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The Supreme Court of the United States on December 5, 2023, heard arguments in the case of Charles G. Moore v. United States, which is looking at whether the government has the right to tax unrealized income.
The case stems from provision in the 2017 Tax Cuts and Jobs Act, which imposes a current tax on 10 percent U.S. shareholders of the accumulated post-1986 deferred foreign income of controlled foreign corporations deemed to be subpart F income. Historically, under the prior deferral regime, U.S. shareholders were not generally taxed on earnings on foreign subsidiaries carrying on a trade or business until those earning were distributed to the U.S. shareholders.
Moore made a greater-than-10 percent investment in an Indian corporation but never received a distribution on the investment and never owed a tax until the Tax Cuts and Jobs Act was enacted.
Leading up to the Supreme Court hearing the case, the case was dismissed at the district court level and then affirmed by the Ninth Circuit Court. That court noted that while “income“ is not clearly defined in the Sixteenth Amendment, the courts have consistently held that taxes similar to the mandatory repatriation tax are constitution.
During the Supreme Court hearing, Andrew Grossman, attorney for Charles Moore, argued that the word “income was understood at the time of the Sixteenth Amendment’s adoption to refer to gains coming into the taxpayer, like wages, rents, and dividends. Appreciation in the value of a home, a stock investment, or other property is not and never has been taxed as income. The reason is that a gain is not income unless and until it has been realized by the taxpayer.”
He argued that it is “undisputed that the petitioners realized nothing from their stock investment. They were taxed not because they had any income but because, in 2017, they happened to own shares in a corporation carrying retained earnings on its books. This is a tax on the ownership of property. It therefore must be apportioned.”
Grossman went on to offer a basic definition of the “realization” of income as “receipt, but in other instances, it would be other types of enjoyment of an economic gain such that the taxpayer can put that gain to his or her own uses and benefits. That might be forgiveness of a loan or it might be assignment of income to a third party.”
He added that “the Court has already said in multiple occasions that realization is, in fact, required for there to be income under the Sixteenth Amendment,” although Justice Kagan noted that “there is quite the history in this country of Congress taxing American shareholders on their gains from foreign corporations,” added that this is done to prevent Americans from stashing their money in foreign companies and not pay taxes on the gains.
He claimed that even though the corporation realized income, Moore’s interest is “solely a capital interest, a property interest, and so the value of their capital has increased. It has appreciated. But, as shareholders, no, they have not realized any income.”
Elizabeth Prelogar, Solicitor General of the United States, argued that the mandatory repatriation tax as enacted in the TCJA “is firmly grounded in the Sixteenth’s Amendment’s text and history. The amendment allows Congress to impose taxes on income. … Several of those taxes were like the MRT in that they taxed shareholders on undistributed corporate earnings, including incomes taxes in 1864, 1865, 1877, and 1870. And this Court upheld Congress’ power to impose those taxes.”
Prelogar added that the Court “doesn’t actually need to resolve any fundamental questions in this case about whether the Sixteenth Amendment requires realization. The MRT taxes income that was actually realized by the foreign corporations, and Congress permissibly attributed the tax on that realized income to U.S. shareholders just as it has done in any number of pass-through taxes throughout our nation’s history.”
When asked to further explain the word “realized,” she said that this is “a paradigmatic case of realization, Justice Thomas, insofar as the thing that’s being taxed, the underlying tax base for the MRT, are the earnings that actually came into the corporation, the foreign corporation’s coffers. So the tax base here was the substantial ordinary business income that the foreign corporation generated through its operations in the foreign country and that has been subject to tax deferral.”
She also stated that the income “has never been taxed at the corporate or entity level. Instead, what Congress did in the MRT is enact a pass-through tax that attributed the liability on that actual income that was realized to the U.S. shareholders.”
Prelogar also argued that the Court needs to define “income“ for all purposes or make a specific determination about “realization.”
“I think it’s sufficient here for the Court to say that you have before you a particular type of tax on undistributed corporate earnings that were actually realized and to look as the history and tradition that demonstrates that that fits will within Congress’ income tax authority,”she said.
By Gregory Twachtman, Washington News Editor
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