The Supreme Court should use its upcoming decision in Moore v. United States to craft guidelines so Congress can impose an accurate tax on constructively received income, says Greenberg Glusker's Thomas Giordano-Lascari.
In the tax world, the Supreme Court's decision to hear arguments in Moore v. United States is a big deal because it challenges the constitutionality of a tax on foreign earnings known as a mandatory repatriation tax, or MRT, under Section 965 of the tax code.
The plaintiffs argue that the MRT is a direct tax on property and must be apportioned. Specifically, they say the MRT isn't a tax on "income," as interpreted under the Sixteenth Amendment. The essence of this argument is that the plaintiffs, as shareholders of a controlled foreign corporation, haven't "realized" any income but instead are being taxed on the value of their shares as measured by that corporation's retained earnings—a direct tax on property.
The plaintiffs contend that "realization" of income is required both plainly by the text of the Sixteenth Amendment and based on the case law interpreting that amendment, relying principally on Eisner v. Macomber, a 103-year-old case in which the high court held that a stock dividend funded by a corporation's undistributed accumulated earnings and profits wasn't income. As a result, the levy at issue was unconstitutional because it was an unapportioned direct tax; the act of distributing stock wasn't an income tax realization event.
In Moore, the US Court of Appeals for the Ninth Circuit disagreed with that century-old argument and, in doing so, drastically expanded the definition of income that's subject to Congressional taxing authority without articulating any limiting principles.
The Supreme Court not only must decide whether the MRT is constitutional, but also whether the Ninth Circuit's interpretation of income is correct—especially considering the enormous consequences of a blanket ruling in favor of the plaintiffs. Regardless of whether the justices deem MRT constitutional, they should shift their focus from what is income in the constitutional sense to when income can be deemed realized, specifically income earned by corporate entities.
Rationale Needed
The fundamental problem with the Ninth Circuit opinion (and that of the US District Court for the Western District of Washington) is that it takes as a fait accompli that Congress had the power to enact the MRT but uses a bare-minimum legal analysis to arrive at that result.
Discussions of precedents lack context, and that may have led the court to its potentially over-broad interpretation of "income." The Supreme Court should articulate a reasonable rationale no matter what it decides on the MRT's constitutionality and provide limits to guide future courts and Congresses.
An intellectually honest consideration of the MRT should recognize that courts generally have required that taxpayers must realize income for it to be taxable. While there's agreement that no constitutional bar exists for Congress to disregard the corporate form, the Supreme Court should acknowledge the generally accepted principle that the corporate form is to be respected absent exceptional circumstances.
The recognition of those concepts, however, doesn't have to lead to the MRT being found unconstitutional. The justices should provide context to the case law cited by the Ninth Circuit and district court to illustrate when the formality of those concepts must give way to a substantive finding that a corporate shareholder has, in fact, constructively realized income.
Most of the case law cited by the Ninth Circuit and district court can be used in favor of the taxpayer if given full context. In all of the cases cited dealing with Congress taxing shareholders directly on foreign corporate income, the taxes at issue were those aimed at abusive or artificial structures primarily involving foreign personal holding companies or their equivalent.
The Supreme Court should incorporate those cases to arrive at a holding that's based on the constructive receipt principles at the heart of the prior case law. Its opinion hopefully will provide boundaries for future Congresses such as for limiting wealth taxes on appreciated property.
A More Challenging Path
A more difficult exercise for the Supreme Court would be if it upholds the MRT as an appropriate application of the constructive receipt doctrine. One way the justices could do this is through an analogy to the accumulated earnings tax, which doesn't apply to foreign corporations. The accumulated earnings tax requires a showing that profits have accumulated beyond the corporation's reasonable business needs—that tax is levied on the corporation rather than the shareholder.
But case law has led to a finding that Congress can tax profits that were accumulated improperly in corporate form, thereby avoiding shareholder-level taxes. Certainly, a case can be made that a significant portion of income being taxed by the MRT had been improperly accumulated beyond the needs of the affected foreign corporations.
Coupling the accumulated earnings tax authority with the impediments to directly taxing foreign corporations may lead the Supreme Court to uphold the constitutionality of the MRT. The precedents cited by the Ninth Circuit and district court at least support the position that foreign corporations create complexities that may require direct shareholder taxation in abusive situations. Critical to that, though, is an abusive element to the tax—which is similar to the unreasonable accumulation that can give rise to an accumulated earnings tax.
The problem, of course, is that the MRT is a blanket tax on all accumulated earnings and profits rather than only accumulations that are unreasonable. Whether Congress can use a broad brush to enact the MRT on all accumulated profits of all controlled foreign corporations, given the difficulty of targeting specific corporations with unreasonable accumulated earnings, will be interesting to see.
But the hope is that the Supreme Court at least will articulate some limiting principles, especially in light of wealth tax and other proposals seeking to tax appreciated property.
The case is: Moore v. United States, U.S., No. 22-800, brief 8/30/23.
Originally published by Bloomberg Law.
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