Paul Young Kim v. US, 5:22-cv-00691
This post is part of our series on recent important tax cases that may be of interest to accounting, tax, and finance professionals. For more like this, see our Federal Tax Update and California Federal Tax Update, which offer a comprehensive analysis of the year’s most pivotal tax developments.
Net Investment Income Tax Cannot Be Reduced by Foreign Tax Credits (Paul Young Kim v. US (5:22-cv-00691 (CA-9, Mar. 28, 2023))
Paul Kim is a US citizen who resided in South Korea until Sep. 2015, when he relocated to California. For the taxable year ending December 31, 2015, Mr. Kim timely filed a Form 1040 reporting in addition to the amount of regular income tax owed $644,382 in net investment income tax (“NIIT”).
Subsequently, Mr. Kim filed a Form 1040X for the 2015 tax year seeking a refund of $638,232 in NIIT. Mr. Kim claimed, under the U.S. – South Korea Income Tax Treaty, that (1) a Korean Resident is exempt from the US Social Security tax and Medicare tax and that NIIT is a Medicare tax, and (2) NIIT can be reduced by the foreign tax credit.
Is NIIT Medicare tax? The IRS argued that NIIT is a tax on investment income, not wages or self-employment income and thus is not affected by the exemption in the US – South Korea Income Tax Treaty. The Court was unconvinced and left the issue to further appeal.
NIIT cannot be reduced by the FTC? In an alternate attempt at relief, Mr. Kim argued that if the NIIT is not a Medicare tax and is instead an income tax, the foreign tax credit should reduce the NIIT. The Court disagreed. The NIIT is a tax that appears in Chapter 2A of the Code. Consequently, IRS regulations under the NIIT disallow credits that can be taken against Chapter 1 taxes – specifically the foreign tax credit – from reducing the amount of NIIT.
Also see.
Catherine Toulouse v. Comm., 157 TC, No. 4, Dec. 61,917 (Aug. 16, 2021), where Catherine Toulouse owed $11,540 of net investment income tax. She offset the NIIT with foreign tax credits claiming that tax treaties with France and Italy allowed her to offset all US income taxes with the $51,456 of taxes she paid to France and Italy in the year at issue. The foreign tax credit is in chapter 1, subtitle A of the IRC, and it expressly applies only against taxes imposed by chapter 1. However, the NIIT is in chapter 2A, subtitle A. Thus, the foreign tax credit does not apply against the NIIT.
Matthew and Katherine Christensen v. US (US Ct. of Claims, No. 20-935T (Sep. 13, 2023)). Note that the tax court did allow Christensen to offset income tax by their FTC while the court in Toulouse did not allow the FTC offset. Both courts quoted the US/France Tax Treaty, but each used different sections of the treaty to explain the court’s position. If your client lives in France, file an amended return. Expect the IRS to appeal Christensen.