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Kostelanetz Alert: U.S. Supreme Court Upholds Tax on Foreign Business Income

Justices Avoid Addressing the Limits of Congress’s Authority to Tax Income
Under the Sixteenth Amendment

The U.S. Supreme Court in Charles G. Moore v. United States (No. 22-800), by a 7-2 vote, rejected a constitutional challenge to the Mandatory Repatriation Tax (“MRT”) imposed by IRC 965. The MRT is a one-time tax on accumulated but undistributed foreign earnings under subpart F, enacted in the Tax Cuts and Jobs Act of 2017.

Petitioners argued that the MRT is unconstitutional because it taxes unrealized gain.  According to petitioners, the Sixteenth Amendment, which grants Congress authority to tax income without apportionment among the several states, requires a realization event, and that is what distinguishes an income tax from a tax on property, which must be apportioned. This issue goes to the core of Congress’s taxing power.

Kostelanetz filed an amicus brief on behalf of Professors Reuven Avi-Yonah, Clinton Wallace, and Bret Wells asserting that there is no constitutional realization requirement, and, to the contrary, exceptions to realization are common and essential to maintaining a fair and progressive income tax.

The Supreme Court decided the case on intentionally narrow grounds and avoided the fundamental issue of whether there is a constitutional realization requirement. The majority opinion, written by Justice Kavanaugh, points out that the MRT taxes a shareholder on income that is clearly realized by a controlled foreign corporation, so the real question is “whether Congress may attribute an entity’s realized and undistributed income to the entity’s shareholders or partners, and then tax the shareholders or partners on their portions of that income.” The majority found ample support for this proposition and dismissed petitioners’ attempts to distinguish the MRT from the many taxes based on the undistributed income of partnerships, S-corporations, controlled foreign corporations, and the like.

In contrast with the majority’s narrow approach, four justices – Justice Barrett, in a concurrence joined by Justice Alito, and Justice Thomas, in a dissent joined by Justice Gorsuch – all endorsed the existence of a constitutional realization requirement. These justices effectively invite future challenges to Congress’s authority to tax various types of income or gains under the Sixteenth Amendment, and taxpayers assuredly will answer the call. This case will not be the last word on the matter.

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