The Supreme Court of the United States recently agreed to review the case of Moore v. United States. The question presented sounds dry and technical: “Whether the Sixteenth Amendment authorizes Congress to tax unrealized amounts without apportionment among the states.” But, if the Court says no, the Court can reverse our current tax code and stop future ones.
He moore The dispute involves a one-time tax imposed by the 2017 Tax Cuts and Jobs Act (TCJA) on approximately $3 trillion in corporate profits that had accumulated offshore. The TCJA restructured the US international tax regime and added the transition tax to prevent retained earnings from becoming permanently tax-free. The Court will hear the case next fall and will likely decide a few months later.
For many years, Charles and Kathleen Moore owned stock in a controlled foreign corporation (CFC), or a foreign corporation more than 50 percent owned or voting rights by U.S. persons, each which owns at least 10 percent. In 2017, the Moores incurred a $15,000 tax bill on their corporation’s retained earnings resulting from the TCJA.
Congress expected the transition tax to raise about $340 billion, overwhelmingly from large US multinational corporations (and a small number of individuals who owned a 10 percent or greater stake in a CFC, such as the Moores). The Moores challenged their share of the transition taxes as unconstitutional, but a Federal District Court and, later, the 9th Circuit ruled: (1) the tax was legitimately retroactive (to prevent prior earnings from going untaxed permanently) and (2) the gains were taxable even though they were not distributed (and therefore not “realized”). “Whether a taxpayer has earned income does not determine whether a tax is constitutional,” the Ninth Circuit said.
Congress’s latitude to tax income is now extensive, but it wasn’t always so. In 1895, the Court shot down Congressional advance income tax, because the Court labeled the tax “direct,” which the Constitution requires to be apportioned among states by population (which is impractical). But, in 1913, the United States adopted the Sixteenth Amendmentto allow Congress to tax “income from any source derived” without apportionment.
Congress then enacted our modern income tax, which includes “all income from any source derived”. But, a few years after enactment, a divided Court decided that a federal tax on the distribution of additional stock certificates to Standard Oil shareholders was not “income” in the Sixteenth Amendment sense because having two certificates instead of one did not enrich shareholders. Justice Oliver Wendell Holmes wrote in a scathing one-paragraph dissent:
I believe the word “revenue” in the Sixteenth Amendment should be read in “the sense most obvious to common understanding at the time of its adoption.” Because it was for public adoption that it was proposed. The known purpose of this Amendment was to get rid of nice questions about what might be direct taxes, and I have no doubt that most non-lawyers would assume when they voted for it that they put a question like this to rest. I am of the opinion that the Amendment justifies the tax.
Twenty years later, the Court described the requirement that money or property be received as a rule of “administrative expediency,” not of constitutional importance. Now, for over a hundred years, the Court has honored Congress’ use of “revenue” for tax purposes.
After the Ninth Circuit ruled against the Moores, conservative activists urged, in amicus briefs, the Court to rule that unrealized income could not be taxed (the briefs largely ignored the issue of retroactivity ). If the Court finds in favor of the Moores, it will entitle the Moores to a refund of $15,000, plus interest. And it can allow all or part of the remaining $340 billion, plus interest, to be returned, mostly to large US multinational corporations.
More generally, the Court could also compel Congress to rewrite important parts of our international tax, transfer and financial regimes. The courts have permitted, For many decades, Congress taxed a corporation’s retained investment income on controlling shareholders of personal foreign investment companies and CFCs (and Congress continues to tax this retained income). These rules prevent wealthy Americans and US multinationals from using foreign corporations as traditional uncapped individual retirement accounts.
Congress also taxes the profits of corporations and other pass-through entities to their owners, whether or not the profits are distributed. Congress requires taxpayers to include annual proceeds from “zero coupon” bonds that pay interest only at maturity. Taxes the gains from “build sales” of certain appreciated financial positions (even if the positions are not actually sold). Congress also taxes regulated futures contracts under a mark-to-market method of accounting (treating the contracts as if they were sold and any gains realized). Congress uses a similar mark-to-market accounting method to tax unrealized gains on securities owned by dealers.
He moore litigation may also be a workhorse to block billionaire and estate taxes, which have been proposed but not yet enacted. President Biden and Senate Finance Chairman Sen. Ron Wyden have proposed taxes on the increase in value of shares owned by billionaires like Jeff Bezos, Elon Musk and Mark Zuckerberg, without requiring them to sell them. One of the amicus briefs charged the Ninth Circuit’s Moore decision as “an invitation to enact more estate taxes.” A lead editorial in the Wall Street Journal motivated the Supreme Court to “close [the] constitutional door” to an estate tax by explicitly ruling that Congress cannot tax unrealized amounts.
But for the Court to preempt taxes that Congress has yet to enact is disturbing and reckless. Shortly after the Court announced its review, some tax advisers recommended that taxpayers file refund claims for transition taxes that have been or will be paid (many taxpayers chose to pay the transition tax in eight annual installments). Other advisers suggested considering income reimbursement claims from CFCs, associations, and similar flow-through tax regimes. We might also expect some taxpayers to exclude income on their tax returns this year, in anticipation of the Court’s ruling.
So we have to wait until next year to assess the damage of a $15,000 tax dispute, but the stakes are much higher: a potentially massive windfall for wealthy investors and multinational corporations. And unwieldy restrictions on Congress’s ability to tax.