Why US domestic law closes the door

The foreign tax credit is allowed only against Chapter 1 taxes, under Sections 27 and 901(a). The NIIT sits in Chapter 2A, outside the reach of the credit. This is not interpretation. It is the architecture of the Code.

Treasury Regulation 1.1411-1(e) states plainly that no foreign tax credit applies against the Section 1411 tax. In the preamble to the 2013 final regulations, Treasury added a sharp position. A treaty that refers to the limitations of US law does not, in its view, supply an independent basis for a credit against the Section 1411 tax.

The starting point is clear, and hostile. The entire dispute turns on one question. Does the treaty change the result.
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The treaty as the only door: two decisions, one appeal

Two decisions of the Court of Federal Claims, a trial-level court, held that the treaty may serve as an independent source for the credit, despite domestic law.

In Christensen, a US citizen couple resident in France, France taxed their investment income at a rate exceeding the regular US tax and the NIIT combined, and the IRS collected the NIIT on the same income. The court held that the treaty creates an independent credit, but only through the Three-Bite paragraph, Article 24(2)(b), which is not subject to the US law limitation. It rejected the general paragraph, 24(2)(a). This is a narrow holding, helpful mainly to residents of the treaty country and only where such language exists.

In Bruyea the holding is far broader. A US citizen resident in Canada sold Canadian real estate at a gain of roughly $7 million, paid about $2 million in Canadian tax, and claimed a NIIT refund of $263,523 under the treaty. The court held that the general paragraph of the Canada treaty grants the credit against the NIIT, despite the US law limitation. As long as the NIIT is a US tax, the treaty applies to it. Because the general paragraph appears in most US treaties, the reach of Bruyea is far greater than that of Christensen.

Alongside the two decisions stands contrary trial-level authority. In Toulouse the taxpayer lost, in part because she relied only on the general paragraph and never raised the Three-Bite paragraph. That gap was later used in Christensen. In Kim, in California, the taxpayer lost as well, adopting the same reasoning. The contrary authority is not a single instance.

The procedural posture as of June 2026 is simple and cautious at once. The Federal Circuit heard both appeals together on March 3, 2026. No decision has issued, and one is expected in late 2026 or in 2027. A broad affirmance along Bruyea, a narrow one along Christensen, a reversal, or a split between the two cases are all possible. A further appeal to the Supreme Court is possible. Until a decision issues, there is no binding precedent here. There are two trial-level decisions on appeal.
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How the Three-Bite works, and why the position is not weak

The mechanism at the heart of the position deserves explanation, because without it, it is hard to see why Article 26(2) matters to an Israeli resident. The savings clause allows the US to tax its citizens as if no treaty existed, and that is what produces the double tax. To cure it, some treaties include a re-sourcing mechanism in three bites, for a US citizen resident in the treaty country who has US-source income.

First bite, the US taxes the US-source income at the reduced treaty rate, and the residence country must credit that tax. Second bite, the residence country taxes the income and credits the first bite, so that the income so far bears the higher of the two rates. Third bite, the US taxes again by reason of citizenship, but must credit the residence country tax, and to that end the income is re-sourced to the residence country. In Christensen the court held that the third-bite credit can offset the NIIT, because the Three-Bite paragraph is not subject to the US law limitation.

Beside the risk set out below, the strong side of the taxpayers' position deserves to be seen, not only what the courts held but why.

The purpose of a treaty is to relieve double taxation, and the government's narrow reading drains the relief article of content. On the taxpayers' view, the phrase "subject to the limitations of the law of the United States" governs how the credit is computed, not whether it exists.

The Croatia point sharpens this. The only treaty signed after the NIIT was enacted used narrower language, a credit to the extent allowed under US law. When the drafters want to confine the credit to the Code, they know how to say so, and in the older treaties they did not.

