There Is More to Moore — Supreme Court Tax Decision May Have Wide-Ranging Impact

In December 2023, the U.S. Supreme Court heard the oral argument in Moore v. United States, a tax case regarding the constitutionality of the Mandatory Repatriation Tax (MRT). The MRT was created by the Tax Cuts and Jobs Act (TCJA) of 2017, as a one-time transition tax for multinational companies to repatriate earnings accumulated overseas.

The taxation of income is permitted by the 16th Amendment to the Constitution, which provides: “The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”

Many people view the case as being about whether the 16th Amendment authorizes the federal government to tax unrealized earnings under the MRT. However, that seemingly straightforward question has profound ramifications beyond the current federal income tax regime. With the Supreme Court’s decision expected this spring, this issue brief reviews the case’s background, arguments from both sides, and major issues arising in Moore.

The Background

Prior to the passage of the TCJA, an estimated $2 trillion dollars of permanently or indefinitely reinvested corporate profits were amassed overseas; these profits were not taxed unless and until they were repatriated to the United States. This scheme was employed by large multinational corporations to avoid U.S. corporate income tax, which was then 35% and among the highest in the world.

The TCJA imposed a transition tax, the MRT, on undistributed earnings accrued by companies overseas between 1986 and 2017. These entities are referred to in the tax code as controlled foreign corporations (CFCs). An entity is considered a CFC when U.S. shareholders, who each own at least 10% of its shares, collectively own more than 50% of the company’s total stock.

The MRT offered companies incentives to bring untaxed foreign corporate profits home, while giving the Treasury much needed tax revenue — until Moore threw a wrench in the works.

The Case

In 2006, a couple — Charles and Kathleen Moore — invested $40,000 for a 13% stake in KisanKraft, an Indian company that provided tools to farmers in India’s impoverished regions. The company, a CFC, reinvested all its earnings and never made any dividend distributions to shareholders. A decade later, the MRT was implemented, resulting in a tax bill of roughly $15,000 for the couple.

Taxpayers argue that the MRT violates the 16th Amendment, which authorizes the federal government to levy income tax without apportioning among the states. In other words, if the federal government imposes a direct tax that is not an income tax (such as taxes on the ownership of land or personal property), it must be apportioned among the states in proportion to their populations. The Moores claim that because they do not have income, the MRT is a direct tax but not an income tax. As a direct tax, they argue, the MRT needs to be apportioned and since there is no apportionment, the tax is unconstitutional.

Separately, they argue that the 16th Amendment has an imbedded realization requirement, which requires income to be realized to be subject to tax. The Moores agree that they have unrealized gains; however, they assert that these gains are not income. If the court were to uphold the MRT, they claim it would either open the floodgates by allowing taxation of any gains as income or expand the federal taxing power by invalidating the apportionment requirement.

The Arguments

Over 40 amicus curiae (friend of the court) briefs were filed before the oral argument took place. Despite having different legal and economic perspectives, all briefs agree the significance of the Moore case cannot be overemphasized. This section summarizes the key arguments from both supporters and opponents of the taxpayers’ claim.

MRT is a Constitutional Income Tax

The federal government claims that the MRT is an income tax and the 16th Amendment never mentioned realization as a requirement: As long as taxpayers demonstrate economic profits or gains the tax can be imposed. This approach was affirmed by both the district and circuit courts.

The government argues that the operation of the MRT is very similar to the Subpart F provisions in the tax code. In force since 1962, this regime aims to deter profit shifting. Subpart F taxes U.S. individuals who own at least 10% of a CFC on their pro rata shares of certain undistributed earnings, known as Subpart F income. Common Subpart F income categories include dividends, interest, annuities, rents, and royalties; they are generally passive income that is easily portable.

For calculation purposes, a CFC’s pro rata share of Subpart F income must be included in the income of U.S. shareholders in the year it is earned, even if the CFC does not distribute earnings to its shareholders during that year. Thus, Subpart F is an example under the current tax code that does not require income realization in order to be taxed.

Some analysts follow a similar line of argument, and emphasize the importance of not maintaining realization as a constitutional requirement to prevent tax sheltering. They argue realization is better viewed as a policy choice or administrative convenience, instead of a constitutional mandate.

