June 26, 2023 – Great News! – The US Supreme Court Agrees To Hear Moore 965 Transition Tax Case!

A direct link to the Supreme Court site which will track the progress and filings of all briefs (including what are expected to be a large number of amicus briefs) is here.

The brief from the CATO Institute frames the question addressed to the Supreme Court as follows:

QUESTION PRESENTED

Whether Congress may levy income tax on a tax-payer who has not realized income.

What follows is a twitter thread (which I will continually update) which includes commentary, resources and general information about the appeal.

Huge news!! The US Supreme Court has agreed to consider the constitutionality of the IRC S. 965 @USTransitionTax. The issues include whether real tax can be imposed on deemed income that the person never received. The result may have some bearing on the 877A expatriation tax too! https://t.co/GeXLKp3SkA

— John Richardson – lawyer for "U.S. persons" abroad (@ExpatriationLaw) June 26, 2023

Litigation against the 965 Mandatory AKA transition tax has come from two sources.

The first source was from U.S. tax lawyer Monte Silver. His challenge to the tax was based generally on procedural grounds and specifically on the failure of U.S. Treasury to comply with the provisions of the Regulatory Flexibility Act. Despite a heroic, valiant and determined effort the Supreme Court refused to hear his cert petition. As a result, in May 2023, his challenge came to an end. Monte Silver’s challenge focused on the legality of the Treasury Regulations insofar as they applied to US citizens living outside the United States.

The second source is the Charles Moore case. This case is arguing that the tax is unconstitutional. Although brought on behalf of an individual shareholder of a CFC, the case makes no mention of the application of the tax to Americans abroad. On June 26, 2023 (about a month after denying the cert petition in the Silver case) the U.S. Supreme Court agreed to hear the Moore case. To be clear, this case is attacking the constitutionality of the tax (not the procedural aspects) head on. Much will be written about this issue and the case.

On September of 2019 I wrote a post describing the Moore lawsuit arguing that the Section 965 Transition Tax AKA Mandatory Repatriation Tax is unconstitutional. Although the Moore’s were not successful in the District Court and Appeals court, the Supreme Court of the United States has agreed to hear the case!

The Cert Petition

The Cert petition was based on an appeal from the 9th Circuit and a dissenting judgment from the plaintiff’s application to rehear the case in the 9th Circuit.

The original 9th Circuit decision is here.

The decision of the 9th Circuit denying the request (with the dissent) to rehear the Moore case is here.

An excellent article discussing the history of the Moore “Transition Tax” ligation is here.

“The cert petition in CHARLES G. MOORE and KATHLEEN F. MOORE, Petitioners, v. UNITED STATES OF AMERICA,Respondent, includes:

III. The Question of Congress’s Power To Tax Unrealized “Income” Without Apportionment Is Exceptionally Important and Warrants Review

The importance of the question presented cannot be overstated. This case presents a fundamental constitutional question concerning Congress’s core power of taxation. That question is not only politically important, but practically important, as American families and businesses plan their financial futures. The decision below upsets the heretofore settled expectation that federal taxation of property and wealth was effectively impossible, due to the difficulty of apportionment. The Court’s review is required to resolve this question of vast legal and practical significance, and this case is the ideal vehicle for the Court to do so.

A. The question of Congress’s power under the Sixteenth Amendment to tax persons on “incomes” they have not realized in any form is exceptionally important. In the proceedings below, neither the Government nor the Ninth Circuit identified any precedent approving an income tax that operates in the absence of realization. The reason is that, following Macomber, Congress refrained from overstepping the line this Court drew. See Helvering v. Nat’l Grocery Co., 304 U.S. 282, 288 n.4 (1938) (describing evolution of tax treatment of corporations’ retained earnings); Griffiths, 318 U.S. at 389–93 (describing Congress’s care in following Macomber); see generally Henry Ordower, Revisiting Realization: Accretion Taxation, the Constitution, Macomber, and Mark to Market, 13 Va. Tax Rev. 1, 9 (1993) (describing the “Macomber effect” that deterred Congress from “tax[ing] the unrealized appreciation in a taxpayer’s property”). It abandoned that restraint with the MRT, which the decision below recognizes to be a “novel concept” in taxation. App.8. It is, at a minimum, a marked departure from Congress’s historic exercise of its taxing power.

