The US Supreme Court released a ruling on the taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.
law case Moore v. United States on Thursday, which explored the scope of income taxes constitutionally allowable under the Sixteenth Amendment. The ruling favored the government 7-2 under the narrow, particular circumstances of the case. However, the opinions strongly suggest that the court could rule in favor of taxpayers under other circumstances.
The question before the court was whether the plaintiffs, Charles and Kathleen Moore, could be taxed on income earned by an Indian business called KisanKraft, in which they had a partial stake. Prior to the Tax Cuts and Jobs Act (TCJA) of 2017, taxpayers could defer taxes on foreign earnings of businesses like KisanKraft until the income was repatriated. After the TCJA, income unrepatriated as of 2017 was taxed under a provision called Section 965 deemed repatriationTax repatriation is the process by which multinational companies bring overseas earnings back to the home country. Prior to the 2017 Tax Cuts and Jobs Act (TCJA), the U.S. tax code created major disincentives for U.S. companies to repatriate their earnings. Changes from the TCJA eliminate these disincentives.
. The Moores challenged this provision as unconstitutional, arguing they had not yet realized the income, and the Sixteenth Amendment allowed taxation only of realized income.
The Court’s majority opinion, authored by Justice Brett Kavanaugh, held that the income was realized by KisanKraft. It further states that even though the income is undistributed, case law holds that Congress has the authority to tax an entity’s shareholders or partners on the undistributed, realized income of that entity. Thus, Congress could tax the Moores on the income of KisanKraft. However, the court’s opinion left many questions undecided:
The Court’s holding is narrow and limited to entities treated as pass-throughs. 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. Nor does this decision attempt to resolve the parties’ disagreement over whether realization is a constitutional requirement for an income tax.
It further reiterates the narrowness of the ruling in a footnote: “Our analysis today does not address the distinct issues that would be raised by (i) an attempt by Congress to tax both the entity and the shareholders or partners on the entity’s undistributed income; (ii) taxes on holdings, wealth, or net worth; or (iii) taxes on appreciation.”
The point is clear: while the court sides with the government in this case, the opinion of the court leaves many other questions unanswered.
What Was—and Remains—At Stake
The immediate implications of the Moore ruling are comparatively unimportant. The Court upholds one relatively small tax law, and the Moores do not get a $14,729 refund from the tax they challenged. However, arguments made in the Moore case concern a very important topic: the scope of the Sixteenth Amendment, which made explicit Congress’ ability to levy an income tax. A larger scope for the Sixteenth Amendment could give a constitutional blessing to a variety of tax proposals, while a smaller scope for the Sixteenth Amendment could have foreclosed those tax proposals, and struck down parts of the current tax code as well.
For example, one potential tax requiring an expansive Sixteenth Amendment is a net wealth taxA wealth tax is imposed on an individual’s net wealth, or the market value of their total owned assets minus liabilities. A wealth tax can be narrowly or widely defined, and depending on the definition of wealth, the base for a wealth tax can vary.
as proposed by Sen. Elizabeth Warren (D-MA). Such a tax could fall repeatedly on unrealized and undistributed income. President Biden’s proposed billionaire minimum tax would effectively levy a one-time income tax on unrealized and undistributed income.
A narrower understanding of the Sixteenth Amendment’s scope could begin to threaten other provisions of the current tax code, not just Section 965 deemed repatriation challenged by the Moores. Provisions like Subpart F, the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax.
inclusion of global intangible low-tax income (GILTI), and the new corporate alternative minimum tax, arguably fall on some unrealized income—but perhaps not as saliently or directly as the Warren or Biden proposals above.
And finally, a very narrow Sixteenth Amendment scope might say that income should not be counted until money is in an individual’s hands. If this view is taken to its strongest possible conclusion, undistributed profits of any corporation or pass-through businessA pass-through business is a sole proprietorship, partnership, or S corporation that is not subject to the corporate income tax; instead, this business reports its income on the individual income tax returns of the owners and is taxed at individual income tax rates.
would not be taxable until returned to shareholders. This could invalidate trillions of dollars of revenue over 10 years, as estimated in a previous Tax Foundation post.
