United States: Christensen V. U.S. – Reducing The N.I.I.T. By Claiming An F.T.C.

INTRODUCTION

The reliance on smartphone G.P.S. applications is nearly ubiquitous in today's world. These "map apps" not only furnish diverse routes to destinations but routinely identify roadblocks and traffic disruptions, ensuring the selection of the most efficient route. Like a map app, the Christensen case delineated two distinct paths for taxpayers to claim a foreign tax credit ("F.T.C.") – either through the Internal Revenue Code (the "Code") or an applicable income tax treaty. As highlighted in the case, one pathway may be a backroad gem when the other is blocked.

In Christensen, the Federal Claims Court allowed U.S. citizen/French tax resident taxpayers to claim the F.T.C. to reduce the net investment income tax ("N.I.I.T.") using Article 24(2)(b) of the France-U.S. Income Tax Treaty ("France-U.S. Treaty").¹ This approach countered the Code's explicit disallowance of the F.T.C. as a way to reduce the N.I.I.T. The Federal Claims Court decision built upon the Tax Court's previous decision in Toulouse, where the Tax Court denied an F.T.C. claimed against the N.I.I.T. by a U.S. citizen/French resident taxpayer.² The disparity in outcomes did not stem from a conflict in reasoning. Rather, it resulted from the application of different provisions of the treaty. The taxpayer in Toulouse relied solely on Article 24(2)(a). The taxpayer did not raise the Article 24(2)(b) argument presented in Christensen. This simple change made all the difference and reinforced the principle that an income tax treaty can serve as the source of an F.T.C.

The decision proves timely, considering the N.I.I.T. applies to tax years beginning in 2013, and the statute of limitations for an F.T.C. claim is ten years.³ Accordingly, the deadline for filing an amended return for the inaugural N.I.I.T. year is April 15, 2024.

An appeal by the U.S. is anticipated, but as of now, the Christensen decision has opened an avenue for U.S. citizens residing in a treaty jurisdiction to pursue an F.T.C. claim in order to reduce liability for the N.I.I.T. The unfolding of time will determine the degree to which taxpayers are broadly allowed to adopt this new path or if the U.S. successfully closes it. If the case is not reversed on appeal, the only course of action to prevent taxpayers from claiming the F.T.C. would involve a bilateral revision to the French Treaty or a unilateral revision to U.S. tax law for the sole purpose of removing the benefit.

NET INVESTMENT INCOME TAX

The N.I.I.T. is a separate levy from the regular income tax imposed on investment income under Chapter 1 of the Code. The N.I.I.T. under Code §1411 appears in its own separate chapter in the Code, Chapter 2A "Unearned Income Medicare Contribution." It first came into effect in 2013 as a means to fund the Affordable Care Act, which is the health care reform law enacted under the Obama administration. Code §1411 imposes a 3.8% tax on individuals on the lesser of net investment income or the excess, if any, of modified adjusted gross income over specified thresholds. Investment income includes interest, dividends, capital gains, rents, royalties, and other types of passive income. The tax typically is owed by higher-income taxpayers who earn a higher proportion of their income from investments.

FACTS OF THE CASE

Christensen involved a married couple, Matthew and Katherine Kaess Christensen, both U.S. citizens living in Paris and classified as tax residents of France. The couple timely filed their 2015 U.S. Federal income tax return and reported the following categories of income:

• Earned income of $369,373
• U.S. source passive income of $7,976
• Foreign source passive income of $101,353

Prior to factoring in any foreign tax credits, the couple faced a $76,376 U.S. Federal income tax liability under Chapter 1 of the Code. The couple also paid N.I.I.T. of 3.8% on both their U.S. source and foreign source passive income, which resulted in N.I.I.T. of $4,155. Of that amount, $3,851 related to foreign source passive income and the remaining $304 was attributed to U.S. source passive income. France exclusively taxed the foreign source portion of their investment income.

In the originally filed tax return, the Christensens did not claim an F.T.C. for either portion of N.I.I.T. In 2020, they filed an amended return claiming an F.T.C. against the N.I.I.T. attributed to their foreign source passive income. This resulted in a claim for a refund of $3,851.

The couple attached Form 8833 (Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b)) to their amended tax return to disclose the basis of their position and refund claim. In relevant part, the couple asserted that Article 24 of the France-U.S. Treaty permitted an F.T.C. against the N.I.I.T. imposed on foreign source passive income. The I.R.S. denied the refund claim, resulting in a substantial 33.8% effective tax rate on their foreign source passive income (30% French capital gain rate plus the 3.8% N.I.I.T. rate). An F.T.C. was allowed against the "regular" income taxes due under Chapter 1 of the Code.

Because U.S. tax was already paid, the Christensens initiated legal proceedings in the U.S. Court of Federal Claims. The U.S. Tax Court did not have jurisdiction.

TAXPAYERS' POSITION

The Christensens acknowledged that the Code does not provide for an F.T.C. against the N.I.I.T. The origin of the F.T.C. is found in Code §27, which provides as follows:

The amount of taxes imposed by foreign countries and possessions of the United States shall be allowed as a credit against the tax imposed by [Chapter 1] to the extent provided in section 901.

Code §901 provides that the tax imposed by Chapter 1 can be reduced by a credit for foreign income taxes. It provides as follows:

If the taxpayer chooses to have the benefits of this subpart, the tax imposed by this chapter shall, subject to the limitation of section 904, be credited with the amounts provided in the applicable paragraph of subsection (b) * * *.

The relevant portion of subsection (b) provides the following:

(1) Citizens and domestic corporations.

In the case of a citizen of the United States * * *, the amount of any income, war profits, and excess profits taxes paid or accrued during the taxable year to any foreign country or to any possession of the United States * * *.

It is crucial to note that the N.I.I.T. does not fall under Chapter 1 but rather resides in Chapter 2A of the Code; hence the lack of availability of an F.T.C. against the N.I.I.T. strictly through the Code. Nonetheless, the couple argued that the F.T.C. was available against the N.I.I.T. under the France-U.S. Treaty either under paragraph (2)(a) or (2)(b) of Article 24.

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Footnotes

1. Christensen v. United States, No 20-935T (2023).

2. Toulouse v. Commr., 157 T.C. No. 4 (2021).

3. Code §6511(d)(3)(A).

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