On June 20, 2024, the Supreme Court released its opinion in Moore et ux v. US, authored by Kavanaugh, decided by 6-3 vote and marking a rare instance for the Court to interpret the 16th Amendment, upholding the constitutionality and application of the so-called "Mandatory Repatriation Tax" [MRT] under Article I, §§8 and 9 and the Sixteenth Amendment. This tax imposed a rate ranging from 8 to 15.5 percent on the pro rata shares of domestic shareholders in American-controlled foreign corporations to attempt to address "trillions of dollars of undistributed income" that had accumulated in such corporations over time.
As a refresher, American businesses can be taxed in two ways: 1) as a pass-through, where the entity does not actually pay any taxes, and the income passes or flows through to individual shareholders or partners who pay; and 2) where the entity does pay directly on its own income, meaning its shareholders are only taxed when the entity distributes a dividend, or upon a sale of their shares. Since 1962 (with subpart F), Congress has treated American-controlled foreign corporations as pass-throughs, attributing certain income, mostly passive, of American-controlled foreign corporations to their American shareholders and then taxing those shareholders on that income. In 2017, Congress enacted new law (the MRT) that attributed more income, including active business income, of American-controlled foreign corporations to their American shareholders and then taxed those shareholders on that income.
In Moore, Charles and Kathleen Moore invested in the American-controlled foreign corporation KisanKraft. Between 2006 to 2017, the corporation earned ample income that it did not distribute to its American shareholders. The MRT, newly applicable for 2017, resulted in a tax liability of approximately $15,000 on the Moores' pro rata share of accumulated corporate income between 2006-2017. The Moores paid the tax and initiated a refund suit, claiming "the MRT was an unapportioned direct tax on their shares of KisanKraft stock." The district court dismissed the suit and the Ninth Circuit affirmed. The Supreme Court, affirming the outcome, held the MRT did not exceed Congress's constitutional authority.
The Government argued that the MRT is a tax on income and therefore need not be apportioned. The Moores contend that the MRT is a tax on property and that the tax is therefore unconstitutional because it is not apportioned. Income, the Moores argue, requires realization, and the MRT does not tax any income that they have realized. But the Court reasoned that the MRT does tax realized income—namely, the income realized by KisanKraft, which the MRT attributes to its shareholders.
The Court stated longstanding precedents plainly establish that, when dealing with an entity's undistributed income, Congress may either tax the entity or tax its shareholders or partners. "Either way, this Court has held that the tax remains a tax on income – and thus an indirect tax that need not be apportioned."
The Moores argued three main points: 1) that taxes on partnerships are distinguishable from the MRT and not controlled by precedent because partnerships are not separate entities from their partners; 2) taxes on S corporations are distinguishable from the MRT because shareholders of S corporations choose to be taxed directly on corporation income; and 3) attempted to distinguish previous laws on the taxing of shareholders of closely held foreign corporations based on their theory of "the doctrine of constructive realization."
Kavanaugh recited longstanding precedents including Burk-Waggoner Oil Assn. v. Hopkins, 269 U. S. 110, in which the status of a business entity under state law could not limit Congress's power to tax a partnership's income as it chose (taxing either the partnership or the partners); Burnet v. Leininger, 285 U. S. 136, ("Congress, having the authority to tax the net income of partnerships, could impose the liability upon the partnership directly," or it could impose tax liability "upon the individuals carrying on business in partnership."); Heiner v. Mellon, 304 U. S. 271, which reaffirmed that Congress may choose to tax either the partnership or the partners on the partnership's undistributed income, even where state law did not allow the partners to personally receive the income; and Helvering v. National Grocery Co., 304 U. S. 282, which explicitly applied the principle in Heiner to corporations and their shareholders.
Ultimately, the Court held its line of precedents established the clear principle that Congress can attribute the undistributed income of an entity to the entity's shareholders or partners and tax the shareholders or partners on their pro rata share of the entity's undistributed income.
This decision will be sure to affect how American-controlled foreign corporations will treat their income and distributions moving forward. Taxpayers should be aware that retained or accumulated income of a foreign corporation will not guarantee the same level of federal tax savings as was historically expected.
Kavanaugh was careful to state that the Court's holding in the case is narrow and limited to entities treated as pass-throughs, and that no part of the opinion is meant to authorize any hypothetical effort to tax both an entity and its shareholders or partners on the same undistributed income realized by the entity, nor to decide whether realization is a constitutional requirement for an income tax.
Read the full opinion here.
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