The US Supreme Court 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 sums without apportionment among the states.” But, if the Court answers no, the Court may upend our current tax code—and hamstring future ones.
The Moore dispute involves a one-time tax imposed by the 2017 Tax Cuts and Jobs Act (TCJA), on about three trillion dollars in corporate earnings that had accumulated overseas. The TCJA restructured the US international tax regime and added the transition tax to prevent accumulated earnings from going untaxed permanently. The Court will hear the case next Fall and likely rule a few months later.
For many years, Charles and Kathleen Moore owned stock of a controlled foreign corporation (CFC), or a foreign corporation whose ownership or voting rights are more than 50 percent owned by US persons who each own at least 10 percent. In 2017, the Moores incurred a $15,000 tax bill on their corporation’s undistributed earnings resulting from the TCJA.
Congress expected the transition tax to raise about $340 billion, overwhelmingly from large US multinational corporations (and a small amount from individuals that owned a 10 percent or larger stake in a CFC, like 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 earnings were taxable even though they were not distributed (and, thus, not “realized”). “Whether a taxpayer has realized income does not determine whether a tax is constitutional,” the 9th Circuit said.
Congress’ latitude to tax income now is wide, but it wasn’t always. In 1895, the Court struck down Congress’ early income tax, because the Court labeled the tax “direct,” which the Constitution requires to be apportioned among the states by population (which is impractical). But, in 1913, the US adopted the Sixteenth Amendment, to permit Congress to tax “incomes from whatever source derived,” without apportionment.
Congress then enacted our modern income tax, which includes “all income from whatever source derived.” But, a few years after enactment, a divided Court decided that a federal tax on a distribution of additional stock certificates to shareholders of Standard Oil was not “income,” within the meaning of the Sixteenth Amendment because having two certificates instead of one did not enrich the shareholders. Justice Oliver Wendell Holmes wrote in a scathing one paragraph dissent:
I think that the word “incomes” in the Sixteenth Amendment should be read in “a sense most obvious to the common understanding at the time of its adoption.” For it was for public adoption that it was proposed. The known purpose of this Amendment was to get rid of nice questions as to what might be direct taxes, and I cannot doubt that most people not lawyers would suppose when they voted for it that they put a question like the present to rest. I am of 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 convenience,” not of constitutional import. Now, for more than one hundred years, the Court has respected Congress’s use of “income” for tax purposes.
After the 9th Circuit ruled against the Moores, conservative activists urged, in amicus briefs, the Court to rule that income that was not realized could not be taxed (the briefs largely ignored the question of retroactivity). If the Court rules for the Moores, it will entitle the Moores to receive a $15,000 refund, plus interest. And it may permit a refund of all or a portion of the remaining $340 billion, plus interest, overwhelmingly to large US multinational corporations.
More broadly, the Court also could force Congress to rewrite major parts of our international, pass-through, and financial tax regimes. The courts have permitted, for many decades, Congress to tax a corporation’s undistributed investment income to the controlling stock holders of personal foreign investment companies and CFCs (and Congress continues to tax these undistributed earnings). These rules prevent wealthy Americans and US multinationals from using foreign corporations like uncapped traditional Individual Retirement Accounts.
Congress also taxes the profits of partnerships, and other pass-through entities, to their owners, whether the profits are distributed or not. Congress requires taxpayers to include income annually from “zero-coupon” bonds that only pay interest at maturity. It taxes gains from “constructive sales” of certain appreciated financial positions (even though the positions are not actually sold). Congress also taxes regulated futures contracts on a mark-to-market accounting method (treating the contracts as if they have been sold, and any gains realized). Congress uses a similar mark-to-market accounting method to tax unrealized gains on securities owned by dealers.
The Moore litigation also may be a stalking horse to block billionaire and wealth taxes, which have been proposed, but not yet enacted. President Biden and Senate Finance Chair Senator Ron Wyden both have proposed taxes on the rise in value of stock owned by billionaires like Jeff Bezos, Elon Musk, and Mark Zuckerberg, without requiring them to sell. One of the amicus briefs labeled the 9th Circuit’s Moore decision “an invitation to enact more wealth taxes.” A lead Wall Street Journal editorial encouraged the Supreme Court to “shut [the] constitutional door” to a wealth tax by ruling explicitly that Congress cannot tax unrealized sums.
But for the Court to preempt taxes that Congress has not yet enacted is unsettling—and unwise. Shortly after the Court announced its review, some tax advisers recommended that taxpayers file refund claims for transition taxes that have been paid or will be paid (many taxpayers elected to pay the transition tax over eight annual installments). Other advisers suggested considering refund claims for income from CFCs, partnerships, and similar flow-through tax regimes. We also might expect some taxpayers to exclude income on their tax returns this year, in anticipation of the Court’s ruling.
So, we must wait until next year to assess the damage from a $15,000 tax dispute, but the stakes are much larger: a potentially massive windfall for wealthy investors and multinational corporations. And unwieldy strictures on Congress’s ability to tax.