As such, the MRT calls into question long-accepted limitations on that power. For example, following Macomber Congress ceased its brief experiment in taxing shareholders on corporations’ retained earnings. Nat’l Grocery Co., 304 U.S. at 288 n.4. The MRT, however, conflicts with the long-held understanding that Congress lacks the power to levy such taxes without apportionment. And the decision below spells out what the MRT implies, holding that nothing prohibits Congress from “attributing a corporation’s income pro-rata to its shareholders” and then taxing them on it. App.13.

The consequences of that alone are earth-shattering. Millions of Americans hold stock in their retirement and investment accounts or through mutual funds. Taken at its word, the decision below authorizes Congress to tax every single one of them on the retained earnings of the corporations in which they’ve invested. The tax would be practically indistinguishable from one on the shares themselves, given that every major corporation has funded its growth, to a large extent, through reinvestment of profits. For example, the retained earnings carried on Exxon’s books actually exceed its total shareholder equity.6 Under the logic of the decision below, Exxon’s shareholders could be deemed to have “income” that exceeds the value of their shares and then taxed on it.

More broadly, repudiating the requirement that taxable income be realized calls into question the longstanding consensus that Congress lacks the power to tax property without apportionment. This Court held as much in Pollock, 158 U.S. at 637 (“taxes on personal property . . . are [ ] direct taxes” requiring apportionment). But the MRT’s logic, as reflected in the decision below, suggests that Pollock turned only on Congress’s failure of imagination in taxing property in so many words; if, instead, it taxes property-owners on deemed “income,” then the apportionment requirement goes out the window. So while Congress cannot lay an unapportioned tax on farmland, it could very well tax farmers on the imputed rental value of their land, deeming that to be their “income.” Or “Congress could simply deem taxpayers to have sold all their assets” and tax them “on the income deemed to result.” Berg & Feingold, supra, at 1354 (discussing import of MRT); see also Ordower (2019), supra, at 1409 (arguing that the MRT provides a model for a one-time tax on all property). Without the need for income to be realized, there is no limit.

This is no idle threat. The President has proposed a tax on appreciation in property, which the White House candidly describes as “unrealized income.” Press Release, The White House, President’s Budget Rewards Work, Not Wealth with new Billionaire Minimum Income Tax (Mar. 28, 2022).7 In the last Congress, legislation to establish a wealth tax was introduced in both the House and the Senate. Ultra-Millionaire Tax Act of 2021, H.R. 1459, 117th Cong. § 2901(a) (2021) (“In the case of any applicable taxpayer, a tax is hereby imposed on the net value of all taxable assets of the taxpayer on the last day of any calendar year.”); S. 510 (same). Meanwhile, the Chairman of the Senate Finance Committee introduced a proposal to tax gains on stockholdings and other “tradeable assets” annually. Press Release, Wyden Unveils Billionaires Income Tax (Oct. 27, 2021).8 There is every reason for the Court to resolve the pivotal constitutional question of realization now, when its judgment can inform lawmakers and stands to head off a major constitutional clash down the line.

The 16th Amendment to the constitution and the constitutional authority to impose income taxes

The 16th Amendment reads as follows:

The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.

The operative words include “collect taxes on incomes“.

Does the 16th Amendment require that income be “realized” (received) for it to qualify as “income”? If so, what is the meaning of “realized”?

This is the question that the Moore’s are asking the Supreme Court to answer. Not only had the Moore’s never received a dividend from the India Corporation, but they did not have the power to compel the payment of a dividend. I will discuss this issue in a subsequent post. What are the “necessary” conditions for the “income” test to be met?

What about attributing income from one U.S. taxpayer to another U.S. taxpayer?

