In a case with far-reaching implications for tax jurisprudence, the U.S. Supreme Court will decide whether the controversial mandatory repatriation tax (MRT), created by the 2017 Tax Cuts and Jobs Act (TCJA), is unconstitutional under the 16th Amendment. The case is Charles G. Moore et al. v. United States, Case No. 22-800. The Court will review a Ninth Circuit decision that upheld the MRT. Moore v. United States, 36 F. 4th 930, reh’g en banc denied, 53 F.4th 507 (9th Cir. 2022).
Broadly, the TCJA moves from a global system, where U.S. corporations are generally taxed on their worldwide income regardless of where their profits are derived, toward a territorial system, where they are generally taxed only on their domestic source income. IRC § 965 was intended to raise revenue to partially fund this move by, among other things, imposing a one-time tax on U.S. shareholders who own 10 percent or more of a foreign corporation primarily owned or controlled by U.S. persons, a Controlled Foreign Corporation (CFC). Under the new law, shareholders had to account for and pay tax on deemed income in proportion to their ownership interest in a CFC back to 1986.
More specifically, Section 965 modified IRC Subpart F by defining all CFC deferred foreign earnings after 1986 as a one-time income taxable in the U.S. in 2017. The intricacies of CFCs and their taxation under IRC Subpart F are beyond the scope of this news brief but, cursorily, before the TCJA, a CFC’s U.S. shareholders could be taxed on a proportionate share of certain categories of the CFC’s undistributed earnings, such as dividends, interest, and earnings invested in certain U.S. property. They were not taxed, however, on a CFC’s income from its active offshore business, for example when it sells its products to another foreign entity. By retaining this income as undistributed and therefore deferred foreign earnings, CFCs had, the government estimated in 2015, amassed $2.6 trillion in offshore earnings that were not presently subject to U.S. taxation. Section 965 was a one-time tax on those massive previously untaxed earnings.
In the Moore case, the taxpayers owned 11 percent of a CFC, but never participated in its day-to-day operations or management. The CFC made a profit each year but never distributed any earnings to its shareholders, instead reinvesting all of its earnings as additional shareholder investments. The taxpayers paid the MRT and sued for a refund, claiming that the tax was not authorized by the 16th Amendment and so violated the Apportionment Clause of the U.S. Constitution, Art. I, Section 2, which requires that direct taxes be apportioned among the states by population. The 16th Amendment, however, specifically authorizes a federal tax on income as an exception to the Apportionment Clause.
The taxpayers argued that their MRT tax bill was wrongly based on the CFC’s income that had not been distributed and so had not been “realized,” and that unrealized income was not included in the common understanding of “income” at the time of the adoption of the 16th Amendment.
The Ninth Circuit disagreed. It held that “realization of income is not a constitutional requirement” for the 16th Amendment’s exemption from apportionment for “taxes on incomes.” T16th Amendment was enacted to overrule an 1895 case holding that income from personal property was subject to the Apportionment Clause, demonstrating, the court decided, that the clause has a “narrow reach.” The court concluded that Section 965 legitimately prevented a windfall for shareholders in foreign corporations who had not yet received distributions. Without the one-time MRT, these shareholders would never pay taxes on their undistributed offshore earnings. The court agreed with the government that other levies that apply taxes without clear realization events are constitutional, such as the tax on U.S. citizens who relinquish citizenship and are taxed on the value of their assets as if they sold them the day before expatriation, regardless of any actual sale.
Amici supporting the Moores’ Petition for Certiorari suggested that the Court should refuse to uphold Section 965 since doing so would set a precedent for the Biden Administration’s proposal for a tax on domestic unrealized capital gains, described as a federal “wealth tax.”.
On the other hand, Senate Finance Committee Chair Ron Wyden, D-Ore, issued a statement that a judgment in favor of the Moores would be “all for the benefit of the ultra-wealthy,” and “[i]f the Republicans on the Supreme Court take the petitioners’ side, they’d be handing a massive windfall to multinational corporations and could potentially lock in a right for billionaires to opt out of paying anything remotely close to a fair share in taxes.”
The Supreme Court’s decision in Moore will obviously have far-reaching consequences and spur litigation whichever way the Court decides.
