Recent US federal court ruling opens the door for using foreign tax credits to offset NIIT tax liability

One of the most “annoying” aspects of US taxes for U.S. citizens living abroad is the NIIT tax (also known as the Obamacare tax or 1411 tax.)  Generally, NIIT tax liability cannot be offset by taxes paid outside the US.   So even if you pay significant taxes in your country of residence on your investment income, you usually owe NIIT to the U.S.

Until now

In the case of Paul Bruyea v. United States, decided on December 5, 2024, by the United States Court of Federal Claims, the court opened the door to using foreign tax credits to offset NIIT taxes. 

Pau Bruyea is a U.S. citizen living in Canada. He paid nearly US$2 million in taxes to Canada and claimed an FTC against his U.S. federal income tax liability for the 2015 tax year.  He did not claim the FTC against the NIIT.  In November 2016, the taxpayer filed an amended return claiming a refund of US$263,523, claiming a treaty-based FTC against his NIIT liability under the US-Canada tax Treaty.  The IRS rejected the refund claim, concluding that the FTC cannot be used to offset the NIIT liability.

The taxpayer filed a complaint against the United States in the Court and sought a refund of the NIIT tax paid.  The question before the court was whether the taxpayer could offset his NIIT liability by claiming a treaty-based FTC. 

The court ruled in favor of Bruyea but what is most interesting is the basis for the ruling, which was extremely broad and applicable to almost all treaties.  This is opposed to the 2023 case of Christensen v. United States where the court reached the same conclusion but based its ruling of specific language found in the US-France tax treaty.  This language does not appear in most treaties thus the Christensen case did not apply to cases outside France.  The Bruyan court, on the other hand, based its ruling on general treaty language that applies to almost all treaties!!

In essence, the court found that (i) the clear goal of a tax treaty is “the elimination of double taxation”, and (ii) that the Canada-US treaty (like most treaties) clearly states that “the United States shall allow to a citizen of the United States as a credit against  United States on income taxes paid in Canada.”

In contrast, the U.S. government argued that the treaty-based FTC clearly states that it is subject to “U.S. law limitations” which clearly do not provide FTC for NIIT. 

The Court rejected the government’s arguments and ruled in favor of the taxpayer.  Given the significance of the Bruyea case, US taxpayers and their US tax professionals have significant room for significant tax savings on the NIIT