IN-DEPTH: What You Need to Know About the Historic Tax Case Before the Supreme Court

U.S. Supreme Court in Washington on July 31, 2023. Madalina Vasiliu/The Epoch Times

The U.S. Supreme Court recently agreed to hear a challenge to the constitutionality of a provision of the Trump-era Tax Cuts and Jobs Act (TCJA), in a case that experts say has major implications for America’s tax system.

At the end of June, the Supreme Court added a new case to its docket for the 2023–24 term that involves weighing whether a provision in the TCJA called the “mandatory repatriation tax” violates the 16th Amendment of the U.S. Constitution.

Some experts argue that if the Supreme Court rules that the provision is unconstitutional, it could have major consequences, including upending key parts of the current U.S. tax system.

The case is called Moore v. United States, and here’s what you need to know about this potentially groundbreaking case in which the Supreme Court recently gave both sides the green light to file briefs on the merits.

Mandatory Repatriation Tax Origin

When then-President Donald Trump signed the TCJA into law in 2017, the measure included a provision that introduced the mandatory repatriation tax as a way to obtain tax revenue from large earnings that corporations held abroad.

The tax was later codified into a revised Internal Revenue Code section 965, which requires some U.S. shareholders to pay a one-time tax on the offshore untaxed earnings and profits of certain foreign corporations as if those earnings had been repatriated to the United States.

Taxpayers affected by the mandatory repatriation tax, which is also known as the “transition tax,” are those who own 10 percent or more shares of a controlled foreign corporation (CFC) or a foreign corporation that has a U.S. shareholder that’s a domestic corporation.

U.S. shareholders can include individuals, S corporations, partnerships, trusts, REITS, domestic corporations, cooperatives, estates, RICs, and tax-exempt organizations.

The transition tax also classifies a certain portion of a U.S. shareholder-controlled foreign corporation’s deferred foreign income as part of that corporation’s taxable income. This means that qualifying U.S. shareholders are required to pay the transition tax on their share of the foreign corporation’s retained earnings, even if they didn’t actually receive any of that money, such as through dividends.

While the mandatory repatriation tax (or transition tax) is a one-time assessment, taxpayers can choose to pay it in installments over an eight-year period.

Failure to comply with the reporting and payment obligations of the mandatory repatriation tax could lead to the imposition of penalties.

Following the adoption of the TCJA and, with it, the transition tax, a Washington state couple who owned shares in a foreign corporation found that the provision increased their tax liability by about $15,000, even though they never received any dividends from that company.

The couple sued on the premise that the relevant provision of the TCJA violated the 16th Amendment, arguing that the mandatory repatriation tax is unconstitutional because it imposes a direct tax that isn’t apportioned.

‘Harsh and Oppressive’

The lawsuit that eventually ended up before the Supreme Court was brought by Charles and Kathleen Moore, who owned a 13 percent stake in an India-based corporation starting in 2006.

The corporation, which supplies power tools to small Indian farms, reinvested its earnings rather than paying out dividends, and the Moores never received any money from their holding.

However, the couple found out in 2018 that, under the TCJA, they were liable for a one-time transition tax of $14,729 for their share of the company’s earnings dating back to 2006.

The Moores paid the tax and sued the U.S. government, arguing in their complaint (pdf) that the mandatory repatriation tax is unconstitutional for two separate reasons.

First, the couple asserted that the tax violates the Fifth Amendment’s due process clause because it imposes a retroactive tax liability for earnings dating back to 1986.

“That is precisely the kind of ‘harsh and oppressive’ retroactive taxation that the Supreme Court has held to ’transgress ... constitutional limitation,'” the couple’s attorneys wrote in the complaint, citing the case of Welch v. Henry.

Second, the Moores argued that the mandatory repatriation tax violated the Constitution’s apportionment clause, which requires direct taxes to be “apportioned among the several states” and if the mandatory repatriation tax is a direct tax and not an income tax, it’s beyond Congress’s power to enact.

However, the 16th Amendment contains a carve-out to that rule, allowing Congress to tax “incomes, from whatever source derived,” without having to apportion that tax among the states.

The couple’s attorneys argued that, based on Supreme Court cases that interpreted the 16th Amendment, income must be distributed before it can be taxed, so the transition tax should be considered as a direct tax that isn’t apportioned to the states and is unconstitutional.

‘Constitutionally Valid’

The government filed a motion to dismiss the Moores’ complaint, arguing that the mandatory repatriation tax is a “taxation of income” that falls within the power of Congress to enact under the 16th Amendment.

A district court granted the government’s motion to dismiss, noting in its decision (pdf) that the mandatory repatriation tax “does not violate due process and, as a tax on income, it is constitutionally valid.”

The Moores appealed to the 9th Circuit Court of Appeals, but the court rejected their arguments and denied a rehearing.

“Whether the taxpayer has realized income does not determine whether a tax is constitutional,” the 9th Circuit’s majority opinion (pdf) reads. “Further, there is no blanket constitutional ban on Congress disregarding the corporate form to facilitate taxation of shareholders’ income. In other words, there is no constitutional prohibition against Congress attributing a corporation’s income pro-rata to its shareholders.”

