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In Moore et ux. v. United States, the Supreme Court, affirming the Court of Appeals for the Ninth Circuit, has held the mandatory repatriation tax (MRT), enacted under IRC Section 965 as part of the Tax Cuts and Jobs Act, is constitutional.

Facts

Charles and Kathleen Moore invested in KisanKraft, an American-controlled foreign corporation that did not distribute income to its American shareholders from 2006 to 2017. In 2017, the United States enacted the MRT, a one-time, pass-through tax on some US shareholders of US-controlled foreign corporations. The MRT imposed a tax rate of 8% to 15.5% on the pro rata shares of US shareholders.

The MRT resulted in the Moores having a tax liability of $14,729 for their pro rata share of KisanKraft's accumulated income. They paid the tax and then sued for a refund, asserting that the MRT violated the Direct Tax clause of the Constitution because it was an unapportioned direct tax on their KisanKraft shares. They also argued that the MRT violated the Due Process clause of the Fifth Amendment because the tax applied retroactively.

The district court dismissed the lawsuit and the Ninth Circuit affirmed. The Moores then appealed to the Supreme Court, making only the Direct Tax clause argument, and the Court granted certiorari.

Holding

Article I of the Constitution allows Congress to impose direct and indirect taxes. Direct taxes apply to persons and property and must be apportioned among the states. Indirect taxes, which include income taxes, apply to activities and transactions and are not required to be apportioned.

The Moores assert that the MRT is a tax on property and must, therefore, be apportioned. The Government argues that the MRT is a tax on income and does not have to be apportioned.

Rejecting the Moores' argument that the MRT does not tax realized income, the Court found the MRT taxes the realized income of KisanKraft, observing that Congress may attribute an entity's realized and undistributed income to its shareholders or partners and then tax those shareholders or partners on their portion of the income. The Court also noted that Courts of Appeals have relied on the principle that Congress may attribute an entity's realized and undistributed income to its shareholders or partners in rejecting constitutional challenges to Subpart F, which taxes US shareholders of US foreign-controlled corporations on undistributed income, primarily passive income.

Additionally, the Court rejected the Moores' arguments that the MRT differs from taxes imposed on partnerships, S corporations and closely held foreign corporations, including taxes under Subpart F. Specifically, the Moores argued that the MRT differs from partnerships because partnerships are not separate from their partners. The Court, however, found that the courts, Congress and states treated partnerships as separate entities when the Sixteenth Amendment was ratified.

The Court also observed that the MRT does not differ from taxes on S corporations because "S corporations are another example of Congress's authority to either tax the corporation itself on corporate income or attribute the undistributed income to the shareholders and tax the shareholders."

Regarding Subpart F, the Court rejected the Moores' use of the term "constructive realization," finding that their theory did not distinguish the MRT from Subpart F. The Court noted their theory "turns on a sufficient degree of control over the entity. But the level of shareholder control with the MRT (at least 10 percent) is the same as under the longstanding [S]ubpart F tax."

Accordingly, the Court, affirming the ruling of the Ninth Circuit Court of Appeals, held the MRT is constitutional.

Implications

In their initial brief, the taxpayers argued that the MRT was unconstitutional because the 16th Amendment requires income to be "realized" before it can be taxed. If the Court agreed, many tried-and-true pieces of the Internal Revenue Code potentially could be ruled unconstitutional for the same reason, from the mark-to-market securities rules of IRC Section 475 to Subpart F to pass-through taxation under subchapters K and S. In contrast, if the Court ruled that no such realization requirement exists, it would open the door for future legislation taxing unrealized appreciation and even wealth. As a result, when oral arguments arrived during the first week of December, it appeared the Court would be presented with a question that could reshape our current and future tax law: does the 16th Amendment of the Constitution contain a realization requirement?

The Court, however, did not address that question. Perhaps realizing the gravity of the question posed, both the taxpayers and the government sought during oral arguments to offer the Court the option of a narrower, less-impactful ruling. For their part, the taxpayers conceded that Subpart F and Subchapters S and K were constitutional for their own specific reasons but insisted that the MRT violated the 16th Amendment by taxing them on income they had never realized. The government pursued an even narrower option, explaining to the Court that it need not rule on a realization requirement at all; rather, the Court could look to its long-standing precedent to conclude that the MRT was constitutional because Congress may attribute the income that has been realized by a corporation to its shareholders, which is exactly what the Court did.

Regarding the MRT, the Court noted income had clearly been realized but was realized by the controlled foreign corporation, rather than the shareholders/taxpayers. As established by precedent like Burk-Waggoner Oil Assn. v Hopkins and Burnet v. Leininger, Congress has a "long-standing practice of taxing the shareholders or partners of a business entity on the entity's undistributed income." The opinion, however, appears to limit Congress's ability to attribute income from an entity to its owners to those situations where the entity is taxed as a pass-through (i.e., partnerships, S corporations, and controlled foreign corporations); it explicitly states that it does not address the issue of whether Congress could tax BOTH the entity and the owner on the same undistributed income.

As a result, the Court's decision in Moore is largely anti-climactic, focusing as it did on "attribution" and leaving the fight over "realization" for another day. In addition, the Court noted in only its second footnote that "our analysis today does not address the distinct issues that would be raised by … (ii) taxes on holdings, wealth, or net worth; or (iii) taxes on appreciation."

With the majority opinion settled in fairly short order, concurring and dissenting opinions were used to express individual justices' thoughts on the limit of Congress's taxing power. In her concurring opinion, Justice Jackson stated that she did not believe there was any constitutional requirement for income to be realized. Justices Barrett and Alito, consenting in judgment, shared their belief that there was a realization requirement, and that the majority may have been too quick to conclude that the realized income of a corporation — as opposed to a partnership or S corporation — may be attributed to its shareholders. Finally, in a dissenting opinion, Justices Thomas and Gorsuch criticized the Court for eschewing the "realization" argument in favor of a ruling based on attribution and stated that they believe realization is clearly required by the 16th Amendment and that attribution of income from a corporation to its shareholders was an "unsupported invention."

In summary, the MRT remains intact, as does Subpart F, Subchapter K and Subchapter S. The fight over whether the 16th Amendment requires a realization requirement and the resulting limit on Congress's taxing power will have to wait for another day.