Tax Hot Topics
On Aug. 31, the U.S. Court of Appeals for the Federal Circuit reversed the Court of Federal Claims (PDF - 179.38KB) in Estate of Paul Bruyea v. United States, holding that the U.S.-Canada income tax treaty does not permit a foreign tax credit (FTC) against the Section 1411 net investment income tax (NIIT).
The Federal Circuit had reached the same general conclusion in the companion Christensen case (PDF - 154.68KB) involving the U.S.-France treaty.
Background
The NIIT under Section 1411 applies when adjusted gross income exceeds $200,000 for single filer or $250,000 for joint filers. It generally imposes a 3.8% tax on investment income such as capital gains, dividends, interest, rents and royalties, as well as income from a trade or business in which the taxpayer is passive. Although the NIIT is an income tax, it is imposed under Chapter 2A of the Internal Revenue Code rather than Chapter 1, where the domestic foreign tax credit rules apply.
In this case, Paul Bruyea, a U.S. citizen residing in Canada, sold Canadian real property in 2015. The gain was subject to Canadian income tax and generated $263,523 of U.S. NIIT. Bruyea claimed a treaty-based FTC against the NIIT under Article XXIV of the U.S.-Canada treaty. The IRS disallowed the credit, but the Court of Federal Claims granted partial summary judgment for Bruyea on Dec. 5, 2024. (See our prior coverage of the Court of Federal Claims decision here.)
Federal Circuit holding
The Federal Circuit reversed the decision, concluding that neither the Internal Revenue Code nor the treaty permits an FTC against the NIIT. Sections 27(a) and 901(a) allow the FTC only against “the tax imposed by this chapter,” meaning Chapter 1, and Section 1411 is imposed under Chapter 2A. Reading those provisions together with Section 26(b), which treats the Section 1411 tax as separate from the Chapter 1 tax, the court held that the code does not authorize an FTC against the NIIT.
The treaty did not provide an independent route around that limitation. Article XXIV requires the U.S. to provide double-tax relief “in accordance with the provisions and subject to the limitations” of U.S. law. The court held that this language incorporates the code’s substantive limitations, including the restriction of the FTC to Chapter 1 taxes. The court also rejected the argument that the treaty’s general purpose of eliminating double taxation required a different result.
Grant Thornton insight:
The decision reverses the taxpayer-favorable Court of Federal Claims result and reinforces the existing line of cases holding that foreign taxes generally cannot be credited against the NIIT. U.S. citizens and residents with foreign investment income may therefore remain subject to both foreign income tax and the 3.8% NIIT on the same income, notwithstanding an applicable income tax treaty. Taxpayers that filed refund claims based on the lower-court decisions should evaluate the effect of the Federal Circuit’s rulings.
Contacts:
Content disclaimer
This content provides information and comments on current issues and developments from Grant Thornton Advisors LLC and Grant Thornton LLP. It is not a comprehensive analysis of the subject matter covered. It is not, and should not be construed as, accounting, legal, tax, or professional advice provided by Grant Thornton Advisors LLC and Grant Thornton LLP. All relevant facts and circumstances, including the pertinent authoritative literature, need to be considered to arrive at conclusions that comply with matters addressed in this content.
For additional information on topics covered in this content, contact a Grant Thornton professional.
Grant Thornton LLP and Grant Thornton Advisors LLC (and their respective subsidiary entities) practice as an alternative practice structure in accordance with the AICPA Code of Professional Conduct and applicable law, regulations and professional standards. Grant Thornton LLP is a licensed independent CPA firm that provides attest services to its clients, and Grant Thornton Advisors LLC and its subsidiary entities provide tax and business consulting services to their clients. Grant Thornton Advisors LLC and its subsidiary entities are not licensed CPA firms.
Tax professional standards statement
This content supports Grant Thornton Advisors LLC’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. It is not, and should not be construed as, accounting, legal, tax, or professional advice provided by Grant Thornton Advisors LLC. If you are interested in the topics presented herein, we encourage you to contact a Grant Thornton Advisors LLC tax professional. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein.
The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal, tax, or professional advice provided by Grant Thornton Advisors LLC. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact a Grant Thornton Advisors LLC tax professional prior to taking any action based upon this information.
Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton Advisors LLC assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.
Grant Thornton Advisors LLC and its subsidiary entities are not licensed CPA firms.
Trending topics
Share with your network
Share