However, some of the 9th Circuit judges dissented, warning that the ruling gave the federal government “unfettered latitude” in redefining what constitutes “income” in a way to expand its taxation powers.

“Without the guardrails of a realization component, the federal government has unfettered latitude to redefine ‘income’ and redraw the boundaries of its power to tax without apportionment,” 9th Circuit Judge Patrick Bumatay wrote on behalf of the dissent.

The appeals court’s decision led the Moores to ask the Supreme Court to weigh in, with various policy and trade organizations filing a total of eight amicus briefs in support of the couple’s petition.

One of the filings (pdf), brought by the U.S. Chamber of Commerce, argued that the 9th Circuit’s decision harms businesses by introducing uncertainty in tax planning.

“First, uncertainty simply costs businesses money, as they are forced to hire lawyers and accountants to navigate the uncertainty, a deadweight loss to the nation’s economy,” the chamber’s amicus brief states.

“Businesses’ necessary and predictable responses to tax uncertainty benefit no one in the long run. Consumers are affirmatively harmed, as they have to pay twice-suffering the generalized depressive effect of deadweight loss on the economy while also paying more for goods and services.”

In their petition (pdf) for Supreme Court review, the Moores argued that the 9th Circuit’s decision “shatters what had been an unbroken judicial consensus dating back to Eisner v. Macomber that the 16th Amendment’s exemption from apportionment is limited to taxes on realized gains.”

The couple also noted that the case has direct implications for the constitutionality of a wealth tax that some in Congress have been advocating for.

The 9th Circuit’s decision “is not only wrong, but dangerous, opening the door ’to new federal taxes on all sorts of wealth and property without the constitutional requirements of apportionment,'” the Moores wrote in their petition, citing the words of the dissenting judge.

They argued that, in light of talk by some members of Congress about a wealth tax, the Supreme Court should take up the case “now, to provide certainty to families and businesses arranging their financial futures and to head off a major constitutional clash when Congress accepts the Ninth Circuit’s invitation to enact an unapportioned tax on property or wealth.”

After considering the case at conference, the Supreme Court issued a disposition (pdf) on June 26 to grant review.

The issue before the Supreme Court is whether the 16th Amendment authorizes Congress to tax unrealized sums without apportionment to the states.

‘Monumental’ Implications

Experts say the implications of the case are significant, with a possible major shakeup of the U.S. tax system.

Some legal experts have warned that the case has the potential to either greenlight a potentially disastrous wealth tax or upend critical parts of America’s tax system.

“A taxpayer-favorable decision would be monumental, as the impact of the court’s decision would presumptively not be limited to the transition tax,” wrote analysts at Forvis, an accounting consultancy.

A favorable decision for the Moores could “encourage litigation over long-standing fundamentals of the current U.S. tax system as it relates to U.S. inclusion regimes like GILTI and Subpart F,” they said.

GILTI (Global Intangible Low-Taxed Income), is a provision in the U.S. tax code that aims to prevent multinational corporations from shifting their profits to low-tax countries. Under GILTI, the U.S. parent company must include a portion of its foreign subsidiaries’ income in its taxable income, regardless of whether the income is distributed as dividends.

Subpart F is another provision in the U.S. tax code that targets certain types of income earned by controlled foreign corporations, with the aim of preventing U.S. shareholders from deferring taxes by keeping certain types of income in foreign corporations. Subpart F requires U.S. shareholders to report and pay taxes on this income in the year it’s earned by the foreign corporation.

Another consultancy, KPMG, wrote in an analysis that the Supreme Court’s decision could have a “far-reaching impact” on taxing entities and individuals who receive income from foreign sources.

“In the short term, it could give rise to refund opportunities for many corporate and individual taxpayers and in the longer term it would cause multinational corporations to re-assess many aspects of their operations, including their international assignment programs, given that some tax costs for international assignees could be reduced or eliminated,” the consultancy stated.

International law firm McDermott Will & Emery wrote in an analysis that a broad ruling in favor of the Moores could have “reverberations throughout the tax law by calling into question the constitutionality of many different income imputation or acceleration regimes.”

If a ruling invalidates all or some of Section 965, Subpart F, or GILTI, this could result in “significant revenue loss” for the U.S. Treasury and could have “adverse collateral consequences” for taxpayers under certain circumstances in the form of taxing for a second time previously taxed earnings and profits unless Section 245A rules are applied to make the distributions tax-free.

“The Court’s rationale could also preempt or support constitutionality challenges to wealth taxes that are being considered or call into question other portions of the tax code that are applying anti-deferral or mark-to-market principles,” McDermott lawyers wrote in their analysis.

Analysts at the Cato Institute, which also filed an amicus brief in support of the Moores, argued that if the Supreme Court jettisons the rule requiring earnings to be realized for an income tax to be imposed, then there would be “no limit to the types of taxes the federal government could enact.”

“Indeed, such a rule would open the door for the federal government to impose a future wealth tax entirely divorced from any connection to actual income,” the analysts wrote, arguing for the Supreme Court to reject the 9th Circuit’s majority opinion.

The Supreme Court has given the Moores until Aug. 30 to file their brief on the merits, while giving the government until Oct. 16 to respond.