Last week, the Supreme Court issued its much anticipated opinion on Moore v. United States, a decision that could have changed the tax law as we know it and provide a clue as to whether a wealth tax could survive judicial scrutiny.
In Moore, the taxpayers were shareholders in a foreign corporation since 2005. While this corporation made a profit every year, the Moores did not get any dividends from the corporation because its profits were reinvested in the business. Generally, U.S. taxpayers were able to defer income from foreign corporations until the money was brought back to the U.S., with some exceptions described in Subpart F of the tax code.
Congress passed the Mandatory Repatriation Tax (MRT) in 2017 as part of the Tax Cuts and Jobs Act. It is a one-time tax on prior years’ offshore corporate profits going back to 1986. As a result of the MRT, the Moores had a tax bill of $14,729. After paying, the Moores sued the government for a refund.
During litigation, the Moores argued that the MRT is not an income tax because they did not receive any money from the corporation. Instead, the MRT is a “direct tax” on property (namely the stock) that, under the Constitution, must be apportioned so that each state pays in proportion to its population. The government countered by arguing that the MRT is an income tax and the Sixteenth Amendment excludes such taxes from apportionment. A tax requiring apportionment has not been passed since the Civil War due to the practical difficulty of meeting this requirement.
In a 7-2 decision authored by Justice Brett Kavanaugh, the Supreme Court held that the MRT is a constitutional income tax that does not require apportionment. The opinion cites past case law where the court held that Congress can legally attribute a business entity’s realized and undistributed income to the entity’s shareholders or partners and then tax the shareholders or partners on their portion that income.
Another issue in the case was whether income has to be realized in order to be taxable. While there has been no formal definition of what constitutes a taxable realization event, it is generally understood to mean a transaction that makes wealth accession real. A holding on this issue could impact multiple provisions of the tax code which could result in confusion and could threaten government revenue.
The opinion also emphasized that its holding is narrow. It is limited to: (1) taxation of the shareholders of an entity, (2) on the undistributed income realized by the entity, (3) which has been attributed to the shareholders, (4) when the entity itself has not been taxed on that income. The opinion does not authorize any hypothetical congressional effort to tax both an entity and its shareholders or partners on the same undistributed income realized by the entity. Its analysis does not address the distinct issues that would be raised by (1) an attempt by Congress to tax both the entity and the shareholders or partners on the entity’s undistributed income, (2) taxes on holdings, wealth, or net worth, or (3) taxes on appreciation.
The majority opinion stated that it will not address the realization issue. However, it did point out that the MRT does tax realized income — namely, income realized by the corporation. The MRT attributes the income of the corporation to the shareholders, and then taxes the shareholders (including the Moores) on their share of that undistributed corporate income.
Lastly, the majority opinion notes that a broad holding could invalidate numerous tax provisions, which could deprive the government of trillions of dollars in lost tax revenue. This could result in raising taxes or decreasing services. The Constitution does not require that fiscal calamity.
Justice Jackson’s concurring opinion takes a more pragmatic look. It states that the realization requirement argued by the Moores may be outdated or possibly overruled. Later court decisions suggest that the realization requirement is based on an administrative convenience. She finally states that people will disagree over tax policy and the remedy is to be found at the ballot box.
Justices Barrett and Alito’s concurring opinion stated that their opinion is based on the fact that the Moores conceded that Subpart F is constitutional. In addition, they also agree that the MRT is not meaningfully different from Subpart F.
But they note that court precedent holds that realization is required before the government may tax financial gain without apportionment, even though realization may take many forms. To realize income, one must perceive something new and valuable beyond the property she already owns. Precedent does not give Congress carte balance to attribute corporate income to a shareholder.
Justices Thomas and Gorsuch’s dissent states that the Sixteenth Amendment includes a realization requirement. It disagrees with the majority’s approval of attributing undistributed corporate earnings to the shareholders.
The court’s opinion doesn’t say much outside of the MRT. But now the public knows that at least four justices require a realization event before a taxpayer’s economic gain is taxable. While this may not deter legislators from proposing a wealth tax in the future, they will have to be very careful about passing laws that arbitrarily tax appreciated assets which the wealthy tend to have.
It is interesting to note that a constitutional challenge to a tax law even made it this far. Taxpayers are warned about making constitutional challenges as they are considered frivolous tax protestor arguments and can be subject to fines.
The majority opinion appears to be sensitive to “fiscal calamity” arguments when they consider the validity of a tax law. This could encourage hyperbolic “too big to fail” arguments. Thomas’ dissenting opinion notes this but warns that the judiciary may not come to the rescue.
Based on their oral arguments, the Moores wanted to focus solely on the MRT and leave everything else alone. While they ultimately lost their nearly $15,000 refund (and likely spent more than that amount on legal fees to date), they have unintentionally set guidelines for future tax laws and triggered a national tax policy debate.
Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolve tax disputes. He is also sympathetic to people with large student loans. He can be reached via email at stevenchungatl@gmail.com. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.