Author: Dean Smith (PhD, CFP, TEP, CPA, CA, RWM; Partner)
US Tax Trends
Canada and the U.S. Net Investment Income Tax (NIIT) – An Update
The Net Investment Income Tax (NIIT), aka Obamacare, was introduced as part of the Health Care and Education Reconciliation Act of 2010 (P.L. 111-152). It was signed into law, by President Obama, on March 30, 2010. The tax applies to the unearned income of individuals, trusts and estates for tax years beginning after December 31, 2012.
The NIIT applies at a rate of 3.8% on the lesser of (i) the taxpayer’s “net investment income” for the year and (ii) the excess of the taxpayer’s modified adjusted gross income (MAGI) over a threshold amount. The current threshold is US $125,000 if married filing separate (MFS), US $200,000 if single or head of household (HOH) or US $250,000 if married filing joint (MFJ).
For non-resident US persons (U.S. citizens or green card holders), the tax has been problematic from the start as, under U.S. domestic law, a taxpayer was unable to claim any foreign tax credit (FTC) against the NIIT. For example, if a U.S. citizen, Canadian resident, had Canadian source investment income the U.S. would grant a foreign tax credit, for the Canadian taxes paid, against U.S. “regular” income tax but there was no mechanism to claim an FTC against the NIIT. In turn, Canada would not grant an FTC for any U.S. taxes paid (such as the NIIT), since the investment income was Canadian source. This amounted to double taxation.
The Canadian tax community came up with two possible filing positions with respect to this double taxation. One position was to treat the NIIT as a form of social security tax (Unearned Income Medicare Contribution – IRC §1411) which would then be covered under “The Agreement Between the United States and Canada” on social security. The second position was that a foreign tax credit should be allowed under Article XXIV of the Canada-United States Tax Convention (1980). Both filing positions, however, were at risk in that the IRS would disallow them if challenged.
In Matthew and Katherine Kaess Christensen v. the United States 168 Fed. Cl. 263 (Fed. Cl. 2023), the Court ruled in favor of the taxpayers and directed the IRS to allow them to claim a treaty based foreign tax credit against the NIIT. This case, however, revolved around specific provisions contained in the “Convention between the government of the French Republic and the government of the United States of America for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital,” FR.-US., Aug. 31, 1994. Practitioners believed that the decision could be applied to other countries which have similar provisions in their respective tax conventions. The Canada-United States Tax Convention (1980), however, did not contain these specific provisions and it was thus a question of fact as to whether the IRS would apply this decision in a wider context.
The issue may now have come to a conclusion. In Paul Bruyea v. United States, No. 23-766T, 2024 BL 445358 (Fed. Cl. Dec. 05, 2024), the United States Court of Federal Claims ruled in favor of the taxpayer in granting the taxpayer a treaty based foreign tax credit under Article XXIV of the Canada-United States Tax Convention (1980). At this time, it is unknown as to whether the IRS will appeal the Court’s decision. Given the incoming administration’s position on many tax provisions and Obamacare, in general, there is also a possibility that the NIIT itself may be repealed. We simply do not know yet.
The recent Court decision, however, gives support to the filing position that double taxation should be eliminated by the IRS granting a treaty based foreign tax credit against the NIIT. Affected taxpayers should consider this filing position with the understanding that the position may not yet represent the latest position of the IRS.
