Court rules: US expat can avoid the 3.8% Obamacare tax using foreign tax credits, if allowed under the specific income tax treaty

Court rules: US expat can avoid the 3.8% Obamacare tax using foreign tax credits, if allowed under the specific income tax treaty

A U.S. Federal court ruled that U.S. citizens living abroad can claim a foreign tax credit (FTC) to offset their 3.8% net investment income tax (NIIT) under U.S. and France tax Treaty.  The 92 page detailed opinion expands the tax planning opportunities for US expats seeking to avoid paying the NIIT tax on foreign-source income such as dividends, the sale of investment assets, 1031, and QSBS.   

The taxpayers lived in France. Seeking a refund of NIIT tax they paid, they amended their return and eliminated their NIIT liability tax by claiming French FTC.  The IRS denied the refund claiming that FTC cannot be claimed against NIIT because it falls outside of Chapter 1 of the IRC.  In fact, the IRS claimed that the regulations clearly disallowed FTC.

The Federal court saw the treaty as a contract between the two countries so analyzed it in great depth to determine what the parties had agreed to when the treaty was signed.  Like most treaties, the U.S.-France treaty applies to “income taxes imposed by the IRC” – including NIIT. But the main focus of the court was on the Article dealing with FTC  – Article 24 in this case.

The Federal court found that an FTC should be allowed under Article 24 because it did not include any restriction that the credit be allowable “in accordance with the provisions” and “subject to the limitations of the law of the United States.” The court dismissed arguments that such a ruling went against congressional intent in putting NIIT in a separate chapter, ruling that there are two separate regimes  – the US tax provisions governing FTC, and the treaty FTC provisions deserved equal weight

The case leaves the issue far from settled for taxpayers. The IRS could appeal the decision to the Federal Circuit Court of Appeals. However, in any case, since NIIT was introduced in 2014, a significant precedence has been established by taxpayers and their tax  professionals who have avoided NIIT in a growing number of situations involving non-US source income – dividends, capital gains, 1031 and QSBS.  Now it appears that planning will involve analysis of income tax treaties.

To read the opinion, see https://drive.google.com/file/d/1_MdGM1pUsR8wFNNKtx-aMEvjaeqtVb1a/view?usp=sharing

 

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