Many outsiders with little stake in the Section 965 repatriation challenged by the Moores followed the case closely or filed amicus briefs because they cared about the broader implications of the case—for example, hoping the court would bless or proscribe certain tax policies.
While the court ruled only on the Moores’ challenge to Section 965, a reading of the opinions can yield some insights into how the justices may approach future cases.
How the Court Ruled
The court’s majority in favor of the government was a big-tent coalition, consisting of seven justices and three opinions. The controlling opinion, written by Kavanaugh and joined by Justices Roberts, Kagan, and Sotomayor, states that KisanKraft had realized the income, and it was legal under existing case law to pass that income through to the Moores and to tax them.
However, the justices declined to answer other questions, most of which were effectively rendered moot by the finding that the income was realized. (For example, since the court finds that the income was realized, it does not have to expand on its views about the taxation of unrealized income.) However, the concurrences offer a bit more insight.
Justice Jackson concurred but suggests that there is no realization requirement. Thus, even if the Moores had convinced the court that the income was unrealized, Jackson might still find the income to be taxable. Jackson noted that there is no realization requirement in the plain text of the Sixteenth Amendment, and instead, the plaintiffs drew heavily on the tax law case Eisner v. Macomber to make that argument. Both Jackson’s concurrence and the opinion of the court are critical of the heavy reliance on Eisner v. Macomber, pointing out that subsequent case law contradicts the plaintiffs’ reading of the ruling.
Justice Barrett also concurs, with Justice Alito joining. Barrett’s opinion is unequivocal on whether the government may tax unrealized income. “The answer is straightforward: No.” However, Barrett finds, like the rest of the majority, that the income was realized by KisanKraft. Barrett then turns to a secondary question—whether that realization of income can be attributed back to the Moores. In other words, does realization by a company in India necessarily pass through a series of corporate entities back to a couple in California? The concurrence suggests it would be open to arguments against this attribution, but that the plaintiffs didn’t argue sufficiently on the question of attribution for her to rule in their favor.
Furthermore, Barrett was puzzled by the plaintiffs’ concession that Subpart F, which has similar properties to Section 965, was constitutional. If a similar tax is constitutional, the argument might go, then why is Section 965 not constitutional?
Justice Thomas issued a dissent, with Justice Gorsuch concurring. Like Barrett, Thomas divided the case into two main questions—the question of realization and the question of attribution. Thomas finds that income must be realized to be taxed, but further states that the attribution doctrine, by which KisanKraft’s gains would be traced back to the Moores, is an “unsupported invention.”
Looking Forward
While Section 965 passes constitutional muster, in the court’s holding, it does so through a very specific chain of logic. This ruling is far from blessing all kinds of taxes.
If anything, the text of the opinions suggests some tax proposals may be struck down under future courts. The Barrett concurrence and Thomas dissent both proscribe taxes on unrealized income. It would take just one justice from the opinion of the court (which demurs on the question, for now) to create a majority against taxes on unrealized income, which could in turn invalidate certain tax ideas.
Consider, for example, the Biden administration’s proposed tax on unrealized gains of high-net-worth individuals. The tax as proposed is on the market value of unsold shares—not, as in the Moore case, realized income passed through to the owners. Take, for instance, a startup company that has not yet turned a profit but enjoys a high market valuation because investors expect it to be successful in the future. Imagine the founder owns many shares but has not yet sold them. Neither the founder’s company nor the founder has realized income, and yet, the founder has a high net worth denominated in unrealized capital gains. The proposed Biden tax would attempt to tax such a founder—but it would not be able to do so under the narrow rationale that upheld Section 965 in Moore.
The government won in Moore. However, given the narrow opinion of the court and the reasoning in the Barrett concurrence and the Thomas dissent, it seems likely that future rulings under other facts and circumstances could favor taxpayers instead.
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