Federal Circuit Decision Clarifies Foreign Tax Credits and the U.S. Net Investment Income Tax (NIIT)

A recent decision by the U.S. Court of Appeals for the Federal Circuit has significant implications for U.S. citizens who live and invest abroad.

On August 31, 2026, the Federal Circuit reversed taxpayer-friendly decisions in Estate of Bruyea v. United States and Christensen v. United States, concluding that foreign income taxes generally cannot be used as a foreign tax credit to offset the 3.8% Net Investment Income Tax (NIIT).

What Is the NIIT?

The NIIT is an additional 3.8% U.S. tax that applies to passive investment income, including interest, dividends, rents, royalties and capital gains, when a taxpayer’s income exceeds applicable thresholds.

For U.S. citizens living abroad, the NIIT can create an additional tax burden because the United States generally taxes its citizens on worldwide income, regardless of where they reside.

Foreign tax credits are designed to reduce double taxation by allowing taxpayers to receive credit for certain taxes paid to another country. The question at issue in these cases was whether those credits could also be used against the NIIT.

The Cases Behind the Decision

The issue first received significant attention in Toulouse v. Commissioner. The U.S. Tax Court concluded that foreign tax credits could not be used to offset the NIIT. The court focused on the way Congress structured the tax code: the NIIT is imposed under Chapter 2A, while the general foreign tax credit provisions apply to taxes imposed under Chapter 1.

Taxpayers subsequently achieved more favorable results in two cases before the U.S. Court of Federal Claims.

In Christensen, U.S. citizens living in France argued that the U.S.-France tax treaty allowed French taxes to be credited against their NIIT. The Court of Federal Claims agreed.

Similarly, in Estate of Bruyea, a U.S. citizen living in Canada paid Canadian tax on the sale of Canadian real estate and argued that the U.S.-Canada tax treaty allowed those taxes to offset his NIIT. The Court of Federal Claims again ruled in the taxpayer’s favor.

The government appealed both decisions, bringing the issue before the Federal Circuit.

What Did the Federal Circuit Decide?

The Federal Circuit reversed the taxpayer victories. The court determined that the U.S. tax code does not permit foreign tax credits against the NIIT and that the tax treaties do not independently override that limitation.

The court also noted that the treaties seek to avoid double taxation but do not necessarily guarantee that taxpayers will never experience any double taxation.

The decision therefore represents a significant setback for taxpayers who had hoped that treaty provisions could be used to eliminate the additional 3.8% tax.

What This Means for U.S. Taxpayers

For U.S. citizens living anywhere in the world, the decision reinforces the importance of understanding the NIIT separately from the regular U.S. income tax.  A taxpayer may be able to claim foreign tax credits against their regular U.S. income tax liability, but that does not necessarily mean those credits can eliminate the NIIT.

This makes the NIIT an important consideration when selling appreciated investments, realizing large capital gains, receiving significant investment income or restructuring a portfolio.

The decision is particularly relevant to Americans residing in Canada because Bruyea directly involved the U.S.-Canada tax treaty.

Canadian residents are generally taxed by Canada on their worldwide income, while U.S. citizens remain subject to U.S. taxation on worldwide income. Although the treaty and foreign tax credit system generally help coordinate the two countries’ tax systems, the Federal Circuit’s decision confirms that Canadian taxes cannot simply be assumed to eliminate the U.S. NIIT.

For Americans in Canada, this means that Canadian taxes may not fully protect against the additional 3.8% NIIT. As a result, investment decisions, including the timing and structure of capital gains, can have significant consequences in both countries.

Conclusion

The Federal Circuit’s decision provides important clarity, but it also highlights a potentially costly issue for U.S. citizens living abroad. Foreign tax credits may reduce regular U.S. tax, but taxpayers should not assume they will also eliminate the 3.8% NIIT.  With the interaction between U.S. citizenship-based taxation, foreign taxes, tax treaties and investment income becoming increasingly complex, proactive planning is essential.

MCA Cross Border Advisors can assist U.S. citizens with comprehensive cross-border financial and tax planning to help navigate the complexities of the Canadian and U.S. tax systems.  Ready to discuss your situation? Click here to request a consultation.