Matthew Christensen and Katherine Kaess Christensen lived in Paris and paid French tax after selling shares in a French company. Their US return carried another charge: $3,851 in net investment income tax.
The couple won a refund judgment in 2023. On Aug. 31, the US Court of Appeals for the Federal Circuit reversed it. The court rejected their argument that the US-France tax treaty entitled them to a credit against the charge.
The court reversed a Canadian resident's victory the same day. Americans in both countries lost favorable rulings on using foreign taxes to offset the existing 3.8% US investment levy.
A larger bill in Canada
Paul Bruyea, a US citizen living in British Columbia, sold Canadian property in 2015. His disputed net investment income tax, commonly called NIIT, reached $263,523.
Bruyea paid the tax and sued for a refund. The Court of Federal Claims ruled in his favor in 2024 under the US-Canada treaty. The Federal Circuit reversed that judgment Aug. 31.
Why didn't the treaties protect them?
Foreign tax credits generally let eligible taxpayers offset US income tax with qualifying income taxes paid abroad, subject to limits. Those ordinary credits remain available.
The NIIT sits outside that system. Congress placed it in Chapter 2A of the Internal Revenue Code; ordinary foreign tax credits apply to Chapter 1 taxes. The taxpayers argued that their treaties supplied the missing credit.
The appeals court held that the treaty credits remained subject to US law's restrictions. That also governed the French provision specifically covering US citizens resident in France, even though it didn't repeat the limitation.
Which Americans face the investment tax?
The NIIT depends on investment income and overall income. The threshold is $200,000 for single filers and heads of household, or $250,000 for married couples filing jointly. For married people filing separately, it's $125,000.
The rate is 3.8%, applied to the smaller of net investment income or modified adjusted gross income above the threshold. Investment income includes interest, dividends and taxable capital gains. Rental income can qualify too.
Overseas earnings complicate the calculation. The foreign earned income exclusion is generally added back to adjusted gross income, with adjustments for related deductions. A foreign salary can therefore push someone above the threshold, though wages themselves aren't subject to the NIIT.
Separate efforts to change the tax rules
These lawsuits sought credits under existing treaties. The residence-based taxation proposal AER covered in July would let qualifying Americans abroad elect US taxation limited to US-source income. That would change the income subject to tax.
Lawmakers have considered narrower foreign tax credit changes too. The Senate Finance Committee removed a proposed increase in simplified foreign tax credit thresholds from its July version of the Taxpayer Assistance and Service Act. That proposal addressed ordinary credits, not the disputed NIIT offset.
Refund claims after the reversals
Refund claims based on the earlier victories are now likely to be denied, KPMG said in its Sept. 2 assessment. That's the firm's forecast for Internal Revenue Service (IRS) action. Its warning covers pending, protective and amended claims relying on the two lower-court decisions.
The firm also raised whether affected taxpayers should preserve protective claims pending any further appeal. Such claims preserve the ability to pursue a refund when entitlement depends on an unresolved event, including litigation.
The IRS generally delays action on protective claims until that event is resolved, its refund guidance states. Filing one doesn't establish that a refund is owed.
