The Supreme Court on June 20 upheld a 2017 tax on “unrealized” income from overseas investments by a vote of 7–2.
Unrealized income reflects theoretical profits that exist “on paper.” The investor doesn’t “realize” the income until he sells the asset, at which point tax is normally due. In the case at hand, Congress imposed a one-time tax on investors’ share of profits they haven’t yet received.
The court affirmed the Mandatory Repatriation Tax (MRT), also known as the Section 965 transition tax, which was part of the Tax Cuts and Jobs Act approved by the Republican-controlled Congress in 2017 and signed into law by President Donald Trump.
The majority found that the tax does not violate the 16th Amendment to the U.S. Constitution, which allowed the federal government to levy an income tax.
Charles and Kathleen Moore, a married couple from Washington state, had argued in a lawsuit that this tax violates the Constitution’s requirement that direct federal taxes must be apportioned among the states and the Constitution’s prohibition against retroactive taxation.
The Moores lost in U.S. district court, appealed, and lost again. They asked the U.S. Court of Appeals for the Ninth Circuit to rehear the case after a circuit panel affirmed the district court’s dismissal of the action seeking to invalidate the tax law provision, but on Nov. 22, 2022, a divided Ninth Circuit again denied the couple’s petition.
“There is no constitutional prohibition against Congress attributing a corporation’s income pro-rata to its shareholder,” the appeals court ruled at the time.
Conservative constitutionalists had said if the Supreme Court ruled that the MRT violates the 16th Amendment to the U.S. Constitution, which allowed an income tax without having to determine it based on population, such a legal precedent could prevent Congress from enacting legislation to tax wealth.
Tax Policies and Proposals
Wealth tax proposals are routinely floated in Congress.For example, in March, Sen. Elizabeth Warren (D-Mass.) and House Democrats reintroduced the proposed Ultra-Millionaire Tax Act that would require the top 0.05 percent of American households to pay 2 cents for every dollar of wealth over $50 million.
In November 2023, Sen. Ron Wyden (D-Ore.) introduced a plan to tax the unrealized capital gains of high earners.
The 2017 law implementing the MRT changed the way foreign income of U.S. corporations was taxed. Lawmakers created the tax because, in their view, too much money was being invested abroad and not benefiting U.S. tax coffers.
Before the change, much of that income wasn’t taxed until it returned, or was repatriated, to the United States. To transition to the new system, Congress imposed a one-time tax on outstanding unrepatriated foreign earnings of U.S. corporations.
The law taxes U.S. corporate earnings abroad going back 30 years, even if the earnings haven’t been distributed. The statute also applies to U.S. taxpayers with 10 percent or more of shares in an overseas corporation as of the end of 2017. The Congressional Budget Office estimated in 2018 that the law would lead corporations to have a one-time tax liability of $347 billion.
In the case before the Supreme Court, the Moores made a modest investment in India-based KisanKraft, which supplies power tools to small-scale, individual Indian farmers with the aim of helping to make their operations more productive. The Moores had owned KisanKraft shares for more than a decade but never received any income from the shares because the company plowed all its profits back into the business.
But after the MRT was enacted, the Moores received a bill from the IRS for $14,729 for additional income tax they owed, despite having never received any payments from KisanKraft.
Majority Opinion
Justice Kavanaugh emphasized the narrowness of the court’s majority opinion.“Nothing in this opinion should be read to authorize any hypothetical congressional effort to tax both an entity and its shareholders or partners on the same undistributed income realized by the entity,” he wrote.
Although the Moores argued that the Mandatory Repatriation Tax did not tax any income they received, the MRT “attributes” the income of the corporation they invested in to them as shareholders and imposes a tax on their portion of that undistributed corporate income, the justice wrote.
The Supreme Court’s “longstanding precedents” show that Congress “may attribute an entity’s realized and undistributed income to the entity’s shareholders or partners, and then tax the shareholders or partners on their portions of that income.”
The MRT operates “in the same basic way as Congress’s longstanding taxation of partnerships, S corporations, and subpart F income,” he wrote, yet the Moores “cannot meaningfully distinguish the MRT” from those taxes.
Their argument, if “taken to its logical conclusion, could render vast swaths of the Internal Revenue Code unconstitutional,” Justice Kavanaugh wrote, citing several provisions of U.S. tax law.
Echoing an argument made by the Biden administration, the justice wrote that if those provisions were “suddenly eliminated,” the government would be deprived of trillions of dollars of tax revenue and Congress would be forced “to either drastically cut critical national programs or significantly increase taxes ... on ordinary Americans.”
“The Constitution does not require that fiscal calamity,” the justice wrote.
Justices Dissent
Justice Amy Coney Barrett filed an opinion concurring with the end result, but not in all the reasoning behind the majority opinion. She suggested the issues involved in the case were not as straightforward as Justice Kavanaugh’s opinion states.Justice Samuel Alito joined with Justice Barrett’s opinion.
Sen. Dick Durbin (D-Ill.), who is pushing legislation to impose a code of conduct on the Supreme Court, had pressed Justice Alito to recuse himself from the case because he has ties to David Rivkin, who is on the Moores’ legal team, but in September 2023, the justice declined to do so.
The question the Supreme Court agreed to review was whether the 16th Amendment “authorizes Congress to tax unrealized sums without apportionment among the states,” Justice Barrett wrote.
“The answer is straightforward: No,” she added.
Apportionment has traditionally been a tough burden for tax-writing lawmakers to meet. Article I of the Constitution mandates that direct taxes must be apportioned among the states by population. To be apportioned, a tax has to be the same amount for every person in every state.
The 16th Amendment and the direct tax clause distinguish between taxes on property that are subject to apportionment and taxes on income realized from that property that are not, Justice Barrett wrote.
The Moores didn’t realize income from their KisanKraft shares, on which the company never declared a dividend. Nor did they realize income by selling their shares. Because they did not receive a dividend or profit from selling their shares, the Moores have not yet received a return on their original investment, she wrote.
Just because Congress can attribute income from a corporation such as KisanKraft to its shareholders “does not mean it has equal power to attribute the income of a publicly traded domestic corporation to anyone holding a few shares in her retirement account,” she wrote
Justice Thomas wrote a dissenting opinion, which Justice Gorsuch joined.
The Moores had to pay taxes on an investment that “never yielded them a penny,” Justice Thomas wrote.
They were “correct” when they argued that a tax on “incomes” as defined by the 16th Amendment cannot be imposed “without apportionment among the several States.”
The amendment necessarily distinguishes between “income” and the “source” from which it is “derived.”
“And, the only way to draw such a distinction is with a realization requirement. Our precedent says as much,” Justice Thomas wrote.
Joe Bishop-Henchman, executive vice president of the National Taxpayers Union Foundation, said the court’s new opinion won’t boost efforts to create a wealth tax.
“This is a narrow decision focused on the one-time international tax that was challenged,” he said in a written statement.
“But the Court makes clear it is not opening the door to a wealth tax, which would still face constitutional problems as a tax on property.”
