Tax Strategy: Moore results in less

On July 20, 2024, in a 7-2 decision, the Supreme Court held that the Code Sec. 965 mandatory repatriation tax was constitutional under the Sixteenth Amendment to the Constitution. The majority opinion crafted a very narrow ruling preserving the status quo, but avoiding the principal issue presented to the court.

The Moores had invested in a controlled foreign corporation. They never received distributions from the CFC or paid any tax with respect to the CFC. Under the Subchapter F rules prior to the Tax Cuts and Jobs Act of 2017, shareholders were not taxed on the operating income of a CFC until distribution; however, 10%-or-more shareholders were currently taxed on movable income of the CFC, such as dividends, interest, rents and royalties.

The TCJA created a one-time Mandatory Repatriation Tax under Code Sec. 965 on a 10%-or-more shareholder’s share of the CFC’s post-1986 accumulated earnings, which consisted of the untaxed, undistributed operating income of the CFC.

Financed by groups seeking a ruling that taxation of unrealized sums was unconstitutional under the Sixteenth Amendment without apportionment among the states, since it was a tax on property and not a tax on “income,” the Moores challenged the constitutionality of Code Sec. 965 in court. They also argued that the MRT constituted a retroactive tax in violation of the Due Process Clause of the Fifth Amendment.

The federal district court held that the MRT was taxation of income within the terms of the Sixteenth Amendment. The Court of Appeals for the Ninth Circuit agreed, citing similar taxes that had been held constitutional over the years. The Ninth Circuit also held that the retroactivity of the tax did not violate the Due Process Clause because it served a legitimate purpose in accelerating the repatriation.

The Supreme Court granted certiorari in June of 2023 on the Sixteenth Amendment issue. The issue as framed by Moore was, “Whether the Sixteenth Amendment authorizes Congress to tax unrealized sums without apportionment among the states.” The government framed the issue as, “Whether the Mandatory Repatriation Tax is a tax … on incomes, from whatever source derived.”

Supreme Court decision

The Supreme Court held that the MRT was a tax on income and not a tax on property. The court framed the issue as whether Congress can attribute an entity’s realized and undistributed income to the entity’s shareholders or partners and then tax the shareholders or partners on their portion of the income.

The majority opinion looked to a long line of precedents that Congress can choose to tax either a business entity or its partners or shareholders, such as the taxation of partnerships and S corporations, and the taxation of Subpart F income. The majority opinion limited its decision to situations involving the taxation of shareholders of an entity on the undistributed income realized by the entity that has been attributed to the shareholders when the entity itself has not been taxed on the income.

By limiting its decision to this narrow issue, the court avoided addressing whether the Sixteenth Amendment includes a realization requirement.

Scope of the Moore decision

The court’s decision supports many longstanding taxes in the Internal Revenue Code, including the taxation of partnerships, S corporations, Subpart F income, global intangible low-taxed income (GILTI), real estate mortgage investment conduits (REMICs), passive foreign investment companies income, original initial discount rules for below-market and short-term loans, and mark-to-market rules for securities dealers, regulated futures contracts, imputed rental income, insurance companies, and the Code Sec. 877A exit tax.

The majority opinion does not address issues such as the constitutionality of proposed wealth taxes and the taxation of the appreciated but unrealized value of the assets of individual taxpayers. The opinion also does not address whether a U.S. entity’s realized income that is already subject to U.S. corporate income tax could be attributed to shareholders.

Concurring and dissenting opinions

The majority Supreme Court opinion was authored by Justice Kavanaugh and joined by Chief Justice Roberts, and Justices Sotomayor, Kagan and Jackson. A concurring opinion by Justice Jackson argued that the realization requirement was not constitutionally required under the Sixteenth Amendment. A concurring opinion authored by Justice Barrett and joined by Justice Alito argued that realization is constitutionally required under the Sixteenth Amendment; however, realization by an entity is sufficient to meet the requirement.

A dissenting opinion authored by Justice Thomas and joined by Justice Gorsuch also argued that the Sixteenth Amendment requires the realization of income. It criticized the majority for focusing on attribution and distinguished the MRT from other forms of pass-through taxation in that the other forms of Subpart F taxation related to the earnings of a U.S. shareholder on the earnings of a foreign corporation during the same year as the shareholder’s control.

Combining the concurring opinion of Justices Barrett and Alito and the dissenting opinion of Justices Thomas and Gorsuch, there were a total of four justices arguing that the Sixteenth Amendment includes a realization requirement. Only Justice Jackson’s concurring opinion argues directly that the Sixteenth Amendment does not include a realization requirement.

Wealth tax

A wealth tax has been proposed in the U.S. by some members of Congress and has been implemented in some European countries. Part of the impetus for financing the Moore case was to try to forestall a wealth tax in the U.S. by getting a ruling that a wealth tax would be a violation of the Sixteenth Amendment as a tax on unrealized income. The Supreme Court did not go that far in Moore; however, it appears that at least four of the current justices are prepared to do so.

President Biden has proposed an end to stepped-up basis at death for gains over $5 million per person and $10 million per married couple, with protections for gifts to charity and family for farms and businesses where the heirs will continue to run the business. Biden has also proposed a 25% income tax on those with wealth of more than $100 million.

Senator Elizabeth Warren has proposed a true wealth tax of a 2% annual surtax on the net worth of households and trusts between $50 million and $1 billion and a 6% annual surtax on the net worth of households and trusts above $1 billion.

Having failed to get the current Supreme Court to rule on the realization requirement in Moore, it may be difficult to find an appropriate case to bring the issue again to the Supreme Court until something similar to a wealth tax is enacted.

Should the realization issue come before the current Supreme Court again in the context of a wealth tax, it may be that Chief Justice Roberts and/or Justice Kavanaugh would join the four justices already indicating support for a realization requirement in the Sixteenth Amendment.

Impact

The Supreme Court’s decision preserves the status quo in protecting various provisions of the Internal Revenue Code, including the MRT specifically at issue in the case. It avoided, however, and left for another day, the issue presented by the Moores — whether the Sixteenth Amendment includes a realization requirement.