The NIIT Chronicles: Foreign Tax Credits in Limbo

In this article, we explore the ongoing debate surrounding the ability of U.S. taxpayers to claim a foreign tax credit (FTC) against the Net Investment Income Tax (NIIT). Despite three significant court cases—Christensen v. United States, Toulouse v. Commissioner, and Bruyea v. United States—we are yet to have a definitive answer on this issue. Additionally, we discuss the option of making a protective claim to preserve the right to a potential refund.

By way of background NIIT, introduced under Section 1411 of the Internal Revenue Code (IRC), applies to individuals with adjusted gross income exceeding $200,000 for single filers or $250,000 for joint filers. This tax, generally set at 3.8%, targets investment income such as capital gains, dividends, interest, rents, royalties, and income from passive business activities. It was established by the Affordable Care Act to mirror employment and self-employment taxes on earned income.  Paying an additional 3.8% can be significant if you are already paying high rates of non US taxes on your investment income.

The three cases in point are:

• Christensen v United States: This case did allow a credit for foreign taxes against NIIT under the French/US treaty in limited circumstances.
• Toulouse v Commissioner: This case concluded that an FTC was not available against NIIT.
• Bruyea v. United States: This case concluded that an FTC was available under the terms of the Canada/US treaty.

So where do taxpayers stand and what should they do?

The IRS will almost certainly appeal against Bruyea and may well win the appeal.  It puts taxpayers in the unenviable position of not knowing whether the credit will be available.  In addition, as the IRS NIIT form currently stands, there is simply no administrative mechanism for claiming a credit.  There is no box on the form for the credit.  This was intentional by the IRS, supporting their view that no credit is due.

Generally, the statute of limitations for U.S. returns is three years from the date the return is filed or two years from the date the tax is paid. This is effectively the period within which a taxpayer can amend a return and request a refund. However, for foreign tax credits, this is extended to ten years. As it stands, it’s clear that the IRS will not be processing refunds for foreign tax credit claims against NIIT. But taxpayers do have the option of making a protective claim, which has the effect of keeping the statute open and means that they will not be timed out.

So, if you have been paying significant amounts of NIIT on your investment income since 2014 and that income has also been subject to foreign tax, it may be worth considering a protective claim. If you would like to speak to us about your options, please do get in touch.