U.S. Citizens in Canada Face New Setback on Investment Income: Court Rejects Foreign Tax Credits Against the NIIT

Summary

This week the U.S. Court of Appeals for the Federal Circuit issued two rulings rejecting efforts to use foreign tax credits to offset the U.S. net investment income tax (NIIT), overturning earlier taxpayer-friendly decisions. As reported by the Financial Post, high-income U.S. citizens living in Canada — including dual citizens — could face an effective marginal tax rate of more than 57 per cent on their investment income.

The NIIT took effect in 2013 under the Affordable Care Act and imposes a 3.8 per cent surtax on the net investment income (interest, dividends and capital gains) of U.S. filers whose adjusted gross income exceeds US$200,000 for single filers. Because the U.S. taxes citizens on worldwide income no matter where they live, U.S. citizens in Canada must file U.S. returns each year. Foreign tax credits generally offset most U.S. federal tax for these filers — but U.S. domestic law does not allow foreign tax credits against the NIIT itself, so investment income taxed in Canada can be taxed again in the U.S.

The two cases involved a U.S.-citizen couple living in Paris who sold shares of a French company and paid US$3,851 of NIIT, and Paul Bruyea, a U.S. citizen resident in British Columbia who sold Canadian real estate in 2015 and owed US$263,523 of NIIT on the same gain after paying Canadian capital gains tax. Both taxpayers won at the U.S. Court of Federal Claims (in 2023 and 2024, respectively), but on appeal the Federal Circuit reversed. The court held that treaty language providing relief from double taxation "in accordance with the provisions and subject to the limitations of the law of the United States" incorporates the U.S. domestic-law restriction, so the Canada-U.S. and France-U.S. treaties do not create an independent foreign tax credit against the NIIT.

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Our Take

For cross-border CA/US filers, these decisions close a relief route many had hoped would survive: using the tax treaty to eliminate NIIT double taxation. Taxpayers who pursued refund claims based on the 2023 and 2024 trial-level wins now face an unfavourable appellate outcome. For U.S. citizens living in provinces with high top marginal rates, investment income already taxed in Canada and then subject to the 3.8 per cent NIIT can carry a very heavy combined burden.

Practical steps worth considering: review where investment income is earned (which accounts and structures generate it), reassess any prior-year NIIT refund positions, and monitor possible legislative or administrative responses. The NIIT, the foreign tax credit limitation rules and treaty application are intensely fact-specific, so affected individuals should consult a CPA who specializes in U.S.-Canada cross-border filing.

Disclaimer: This article is general information only and does not constitute tax advice; it should not substitute professional tax counsel. Please consult a licensed CPA for advice specific to your situation.