Tax Strategy: Moore Achieves Less

On July 20, 2024, in a 7-2 decision, the Supreme Court held that the mandatory repatriation tax in section 965 of the Code is constitutional under the Sixteenth Amendment. The majority opinion was a very narrow ruling, preserving the status quo but ignoring the central issue before the court.

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

The TCJA established a one-time mandatory repatriation tax under section 965 of the Code on a shareholder’s interest in 10% or more of a CFC’s post-1986 accumulated earnings that consisted of the CFC’s untaxed, undistributed operating income.

Financed by groups seeking a ruling that taxing unearned amounts is unconstitutional under the Sixteenth Amendment without apportionment to the states because it is a property tax and not a tax on “income,” the Moores challenged the constitutionality of Code section 965 in court. They also argued that the MRT constituted a retroactive tax, violating the Due Process Clause of the Fifth Amendment.

A federal district court ruled that the MRT constituted an income tax under the Sixteenth Amendment. The Ninth Circuit Court of Appeals agreed, citing similar taxes that had been held constitutional for years. The Ninth Circuit also ruled that the tax’s retroactivity did not violate the Due Process Clause because it served the legitimate purpose of expediting repatriation.

The Supreme Court granted certiorari in June 2023 on the Sixteenth Amendment issue. The issue framed by Moore was: “Whether the Sixteenth Amendment authorizes Congress to tax unearned amounts without apportionment among the States.” The government framed the issue as follows: “Whether the mandatory repatriation tax is a tax… on income, regardless of the source thereof.”

Supreme Court decision

The Supreme Court ruled that the MRT is an income tax, not a wealth tax. The court framed the issue as whether Congress may allocate the realized and undistributed income of an entity to its shareholders or partners and then tax the shareholders or partners on their share of the income.

The majority opinion cited a long list of precedents under which Congress may choose to tax a business entity or its partners or shareholders, such as the taxation of partnerships and S corporations and the taxation of subchapter F income. The majority opinion limited its decision to situations involving taxation of an entity’s shareholders on undistributed income earned by the entity that was allocated to the shareholders when the entity itself was not taxed on the income.

By limiting its decision to such a narrow issue, the court avoided addressing the issue of whether the Sixteenth Amendment contains a performance requirement.

Scope of Moore’s ruling

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

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

Convergent and divergent opinions

The majority opinion of the Supreme Court was written by Justice Kavanaugh, joined by Chief Justice Roberts and Justices Sotomayor, Kagan, and Jackson. The companion opinion by Justice Jackson argued that the implementation requirement was not constitutionally required under the Sixteenth Amendment. The companion opinion by Justice Barrett, joined by Justice Alito, argued that implementation is constitutionally required under the Sixteenth Amendment; however, implementation by the entity is sufficient to satisfy the requirement.

The dissent by Justice Thomas, joined by Justice Gorsuch, also argued that the Sixteenth Amendment requires realization of income. It criticized the majority for focusing on attribution and distinguished MRT from other forms of pass-through taxation because other forms of Subpart F taxation applied to a U.S. shareholder’s gains from a foreign corporation’s profits in the same year in which the shareholder had control.

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

Property 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 funding the Moore case was an attempt to prevent a wealth tax in the U.S. by obtaining a ruling that a wealth tax would violate the Sixteenth Amendment as a tax on unearned income. The Supreme Court did not go that far in the Moore case; however, at least four current justices appear willing to do so.

President Biden has proposed ending the step-up tax on death for gains above $5 million for an individual and $10 million for a married couple, with protections for charitable and family gifts for farms and businesses that heirs continue to operate. Biden has also proposed a 25% income tax for individuals with assets above $100 million.

Senator Elizabeth Warren has proposed an actual wealth tax of 2% per year on household and trust net worth between $50 million and $1 billion, and 6% per year on household and trust net worth above $1 billion.

Since the current Supreme Court failed to issue a ruling in Moore on the realization requirement, finding a suitable case on which to return to the Supreme Court may prove difficult until something like a wealth tax is enacted.

If the issue of realization were to arise again before the current Supreme Court in the context of a wealth tax, perhaps Chief Justice Roberts and/or Justice Kavanaugh would join the four justices who have already expressed support for the realization requirement in the Sixteenth Amendment.

Hit

The Supreme Court’s decision preserves the status quo in protecting various provisions of the Internal Revenue Code, including the MRT at issue in this case. However, it sidestepped and left for another day the question raised by Moores—whether the Sixteenth Amendment includes a performance requirement.