Similar examples of nonrealized income being taxed can be found in tax treaties and at least a dozen tax rules. Besides Subpart F, the most cited example is global intangible low-taxed income (GILTI). Created as part of the TCJA, GILTI is a 10.5% minimum tax levied on income from intangible assets (such as patents, trademarks, and copyrights) held abroad. Because intangible assets are highly mobile, multinational companies have both the incentive and means to shift profits associated with these assets to low-tax jurisdictions and avoid tax. U.S. companies must include GILTI income in their annual corporate income tax reporting, regardless of whether that income has been distributed. If the Supreme Court ruling in Moore invalidates these anti-avoidance provisions, the U.S. tax base would be subject to significant profit shifting.

Other practitioners raise a slightly different view: The MRT is not a new tax, it is simply a curtailment of deferral benefits that Congress previously granted to certain foreign income. Since it is a revision to an existing tax, it is clearly an income tax instead of a property tax. They also believe the income has already been realized; hence there is no need to debate realization requirements.

In its brief, the federal government reminds the court about the financial consequences. According to the Joint Committee on Taxation (JCT), the direct impact of a decision striking down the MRT would be a loss of $338 billion in MRT tax revenue over the 2018–27 timeframe. In addition, such a decision would require the IRS to issue large amounts of tax refunds. Further lawsuits may follow with more costs.

An Excise Tax? Special Case?

The federal government and several practitioners argue that even if the MRT is not an income tax, it could be viewed as an excise tax — it is a levy on an entity’s privilege of doing business as a corporation (in this case, a CFC). On this basis, the MRT is not a direct tax and there is no need to apportion. The taxpayers disagree: In their reply brief, they argue that the MRT is imposed simply because of the “mere ownership of property” and not the “actual doing of business in a certain way.” The MRT is not an excise tax on the use of property, they argue, but direct taxation upon property solely because of its ownership.

Finally, some believe the MRT should be viewed as a special case. It is a one-time transition tax which applies in specific circumstances involving a particular type of entity (CFC) under unprecedented circumstances (repatriated earnings accumulated over 30 years). The MRT is not a direct tax because it falls on foreign business activities and so there is no need for apportionment.

MRT is an Unconstitutional Property Tax

On the other hand, practitioners who support Moore believe that realization is a precondition for taxation. Because no income is realized, the MRT is a levy on accumulated wealth and not an income tax. Specifically, the Moores were taxed on their investment in KisanKraft based on their pro rata share of the company’s earnings accumulated over a decade, which is analogous to a property tax. Because the MRT failed to apportion in accordance with states’ populations, it is unconstitutional. Supporters of Moore also emphasize that if the court does not formally uphold the realization requirement, businesses will suffer due to the lack of predictability and certainty in tax laws to plan their operations.

Another different viewpoint rests on Subpart F and GILTI. Proponents argue that the Subpart F and GILTI are different from the MRT as the anti-abuse taxes are only imposed on certain types of income, and they only tax current income instead of accumulated earnings. As such, supporters believe that the MRT can be struck down without disrupting the rest of the tax code. As discussed below, the government disagrees with this view.

Federal Income Tax Implications

The Moore decision will primarily affect federal income tax. Under the current federal income tax system, several categories of unrealized income are taxed. Some practitioners believe a ruling that imposes income realization as a constitutional requirement would affect a substantial portion of the U.S. income tax code.

In addition to the likely impact on Subpart F and GILTI, another affected area is the taxation of pass-through entities. Pass-through businesses — for example, partnerships, sole proprietors, and S corporations — are not subject to tax at the entity level; instead, earnings are passed through to the owners and taxed on the owners’ returns. In practice, the annual gains or losses of the businesses are divided among the equity investors and reported on their individual returns even when there are no cash payments. If realization is required for tax purposes, these investors will not need to report these earnings until they cash out their equity interests in those businesses.

As well as the pass-through realization mentioned above, the JCT identifies a separate category of provisions that taxes unrealized income, the “deemed” realization. Under these provisions, income is recognized for tax purposes although it has not been received. Generally, to satisfy the deemed realization requirement, a transaction is deemed to have been undertaken or something valuable is deemed to have been received during the tax year. Examples include, among others:

• Sophisticated investment vehicles, such as original issue discount (OID) — where debt holders who pay no interest until maturity need to pay deemed interest annually.
• Below-market loans — interest payments are imputed on below market interest loans.
• The mark-to-market accounting method for regulated futures contracts and life insurance companies — where investors are taxed before they receive the proceeds.
• Imputed rental income.

