse v. Commissioner. The Christensens attempted to offset their NIIT liability with the FTC using the U.S.-France treaty. After many notices of math errors and correspondence with the IRS, they eventually brought the matter to court. However, instead of citing Article 24(2)(a) as their reason for using the FTC to decrease their NIIT liability, they cited Article 24(2)(b). This paragraph of the treaty does not include the wording, “...subject to the limitation of the law of the United States.” Therefore, paragraph 2(b) seems to allow U.S. citizens residing in France to use the FTC to decrease their NIIT liability. The judge presiding over their case eventually ruled with a partial summary, which means both the plaintiff’s and defendant’s motions for partial summary judgment were granted in part and denied in part. The ruling states, “The court also concludes, however, that paragraph 2(b) of Article 24 of the 1994 Treaty, as amended, can provide a Foreign Tax Credit against the Net Investment Income Tax imposed by I.R.C. §1411 for the French income taxes paid by plaintiffs.” The IRS has appealed the decision, which will send the case to the Federal Circuit Court of Appeals.
How will this decision affect international taxpayers?
Until a final ruling, taxpayers will need to decide whether to rely on the Christensen case and take a treaty position to claim FTCs against the NIIT. We may see some taxpayers file refund claims for previous NIIT paid.
Additionally, this case may have a broader impact as there are other treaties that have similar provisions. We will continue to monitor this case and and the result of the appeal.
Let our team of experienced professionals help you analyze the potential tax benefits. Call us to schedule a consultation and determine whether this court case will impact you.
The information contained herein is of a general nature and should not be construed as professional advice. The reader should also be cautioned that the alert may not be specific to the reader’s exact circumstances and needs and may require additional information. You should not act upon the information provided without obtaining specific professional advice. The information above is subject to change.
For additional information concerning this alert, please contact: Melody C. Horton at (864) 502-8311.