There is also authority that a treaty granted a credit beyond the Code. The Denmark and Italy treaties granted credits for the Danish hydrocarbon tax and the Italian IRAP, taxes not creditable under the Code. A treaty can therefore confer a benefit the statute does not.

And in Bruyea a simple question arose. There is no principled reason to apply the US law limitation to the general paragraph alone and not to the other paragraphs of the same article. Were the position plainly weak, there would not be two trial-level decisions for the taxpayers and an appeal heard in earnest.
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The Israeli hook: Article 26 and its two mechanisms

The treaty between Israel and the United States was signed on November 20, 1975 and entered into force on January 1, 1995, after protocols in 1980 and 1993. Article 26, the relief from double taxation, holds both mechanisms at the center of the litigation.

Article 26(1), the general paragraph, opens with language identical to the one at the heart of the dispute, a credit given subject to the limitations of US law. This is the Bruyea hook. If the appeal is affirmed along this line, that argument may support a credit against the NIIT for Israeli tax on Israeli-source income.

Article 26(2), replaced by the 1993 protocol, applies expressly where a US citizen is a resident of Israel, and operates the same Three-Bite mechanism described above. This is the Christensen hook. On its face, Article 26(2) does not carry the US law limitation language, the same structural feature that let the Christensen taxpayers prevail on France's Article 24(2)(b). This reading is favorable, but it has not been tested as to Israel.

A decisive structural point. The savings clause in the Israel treaty sits in Article 6(3), and it allows the US to tax its citizens as if no treaty existed, which is exactly the mechanism that creates the double tax. Yet Article 6(4)(a) carves Article 26 out of the savings clause. The technical explanation confirms that Article 26 may be invoked by a citizen or resident. The meaning, a US citizen resident in Israel may rely on Article 26 despite the savings clause.

Mapping by source of income. Israeli-source income taxed in Israel rests on Article 26(1), the Bruyea logic. US-source income taxed both in Israel as the residence country and in the United States as the source and citizenship country rests on the re-sourcing in Article 26(2), the Christensen logic, and only as needed.

That said, determining the source itself is not automatic. Under Section 865, gain on the sale of capital property is generally sourced by the seller's residence, so for a US person it tends to be US-source. For the credit to work, the income usually must be re-sourced to the foreign country, and the domestic mechanism for that runs through Sections 865(h) and 904, with a separate Form 1116 for income re-sourced by treaty. This is a step of work in itself, not an automatic determination.

And the presence of two mechanisms is not belt and suspenders. They map to two different appeal outcomes. If Bruyea is affirmed, Article 26(1) carries most of the weight and Article 26(2) is nearly redundant. If only Christensen survives, Article 26(2) is the main route, and it is the one that has never been tested.
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The Israeli threshold questions that can collapse the basis

Here caution is required, because each of the following questions may collapse the entire position for a given client.

Is the NIIT a covered tax under the Israel treaty. Article 1 applies to the federal income taxes in the Code, and a further paragraph extends to any tax substantially similar imposed after November 20, 1975. There is textual footing both ways, but whether the NIIT is an income tax or a separate Medicare levy is contested. In Canada and France the US government agreed that the NIIT is a covered US tax. There is no assurance it will agree as to Israel.

The new immigrant and senior returning resident exemption under Section 14 of the Ordinance. If the client enjoys the exemption on income from outside Israel, Israel does not tax the income. And where there is no Israeli tax, there is no double tax and nothing to credit. The basis for the entire position collapses for that income. This is a substantive Israeli distinction that is easy to miss.

The actual Israeli tax. The position helps only where the Israeli tax on the relevant income exceeds the regular US tax, so that residual NIIT remains and there is excess credit to absorb it. Israeli rates on investment income are at times high enough, but this is fact dependent, and the current rates should be verified.

