New Supreme Court Case Could Unsettle Large, Longstanding, Parts of the Tax Code Built on a Bipartisan Basis Over Decades and Give a Windfall to Multinational Corporations
By David Kamin, Thalia Spinrad, and Chye-Ching Huang
If the Supreme Court rules for the plaintiffs, that would invite litigation unsettling swaths of the tax code that have been enacted by both parties over many decades based on their shared, correct understanding of the Constitution.
The Supreme Court today announced it will hear Moore v. United States, a case that challenges the constitutionality of the mandatory repatriation tax (MRT) enacted in 2017 as part of the Tax Cuts and Jobs Act (TCJA). If the Supreme Court reverses the Ninth Circuit and rules for the petitioners, it could result in a windfall for large multinational corporations, and dismantle or unsettle wide swaths of the tax code, including fundamentals of the tax system that have been on the books for decades and were built on a bipartisan basis.
Amicus briefs and coverage of this case have focused on how a ruling in favor of the petitioners, the Moores, would effectively erect a constitutional barrier to certain approaches to taxing capital income, such as mark-to-market taxes on rising asset values, or a wealth tax. But because this case is about a tax which works very differently than wealth or mark-to-market taxes and is similar in key ways to a number of long-standing provisions in the tax code, it cannot directly and cleanly answer the question of the constitutionality of such taxes. Instead, a ruling in favor of the petitioners could have far more sweeping effects: it could offer the corporations now paying the MRT a windfall, and would invite litigation about the constitutionality of tax provisions enacted on a bipartisan basis and over decades, creating major uncertainty about the taxation of huge swaths of business activity. The provisions that litigation could then attempt to unsettle include, but are not limited to, Subpart F (the tax treatment of certain foreign profits of US multinationals), the tax treatment of Global Low Taxed Intangible Income (GILTI) (a minimum tax applicable to foreign profits of US multinationals), and Subchapters K (pass-through tax treatment of partnerships) and S (tax treatment of corporations that elect pass-through taxation).
This post is an introduction to the Moore case and the broad risks it poses to the tax system. We will provide more in-depth analysis as the case proceeds.
I. Background
In 2017, lawmakers enacted the TCJA, which made major cuts to corporate taxes. To help partially pay for these cuts, Congress included in the reform package the MRT, which was projected to raise about $339 billion over ten years.
The MRT is about the taxation of offshore profits. Controlled foreign corporations (CFCs) are foreign companies more than 50% owned by US shareholders. Before the TCJA, US shareholders could indefinitely defer paying taxes on their share of earnings of their CFCs. US shareholders in CFCs typically did not have to pay taxes on their CFC earnings until the CFC distributed those earnings to them as dividends. The CFC realized income in the year that it was earned, but tax on shareholders’ portion of that income was indefinitely deferred. This meant that many CFCs had significant income that they had realized in years (even decades) up to the end of 2017, but that income had not faced US income tax. More than $2 trillion of these earnings were estimated to exist at the end of 2017.
The MRT changed that: US shareholders who owned over 10% of a CFC could not continue to defer taxes on their share of the income earned since 1986. The MRT was a one-time tax on this deferred income, though the law gave shareholders the option to pay it in installments over eight years. The MRT was not an extra tax; it just changed the timing of tax on already realized income, and, in fact, applied a reduced tax rate to the earnings (at rates of 8% or 15% for corporate shareholders, and a percent or two higher for individual shareholders, as compared to the previous 35% corporate rate or the current 21% rate).
The TCJA also transitioned to a new system for taxing CFCs going forward. Under the new system, corporate US shareholders would immediately pay some minimum level of tax on CFC earnings in the year that they were earned and realized through GILTI, but no longer have to pay tax on dividends from CFCs. So, in sum, the MRT was designed to address the past previously realized earnings of CFCs in order to transition to this new system. Without the MRT, shareholders of CFCs could have continued indefinitely deferring taxes on their CFCs’ past earnings and never pay tax on them.
In this case, the Moores invested in 2005 in a CFC incorporated in India but controlled by US owners, and, as of 2017, the Moores themselves held a 13% ownership stake in the company. The company turned a profit each year, but until 2017, the Moores’ tax liability on their share of the income was deferred. In 2017, under the MRT, the Moores owed taxes on their share of the earnings the company accrued between 2005 and 2017. Their share of the earnings was about $508,000, which increased the Moores taxable income by about $132,512 and their tax liability by about $15,000.
After paying, the Moores challenged the MRT. They lost before the District Court, which dismissed the case, and also lost before the Ninth Circuit. They appealed, and the Supreme Court has now taken the case.
