The Christensen's Case: A Foreign Tax Credit Against the NIIT {AKA "Obamacare" Tax}.

Photo by raouf meftah: https://www.pexels.com/photo/aerial-view-of-port-de-nice-in-france-17200665/

Twenty twenty-three was a landmark year for court cases involving various foreign compliance requirements for tax residents/ citizens/ Green Card holders in the United States. Bittner, Farhy and the pending Moore case in the Supreme Court are some examples. We wrote about them here.  

Court cases that involve interpretation of Tax Treaties are always fun! Especially if the interpretation is in the taxpayer's favor. In the field of foreign and cross-border tax matters, bringing good news when going over onerous tax filings & penalties for non-compliance is a small silver lining. 

In the case of Christensen v. United States, the court interpreted the US-France income tax treaty to allow US citizens residing in France to claim a treaty based foreign tax credit (more on mechanics of the FTC in our post here) against the US Net Investment Income tax or NIIT for income tax imposed by France on foreign-source income. This case is important because this could support US citizens who are residents of various other foreign countries that have similar tax treaties, to claim a treaty based foreign tax credit against the NIIT. 

Remember, the 3.8% NIIT is imposed on passive income under IRC §1411. 

Case Details. Let's meet the Christensen's: They are US citizens residing in Paris, France and filed a joint US return (original & later amended) for 2015. On the return was $369,373 of earned income, $7,976 of US-source passive income, and $101,353 of foreign-source passive income. They paid 3.8% NIIT of $4,155 on their total US and foreign source passive income. They later filed an amended return in 2020 claiming a refund of the NIIT filed on their French passive income stating that this was off-set by the treaty under Article 24. 

Article 24(2)(b) has a "three-bite" rule which is a part of US income tax treaties but may differ in treaties with different countries. Generally, for a US citizen who is a resident of France, it works as follows: 

1. The "first bite": An individual pays US tax on US-source income as permitted under the Treaty if the individual was a resident of France. 
2. The "second bite": France taxes the individual as a French resident, providing a credit for the US tax paid under the "first bite" on US source income including passive income. 
3. The "third bite": The individual pays residual taxes (if any) to the United States on the basis of citizenship. However, under article 24(2)(b), the US must allow a credit for the French income tax paid in the "second bite" that went over what was paid in the "first bite". 

The Court interpreted this to mean that US citizens who are resident in France can claim a treaty based foreign tax credit against NIIT under Article 24(2)(b). 

When compared with an earlier Tax Court case, Toulouse v. Commissioner from 2021, the court had denied a foreign tax credit for the NIIT claimed against tax imposed by France & Italy on the taxpayer's passive income. The Court had interpreted that under Article 24(2)(a). 

For the Christensen's, the Court stayed with the Toulouse's interpretation under Article 24(2)(a) but went beyond the Toulouse's analysis under Article 24(2)(b). 

What Does This Mean For You? This is a taxpayer win, but we should be aware that this ruling is probably applicable to a narrow group of people. The tax-treaty for your resident country needs to be examined for Article 24(2)(b)'s three bite rule to check if you can indeed claim a foreign tax credit against the NIIT. 

Find a tax professional who is aware of these implications and will not "bite off more than they can chew". Pun intended! 

Bibliography: TBAT Blog Post on the 3.8% NIIT Intro; Matthew and Katherine Kaess Christensen v. United States; US-France Tax Treaty; Bittner, Farhy and Moore: Who Are They and Why Are They Important?; Learning the Mechanics of a Foreign Tax Credit; Internal Revenue Code § 1411; 

Our obligatory disclaimer is here.    

Bibliography: Matthew and Katherine Kaess Christensen v. United States;