Foreign Tax Credit and Other Expat Benefits May Not Prevent Double Taxation
According to recent articles in Tax Notes Today and Mondaq.com, the Patient Protection and Affordable Care Act of 2010 – what is commonly referred to as Obamacare – may expose US expats to double taxation. While many Americans living abroad are able to use the Foreign Tax Credit, Foreign Earned Income Exclusion, and other tax savings to minimize their US tax liability, the PPACA imposes a 3.8 percent tax on net investment income (NII) that is not creditable.
This makes the tax on NII different than taxes paid on most other foreign income earned by Americans living abroad, which can be offset by the Foreign Tax Credit. As explained by the Mondaq article, “[Section 27 of the tax code states] ’The amount of taxes imposed by foreign countries and possessions of the United States shall be allowed as a credit against the tax imposed by this chapter to the extent provided in section 901.’ The words ‘this chapter’ refer to chapter 1 of the code, which spans sections 1 through 1400U. Section 1411 appears in new chapter 2a of the code. On its face then, it seems that foreign taxes paid on NII may not reduce the tax imposed by section 1411, potentially resulting in double taxation on that income.”
This has come as a surprise to many tax experts, who note that the taxes described in section 1411 are very similar to the taxes that are currently covered by US foreign tax treaties that bolster the Foreign Tax Credit provision. Even the guidelines proposed by the US Department of Treasury in December 2012 reflected an expectation that the NII would be creditable to the Foreign Tax Credit. However, during a webcast for the American Institute of Certified Public Accountants, an IRS official concluded that it does not apply to the Foreign Tax Credit.
Currently, there are ample court decisions that explain exactly what forms of foreign income apply to the Foreign Tax Credit, but none of them address NII and the provisions of the PPACA specifically. A case that will soon reach the Supreme Court, PPL Corporation vs. Commissioner, may shed further light on the subject, but as it is not aimed directly at the terms of Section 1411, it may take some time before any decisive case law develops.
In the meantime, Americans living abroad should assume that NII is not creditable to the Foreign Tax Credit. That may mean setting aside money to cover potential taxation for Tax Year 2013 and beyond.
Need help with the Foreign Tax Credit or Other Expat Tax Savings?
An expat expert CPA or IRS Enrolled Agent can explain available tax savings that apply to US citizens overseas. In the meantime, here is an in-depth post about the foreign tax credit. If you have questions about your particular situation in regards to this tax provision or any other, or if you would like help with your US expat tax return, please contact us.