From an international tax perspective, some note that if the Subpart F and GILTI provisions were invalidated, the U.S. would not conform to the OECD/G20 global minimum tax (Pillar 2). The worst-case consequence would result in the U.S. not being able to tax income of foreign subsidiaries; instead, CFCs would be taxed by the countries where the entities are located.

Economists express caution about the well-documented economic inefficiency of lock-in effects, where taxpayers hold onto assets longer than they otherwise would to avoid income realization. Others are concerned that taxpayers would prefer to operate through certain types of entities to avoid paying taxes. High net worth individuals and multinational companies stand to reap the biggest benefits from these methods.

State Tax Implications

Moore Wins, States Negatively Affected

One argument is that if realization becomes a constitutional requirement, it will negatively impact states’ tax revenue. Many states use taxpayers’ federal adjusted gross income (AGI) as a starting point to calculate state income taxes, so the realization requirement at the federal level would affect states’ tax base. The more a state relies on unrealized income (such as partnerships or mark-to-market), the bigger the fiscal impact.

A group of 16 Democratic state attorneys general share a similar concern in their amicus brief. State tax codes rely on conformity with federal tax codes for revenue collection and compliance purposes. This means that if the federal government’s ability to tax unrealized earnings is affected because of Moore, the state tax base will also be affected. If a state updates its tax codes automatically as federal tax codes change, it will be vulnerable to any changes that affect federal government tax collection — unless it decouples from federal rules.

Moore Loses, States Negatively Affected

Those that see the MRT as a property tax are concerned that if the federal government prevails, this will extend the taxing power into an area traditionally considered a key state revenue source. Consequently they see a federal government win as a threat to the balance of federal-state taxing power and think that states’ revenue will be negatively affected.

Wealth Tax Implications

Certain observers believe that a taxpayer loss will clear the constitutional obstacles to a wealth tax. A group of 17 Republican attorneys general, including Texas’ chief legal officer, argue that the lack of a realization requirement effectively extends the federal power of taxation, and this power has the potential to morph into a federal wealth tax. However, others, including those who support the government in Moore, are against using this case as a backdoor way to implement a wealth tax.

From an economic perspective, a win by the Moores would remove most of the revenue potential and favorable prospects of a wealth tax. A wealth tax is imposed on the accumulated value of individuals’ assets, and wealthy taxpayers own more assets that would be subject to the tax. However, well-off individuals usually have the ability and means to time realizations to optimize their tax outcomes. A realization requirement would essentially take away much of the revenue to be gained from a wealth tax, removing a large portion of its policy appeal.

Conclusion

The outcome and scope of the final Supreme Court ruling in Moore v. United States will have significant ramifications to the tax code and tax administration. As well as implications for income taxation, there will be consequences to state tax bases and the possibility of a wealth tax.

Supporters of Moore have urged the court to explicitly declare realization as a constitutional requirement for taxing income — to restrain the government’s taxing power and limit the prospects of a wealth tax.

Opponents have expressed a variety of views that support the government, all of which point to the possibility of a narrow ruling instead of a decision that comprehensively addresses all the issues.

As we await the court’s ruling with bated breath, there are several possible outcomes. The Supreme Court may:

• Simply affirm the lower courts’ opinion that there is no realization requirement in the 16th Amendment.
• Choose to be silent on wealth tax issues.
• Avoid commenting on whether the Constitution imposes a realization requirement and concur with the view that income is already realized.
• Decide that the MRT is a one-time “special case” tax — in which case the court can avoid addressing whether the MRT is an income tax.
• Decide that the MRT is an excise tax — so it can bypass the issue of whether it is an income tax or whether realization is required.

Given the wide-ranging impacts of the decision, a narrow ruling is increasingly likely.

 

 

This material may be quoted or reproduced without prior permission, provided appropriate credit is given to the author and Rice University’s Baker Institute for Public Policy. The views expressed herein are those of the individual author(s), and do not necessarily represent the views of Rice University’s Baker Institute for Public Policy.