In Moore v. United States, the Supreme Court upheld the constitutionality of the mandatory repatriation tax (MRT), saving a significant portion of the current tax code for now. The question in front of the Court was whether the Constitution requires income to be realized before it may be taxed and, if so, whether the realization requirement was met. The Court found that the income in question had in fact been realized, avoiding a broader ruling on whether realization is always required to tax income.
The Supreme Court has saved the tax code for now, ruling in favor of the government in the eagerly awaited decision in Moore v. United States. Tax professionals feared that a decision in favor of the taxpayers could upend a significant portion of the current tax code. The 7-2 ruling belies the actual closeness of the decision, with only five Justices willing to state that the tax. which was the subject of the case, is constitutional.
The question in front of the Court in Moore was whether the Constitution requires income to be realized before it may be taxed and, if so, whether the realization requirement was met. The Court's opinion, drafted by Justice Kavanaugh, found that the income in question had in fact been realized, allowing it to skirt the larger question of whether realization is always required to tax income.
The specific tax at issue was the mandatory repatriation tax (MRT). The tax code treats certain U.S.-controlled foreign corporations as pass-through entities for some tax purposes, for instance taxing U.S. shareholders on the passive income of such foreign corporations. The MRT, enacted as part of the Tax Cuts and Jobs Act in 2017, imposed a one-time backward-looking tax on U.S. shareholders of foreign corporations with respect to accumulated earnings as part of a transition to a more territorial tax system. The Moores, who were husband and wife minority shareholders of a U.S.-controlled foreign corporation, paid tax on their pro rata share of the corporation's undistributed income and sued for a refund, claiming that they had realized no income and thus the MRT was an unapportioned direct tax on their shares of the foreign corporation. The Constitution requires that direct taxes, unlike income taxes, must be apportioned among the States according to population.
In holding the MRT constitutional, the Court explained that a long line of precedents has established that Congress may tax either an entity or the entity's shareholders or partners on its undistributed income. The Court reasoned that the MRT is a tax on income that need not be apportioned because the MRT taxes income that has been realized by the foreign corporation and attributes such income to the shareholders, who pay taxes on their share of the undistributed income on behalf of the corporation. The Court appeared to be driven in part by practical considerations, noting that "the logical implications of the Moores' argument, taken to its logical conclusion, could render vast swaths of the Internal Revenue Code unconstitutional." The Court further stated that "the Constitution does not require that fiscal calamity."
Justice Jackson, in a concurring opinion, stated that the realization requirement for income tax does not appear in the text of the Constitution and that the definition of income could include both realized and unrealized gains. She was the only justice who said that realization is not a constitutional requirement to tax income.
Justice Barrett, joined by Justice Alito, also wrote a concurring opinion. Justice Barrett stated that the Constitution does include a realization requirement, pointing to the word "derived" in the phrase "from whatever source derived". Notably, she explicitly declined to decide whether the MRT passes constitutional muster. However, Justice Barrett ultimately ruled for the government, finding that the Moores had failed to prove that they were due a refund because they had conceded that Congress could tax U.S. shareholders on the passive income of foreign corporations and she could not meaningfully distinguish the MRT from that tax.
Justice Thomas, joined by Justice Gorsuch, dissented, flatly stating that income tax required realization and that the Moores had realized no income. Justice Thomas denied that invalidating the MRT on these grounds would lead to the fiscal calamity that so concerned the majority.
The good news for Treasury is that seven justices, for varying reasons, were reluctant to call into question large parts of the current tax code. However, four justices agreeing that realization is required for an income tax, with only one explicitly saying otherwise, is a shot across the bow to politicians contemplating the enactment of a national wealth or mark-to-market tax. Indeed, this case could encourage a challenge to other areas of current tax law, such as mark-to-market taxation of dealers and commodities transactions. One thing that seems certain is that this issue is far from settled, and that taxpayers will be looking for another chance to convince a fifth Justice to rule in favor of a realization requirement.
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