For the professional desk Before drafting a position, map three questions for the specific client. First, whether the NIIT will be treated as a covered tax under the Israel treaty, a question that has not been resolved and has not been conceded as it was in Canada and France. Second, whether the client enjoys the Section 14 exemption, since then there is no Israeli tax to credit and the position is empty. Third, whether the Israeli tax on the income in fact exceeds the regular US tax, otherwise there is no residual NIIT to absorb. A no on any one of the three is enough to hollow out the opinion.
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The risk that is not always priced in

As the issue spreads, it is at times presented as a clearer opportunity than it is. The risk deserves to be broken down.

The decisions are trial-level and on appeal, and contrary authority stands beside them. Israel has never been tested, and the entire application is by analogy from France and Canada. The IRS denies these claims, a treaty-based position requires disclosure on Form 8833 under Section 6114, and an aggressive position on a current return exposes the client to penalty and interest if the government prevails. The forms are not built for this either, and in practice Form 8960 must be adjusted by hand.
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The responsible posture: an opportunity preserved with discipline

The opportunity is real. If Bruyea is affirmed, the result is real refunds for many American-Israelis. That is precisely why the right course is not to forgo it in advance, and not to rush at it without cover, but to preserve the right with discipline.

The way to do that is a protective refund claim, meant to preserve the right until the appeal is decided, rather than claiming the credit aggressively on a current return.

Here too precision is required. The general ten-year period for a foreign tax credit under Section 6511(d)(3)(A) is framed by reference to a credit under Section 901, and whether it applies to a treaty-based credit, which is not a Section 901 credit, is itself an open question worth verifying.

The accepted course is to wait for the outcome of the appeal. If the taxpayers prevail, an amended return and a refund claim follow. If the government prevails, an early aggressive claim exposes the client to tax, penalty and interest.

A good opinion here does not tell you whether you can win. It tells you whether the client is prepared to lose.
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Frequently asked questions

What is the NIIT. A US tax of 3.8% on net investment income above a threshold, under Section 1411, enacted in 2010.

Why can foreign tax not be credited against it. Because the credit is allowed only against Chapter 1 taxes under Sections 27 and 901(a), while the NIIT sits in Chapter 2A, outside the reach of the credit, as Treasury Regulation 1.1411-1(e) also provides.

What is the Three-Bite Rule. A three-bite re-sourcing mechanism for a US citizen resident in a treaty country. Reduced US-source tax, residence-country tax that credits it, and a residual US citizenship tax that must credit the residence-country tax by re-sourcing the income. It is the basis on which Christensen rests, and also Article 26(2) of the Israel treaty.

What changed with Christensen and Bruyea. Two trial-level courts held that the treaty may supply an independent basis for the credit despite domestic law. Christensen on a narrow line through the Three-Bite paragraph, Bruyea on a broad line through the general paragraph. Both are on appeal and undecided.

Do the decisions apply to Israel. Not directly. The Israel treaty carries the same language and both mechanisms, but the Israeli question has never been tested, and the application is by analogy only and depends on the appeal.

What is the main risk of a favorable opinion now. It rests on trial-level authority that is not final, on an analogy untested as to Israel, and on threshold questions that may collapse the basis, while the IRS denies the claims and an aggressive position exposes the client to penalty and interest.

What is the cautious step. In suitable cases, a protective refund claim to preserve the right and waiting for the outcome of the appeal, rather than an aggressive claim on a current return.
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Reviewing a US-Israeli client's NIIT exposure

The firm advises American citizens resident in Israel, and the advisors and accountants who serve them, on cross-border tax matters. We would be glad to help if you are facing one of these:

• A US-Israeli client exposed to the NIIT on income already taxed in Israel, weighing whether and how to preserve a right to the credit.
• A question whether to file a protective refund claim now or wait for the outcome of the Federal Circuit appeal.
• A need to map the threshold questions, including the Section 14 exemption and whether the NIIT is a covered tax under the Israel treaty, before taking a position.

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KLF Law is a firm specializing in international taxation, with experience in cross-border practice between Israel and the United States. To get in touch: royk@klf.co.il

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