Executive summary
The U.S. Supreme Court on Dec. 5 heard oral arguments in Moore v. United States. The narrow question in this case is whether Congress had the constitutional power—on a one-time basis in 2017 as part of a reform to certain foreign tax rules—to require U.S. shareholders in foreign corporations to pay tax on their share of the foreign company’s accumulated and undistributed earnings, without any actual dividend being declared or paid. It is sometimes called the mandatory repatriation tax, or MRT.
A somewhat similar tax was found by the Supreme Court to be unconstitutional in 1920. A pivotal question in front of the Court is whether and to what degree that 1920 case applies today.
Some observers believe that a decision invalidating the MRT—because no income was “realized” by the individual shareholders—could raise questions about many other provisions of the U.S. tax code under which taxpayers pay taxes even though they have not received any cash.
On the other side, some are concerned that a decision holding that “realization” is not required would suggest that it is constitutionally permissible to change the treatment of long-term capital gains—requiring taxes to be paid even before a gain is realized.
During the oral arguments, many of the justices were concerned about the reaches of their ruling; that a ruling for the Moores could cause major portions of the tax law to be invalidated. But many were also concerned that the absence of any restriction on the government’s ability to tax could lead to abusive or onerous taxation.
Based on the oral arguments, it appears unlikely that the Supreme Court is poised to issue a decision that will bring about significant changes to the current federal tax rules. However, the Court’s decision could affect the viability of future tax legislation governing both domestic and global capital markets, such as legislation relating to a wealth tax or a tax on unrealized capital gains.
A ruling is expected in spring 2024.
What is Moore v. United States all about?
In the 2017 Tax Cuts and Jobs Act, Congress enacted a one-time “mandatory repatriation tax.” This was part of a general reform of the rules governing foreign corporate investments and was viewed by many as a favorable change, even though some taxes were accelerated by a “mandatory repatriation” or “deemed dividend.”
That provision required U.S. shareholders who own 10% or more of a foreign corporation to pay a one-time tax (spread over a number of years and applied at a reduced rate in many cases) reflecting their share of the corporation’s accumulated post-1986 income. Essentially, the tax requires 10% shareholders to pay a tax on their share of the corporation’s retained earnings even though that money was not actually distributed to them.
Mr. and Mrs. Moore, who were required to pay a tax of approximately $15,000, sued for a refund. They asserted that the tax was unconstitutional. They cited a 1920 Supreme Court case, Eisner v. Macomber, that invalidated a somewhat similar tax on accumulated corporate earnings, imposed on shareholders of domestic corporations even though they received no cash dividend. Instead, they received only a valueless “stock dividend” tantamount to a stock split.
In Moore, there is little question that the taxpayers were wealthier on account of the accumulated earnings. Their shares presumably were worth more. Why do provisions like this raise constitutional issues?
Under Article I of the Constitution, Congress can only impose “direct taxes” if they are apportioned among the states in proportion to their populations, a requirement that makes any “direct tax” almost impossible to enact.
The 16th Amendment, passed in 1909, created an exception that permitted Congress to impose an income tax without apportionment. Congress proceeded to enact an income tax in 1913, which is the precursor to our current federal income tax.
However, Eisner v. Macomber and several other Supreme Court cases (dating back to 1920 and 1955) suggest that the 16th Amendment only permits income to be taxed if the income is “realized,” a term whose meaning is less than entirely clear.
In the Macomber case, the Court said there was no “realization” because the corporate earnings there were not actually distributed to the shareholders. Many believe that the same principle prohibits Congress from taxing unrealized capital gains on a long-term investment in stocks, real estate or other property until the property is actually sold (or exchanged for materially different property).
Does the modern tax code truly require that income must be realized? After all, many provisions currently in force impose a tax on income that is not received in cash. What exactly does it mean for income to be “realized?” These are the crux of the issues at heart in the Moore case.
The Moores asserted that:
(i) Realization remains a constitutional requirement to this day
(ii) The 2017 repatriation tax constitutes a tax on unrealized gains.
The government responded that realization is not a constitutional requirement. Commentators have suggested a middle ground: Although realization remains a constitutional requirement, the 2017 repatriation tax does not constitute a tax on unrealized gain, for any of several reasons.
How can this case affect other provisions of the tax code?
The case has attracted a tremendous amount of commentary and attention. Many have argued that, under the Moores’ argument, many longstanding provisions of the tax code could be attacked under the theory that those provisions are no different than the repatriation tax and involve a tax on unrealized gains. Some of the provisions of concern might include:
- The subpart F and similar rules requiring certain foreign corporate income to be imputed to U.S. shareholders
- Taxing partners and S corporation shareholders on their share of entity income
- Anti-abuse rules like the mark-to-market rules applicable to securities dealers or investors in regulated futures contracts and similar investments
- Accrual method taxation, including the required accrual of interest or original issue discount (OID) on certain instruments.
- The Moores argue that these other provisions are distinguishable and would not be affected by a narrowly drawn opinion invalidating the MRT.
Did the Supreme Court accept this case simply to opine on the repatriation tax?
Many believe that the Supreme Court’s interest in this case relates to tax proposals that are not currently part of the tax law. In recent years, some commentators and legislators have proposed various new forms of taxes; some have proposed enacting a wealth tax and others have proposed enacting a requirement that “paper” gains on stocks or other assets be taxed, even though nothing has been sold or disposed of. These proposals might not be viable if the Supreme Court invalidates the MRT on constitutional grounds or issues another ruling affirming similar constitutional principles.
Of note, during the oral arguments, the U.S. government’s attorney appeared to concede that a wealth tax would be unconstitutional under the 16th Amendment.
What did we learn from the oral arguments?
During the oral arguments, many of the justices were concerned that a ruling for the Moores could cause major portions of the tax law to be invalidated. They repeatedly pressed the Moores’ attorney to explain how the MRT differs from other, longstanding provisions of the tax code.
At the same time, many of the justices seemed uncomfortable with a position that would completely jettison the realization requirement. They raised questions that might suggest they are concerned that the absence of any restriction on the government’s ability to tax could lead to abusive or onerous taxation—such as wholesale taxes on unrealized gains on stocks, retirement accounts, mutual funds and real estate.
Ultimately, based on the justices’ questions—which may not indicate their actual views or intentions—many of them seemed intent on drawing a line somewhere between the two extremes of, on the one hand, abandoning the realization requirement completely and, on the other hand, retaining it in a way that would jeopardize existing code provisions.
When will the case be decided? And what are the chances that the case will actually bring about major changes to the tax code?
Cases are typically decided within two or three months of oral argument, but difficult or important cases are sometimes deferred until the following June.
Based on the oral arguments, it seems unlikely that the Court is interested in issuing a ruling that would invalidate existing tax laws. And neither a wealth tax, nor a tax on unrealized capital gains, is part of the tax law, so the Court cannot rule directly on those issues. However, the Court might potentially craft its opinion in a way that would affect the viability of future legislation relating to a wealth tax or a tax on unrealized capital gains.