II. Risks the case poses to the tax system
As the Moores frame it, the question the Court should answer is whether income taxes under the 16th Amendment can only tax realized income. They contend that they never realized the income that was taxed under the MRT and that the MRT is therefore unconstitutional, at least as applied to them. But the income taxed under the MRT was realized by the CFC. To win the case, the Moores would have to not only convince the Court that income has to be realized before it’s taxed but also that they can’t be taxed on their share of the income that the CFC realized. This is contrary to the prevailing understanding of tax law. George Callas, who helped draft the MRT as a senior House Republican aide, has stated that no one involved in writing the law was worried that it taxed unrealized income because “it’s crystal clear that you can attribute the earnings of an entity to its owners.” To find that the earnings of an entity cannot in fact be attributed to its owners, the Court would have to accept one of two arguments, both of which would unsettle major portions of the tax code.
A. The Moores’ argument against taxing owners on income realized at the corporate level poses threats to major portions of the tax code. The Moores appear to claim that Congress cannot look through a corporation to tax minority shareholders on income that is realized at the entity level. They argue that Congress lacks this power even when those minority shareholders, like the Moores, own over 10% of a company controlled by US shareholders.
However, the MRT’s basic structure in this regard is built directly off of Subpart F of the corporate tax code, first enacted in 1962 and revisited by Congress many times since. Subpart F taxes US owners with over 10 percent ownership of CFCs on passive income realized at the corporate level. Lower courts have found Subpart F to be constitutional based on the idea that the income is constructively realized by the US owners subject to the system. Notably, the GILTI regime that Congress adopted in TCJA for taxing CFCs’ active business income going forward also takes the same approach. The Moores’ argument seems to reject the “constructive realization” approach taken by courts in the past and underlying these systems.
More broadly, entire parts of the tax code rely on looking through business entities and taxing owners on income realized by the entity. This includes the treatment of S-Corporations, incorporated entities that elect pass-through taxation under part of the code first enacted in 1958, and other kinds of pass-throughs under Subchapter K, which dates back to 1954. Importantly, Subchapter K’s treatment extends not only to partnerships where there is limited legal separation between owners and the entity but also to limited liability companies (LLCs), which are legally separate from their owners and, among other things, confer limited liability on the members–much like corporations. Some 40 percent of business profits flow through these pass-through regimes built up on a bipartisan basis over decades.
If the Court were to adopt the position that the Moores are asking for, it would put at risk much more than the MRT or wealth taxes and mark-to-market taxes — it would also spur litigation over these long-standing provisions of the tax code adopted on a bipartisan basis over decades.
B. The Moores’ argument about deferred taxation threatens international tax reform adopted in 2017 and could give a windfall to corporations. The Moores and others also appear to suggest that it is unconstitutional for the MRT to require tax to be paid on income that was accrued in prior years but on which tax was previously deferred. This argument is odd because it would seem to suggest that the Constitution requires annual tax accounting, but, in fact, the accounting period is and has always been defined by Congress. If the Court were to rule for the Moores on this point, it could imply that the MRT is unconstitutional for all taxpayers, ranging from the Moores to the largest corporations being taxed on the accrued realized income of their subsidiaries. This would offer a giant windfall gain — of over $300 billion — to corporations that paid this one-time tax, which Congress adopted in exchange for allowing distributions of those profits to not be taxed in the future.
If the Court found the MRT unconstitutional, it would also raise fundamental questions — which should not exist — about the status of the 2017 corporate tax reform as a whole. The MRT was a key and irreplaceable part of the international tax reform portion of the 2017 tax law. It is questionable whether Congress would have moved forward with international tax reform without imposing the MRT.
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Notably, Congress has the power to tax the Moores on this income not only under the 16th Amendment as income, but also under Congress’s separate power to apply excise taxes. This is a power to tax a particular use or enjoyment of property — in this case, the choice to own a CFC with deferred income. As a result, however the Court resolves the question of Congress’s power to tax income under the 16th Amendment, Congress would still have this power under its separate authority to apply excise taxes.
If the Court ruled for the Moores, it could try to make non-binding statements that its ruling does not unsettle these regimes. But even if lower courts accepted these non-binding statements, which they might not, doing so would pose challenges to the basic logic that the Moores are asking the court to accept — and could in any event only be so effective. At best, there would still be broad uncertainty over wide parts of the economy and multiple challenges to important parts of the tax code that could take years to resolve.
III. Conclusion
We do not believe that the 16th Amendment should be read to include a realization requirement. Income can be made and taxed even if assets aren’t sold. However, because the income here was realized, this case does not cleanly present the issue and, even if there were such a requirement, the Moores should lose the case. Otherwise, the newfound restrictions on Congress’s power could lead to entirely unintended windfall gains to large corporations, raise questions about the validity of much of the post-2017 international tax code given the centrality of the MRT to that reform, and unsettle other major swaths of the tax treatment of U.S. business built up on a bipartisan basis over decades and based on a shared, settled understanding of Congress’s taxing power.
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