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Unpacking the Landmark Court Cases of 2023: A Closer Look at Christensen v. United States

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The year 2023 has been pivotal for court cases addressing foreign compliance requirements for U.S. tax residents, citizens, and Green Card holders. Among the noteworthy cases are Bittner, Farhy, and the impending Moore case in the Supreme Court. For those interested, you can delve deeper into these cases here.

Court rulings concerning tax treaties often captivate public interest, particularly when the outcomes favor taxpayers. Within the complex landscape of foreign and cross-border tax matters, positive news about overcoming burdensome tax filings and penalties provides a much-needed respite.

The Christensen v. United States Case

In a landmark ruling, the court interpreted the U.S.-France income tax treaty to permit U.S. citizens residing in France to claim a treaty-based foreign tax credit against the U.S. Net Investment Income Tax (NIIT) for income tax levied by France on foreign-source income. For a detailed explanation of the Foreign Tax Credit (FTC), you can visit our post here.

This decision is significant as it potentially opens the door for U.S. citizens living in other countries with similar tax treaties to claim a treaty-based foreign tax credit against the NIIT. It’s important to understand that the NIIT, which is a 3.8% tax on passive income, falls under Section 1411 of the Internal Revenue Code.

Case Background: Christensen v. United States

Let’s meet the Christensens: U.S. citizens residing in Paris, France. They filed a joint U.S. tax return for 2015, which included $369,373 in earned income, $7,976 in U.S.-source passive income, and $101,353 in foreign-source passive income. Consequently, they paid $4,155 (3.8%) in NIIT on their total U.S. and foreign passive income. In 2020, they submitted an amended return claiming a refund of the NIIT paid on their French passive income, citing Article 24 of the treaty.

Understanding Article 24(2)(b)’s “Three-Bite” Rule

Article 24(2)(b) of the U.S.-France income tax treaty incorporates a "three-bite" rule, which may vary across different treaties. Here’s a simplified breakdown for U.S. citizens residing in France:

1. The "First Bite": The individual pays U.S. tax on U.S.-source income as allowed under the Treaty if they are a resident of France.
2. The "Second Bite": France taxes the individual as a French resident and offers credit for U.S. taxes paid on U.S.-source income, including passive income.
3. The "Third Bite": Any residual taxes owed to the U.S. based on citizenship must be paid. However, under Article 24(2)(b), the U.S. must provide credit for French income taxes paid in the "second bite" that exceed the amounts paid in the "first bite."

The court concluded that U.S. citizens residing in France could claim a treaty-based foreign tax credit against the NIIT under Article 24(2)(b).

Comparing Past Precedents: Toulouse v. Commissioner

In a previous case, Toulouse v. Commissioner (2021), the Tax Court denied a foreign tax credit against the NIIT for taxes imposed by France and Italy on the taxpayer’s passive income, interpreting the matter under Article 24(2)(a). However, in the Christensen case, the court adhered to the interpretation under Article 24(2)(a) but expanded its analysis under Article 24(2)(b).

Implications and Next Steps

This ruling is a notable victory for taxpayers, but its applicability might be limited to a specific group. You should consult a tax professional to examine whether the three-bite rule in Article 24(2)(b) applies to your resident country’s tax treaty, thereby enabling you to claim a foreign tax credit against the NIIT.

Finally, trust a knowledgeable tax advisor to navigate these intricate issues without "biting off more than they can chew." For more detailed legal texts, you can refer to the court’s decision here.

For further reading, our obligatory disclaimer is accessible here.

By staying informed and consulting the right experts, you can effectively manage your tax obligations while optimizing your benefits under applicable treaties.