Interestingly, the 16th Amendment does NOT require that the person/entity receiving the income be the person/entity required to pay the tax on that income! This “may” create the possibility of one individual realizing the income and that income being attributed to another individual for tax purposes. In this case, the United States clearly has the right to tax the income. The only question is which specific individual receives the income and is therefore required to pay the tax.

What about attributing non-U.S. source income from a “nonresident alien” to a “US Person”?

In the Moore case, the entity receiving the income was the India corporation (which for U.S. tax purposes was a nonresident alien). The United States may (as per IRC 871) impose taxation on certain business income/profits connected with the United States. That said, the United States has no right to impose U.S. taxation on the undistributed earnings/profits of the India Corporation. Significantly, Article 10 of the U.S. India Tax Treaty prohibits the United States from even directly taxing the undistributed profits of the India Corporation even when “the undistributed profits consist wholly or partly of profits or income arising in” the United States. (The whole purpose of the 965 transition tax was to impose U.S. taxation on a portion of the undistributed profits of the India corporation. This was achieved by taxing the U.S. shareholder rather than the India corporation.) The Moore’s (as shareholders) were required to pay the tax on the undistributed profits of the India corporation.

Clearly the foreign corporation is receiving the income (which is not taxable by the United States) and the U.S. shareholder is being deemed to receive the income of the corporation for U.S. tax purposes. I would characterize this as:

“real taxation on deemed income”.

So, far we have considered this issue ONLY from the perspective of current income.

What about the role of retroactivity? Deemed income for the 31 year period from 1986 to 2017?

The Subpart F rules have always operated in real time on a current year basis. To the extent that Subpart F applies, income from the foreign corporation is deemed to have been received by the U.S. person shareholder in “real time”. The issue of Subpart F income was considered from the perspective of the current tax year. The 965 transition tax was extraordinary in that while including the current year, also went back and forced the inclusion of the previous 30 years of undistributed earnings. In this sense the transition tax moved from:

“real taxation on deemed income” in the current year; to

“retroactive taxation on deemed income based on the previous 30 years.

To put it simply, the IRC 965 transition AKA mandatory repatriation tax was actually:

Retroactive REAL taxation on DEEMED income (never received by the shareholder) for 30 years!!

How can income that was never subject to U.S. taxation before, be subject to U.S. taxation now? Is this within the spirit of the 16th Amendment?

About the Moore’s … You will recall that the Moores:

– held a 13% interest in their Controlled Foreign Corporation (“CFC”) and therefore completely lacked any control of the India corporation’s income

– had received NO distribution from the India corporation during the years of the investment

– Yet was required to include to include 13% of the corporation’s income (from inception to 2017) in their personal U.S. tax return

– the income inclusion reflected corporate income for years that the income could not be attributed to the Moore’s under the Subpart F rules as they applied at the time (in other words it was a retroactive tax)

The issues in the case include (but are not limited to) the following:

1. Does the 16th Amendment (as a general principle) require that income be “realized” (actually received) in order for the tax to meet the requirements of the 16 amendment?

2. Will “any” income realization (for example the corporation realized income) suffice or must the U.S. taxpayer “realize” the income?

3. Can a U.S. Shareholder who CANNOT compel the payment of a dividend be subject to “deemed income inclusions” under the Subpart F rules?

4. Can the Moores be deemed to have “realized income” even when (1) they received no distribution from the corporation and could not compel a distribution from the corporation?

5. What is the significance of the 965 transition tax being a “retroactive tax”? For no year prior to 2017 were the Moore’s required to include their share of the corporation’s income on their personal tax returns. Yet, the transition tax was clearly requiring them to pay tax on income that was not taxable when it was earned by the corporation.

All this and Moore (pun intended) …

This is a very important case. The court’s decision is likely to determine the direction of U.S. taxation for years to come.

For background about the the transition AKA repatriation tax see:

The Little Red Transition Tax Book
Have a question? Contact John Richardson, Citizenship Solutions.