Expats Poised for Years of Refunds With New Foreign Tax Ruling

The US Court of Federal Claims delivered excellent news for expats last month with its ruling in Bruyea v. US, which found the IRS has been wrongfully disallowing treaty-based foreign tax credits against taxpayers’ net investment income tax liability.

The US-Canada tax treaty entitled taxpayer Paul Bruyea to more than $263,500 in refunds, the court ruled. While domestic law prohibits offsetting NIIT with foreign tax credits under domestic law, a treaty can allow foreign tax credits to offset NIIT to relieve double taxation, according to the ruling.

This is the second time in recent years that the Court of Federal Claims has ruled that taxpayers can claim a treaty-based foreign tax credit against their NIIT liability. If upheld, these decisions could allow taxpayers to begin filing up to a decade’s worth of refund claims.

As a result, taxpayers and practitioners should consider amending returns to claim refunds for NIIT paid in prior years. Taxpayers normally have up to three years past the original filing date to claim a refund, but refunds based on foreign tax credits may be claimed for up to 10 years. This means the possibility to claim NIIT refunds from 2014 tax returns is due to expire this year.

Although the IRS likely won’t issue refunds if it chooses to appeal the court’s decisions, filing amended returns can prevent the statute of limitations from expiring on potential refunds if the rulings are upheld.

The Bruyea decision is significant because it rules that the treaty supersedes domestic rules prohibiting foreign tax credits from offsetting the NIIT—in the same way that countless other benefits provided by the treaty take precedence over domestic law.

Generally, a treaty defines the taxes covered as “all income and similar taxes.” Although the NIIT is often referred to as a type of Medicare tax, it’s considered an income tax. Therefore, the creditability of foreign income taxes against the NIIT is governed by the treaty’s provision on relief from double taxation.

Bruyea fundamentally disagrees with rulings in Toulouse v. Commissioner and Christensen v. US. Those decisions in 2021 and 2023, respectively, both held that the treaty’s domestic law limitation made the NIIT ineligible to be offset by foreign tax credits.

The court in Christensen ruled the domestic law limitation didn’t apply to the treaty paragraph on which the taxpayer had based their claim. If the domestic law limitation did apply to that paragraph, as the IRS is arguing in its ongoing appeal, the original court in Christensen would have agreed that no credit is allowed.

The Bruyea decision understands that when the treaty subjects its foreign tax credit to the rules and limitations of domestic law, it refers only to how the credit is calculated, not the taxes eligible to be offset by the credit.

Ironically, the Bruyea decision mentions the court agrees with the government’s arguments in Christensen—that the domestic law limitation mentioned at the beginning of the article on relief from double taxation applies to the later paragraphs as well.

The Toulouse ruling triggered strong reactions from some in the legal community, with practitioners publishing articles explaining why they believed the ruling to be erroneous. The Bruyea decision seems to vindicate many of their arguments.

The IRS forms aren’t currently set up to allow claiming this refund and would need to be redesigned if Bruyea is upheld. Taxpayers who want to claim a refund will need to adopt some type of workaround in the meantime.

One option might be to reduce the amount of the NIIT reported on Form 1040, Schedule 2, by the foreign tax credit and attach an accompanying statement to detail the calculation. Form 1116 also would require certain overrides.

The parties are set to give the court a joint status report by Jan. 16 regarding how the case should proceed.

The case is Bruyea v. US, Fed. Cl., 23-766T, 12/6/24.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Josh Pittleman is a tax senior in EisnerAmper’s financial services group, providing tax services to private equity, hedge fund, and individual clients.

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