Part A – Prologue And Introduction

The Moore transition tax appeal is about whether “income” under the 16th Amendment requires “realization” in order to qualify as income. Resolution of this issue requires an analysis of both the meaning of “income” (whatever “income” may mean) and whether “income” must be “realized” to meet constitutional requirements. Generally, the income tax is constitutional because of the 16th amendment which reads:

The Congress shall have the 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 16th Amendment (1) creates the constitutional jurisdiction for Congress to tax “incomes” but (2) creates the constitutional jurisdiction to tax ONLY “income” (under the 16th Amendment).

The 16th Amendment does NOT say that Congress has the power to collect taxes on anything that Congress decides to designate as income. Rather the 16th Amendment specifies a tax on “income”. In this respect, the 16th Amendment implies that there are limitations on the kinds of “accessions to wealth, clearly realized, and over which the taxpayers have complete dominion” (or other events) that qualify as income. Something must have some objective characteristics in order to qualify as “income”. Perhaps an “event”. Perhaps an “accession to wealth”. Perhaps “realization”. Perhaps something else.

Income must meet some necessary and objective requirements

The word “income” (difficult as it may be to define) must have some “objective” limitation. Absent an “objective” limitation, Congress would be able to simply “designate” anything as income and then impose taxation on it. Specifically legislating something as income is neither a necessary (See IRC § 61) nor sufficient condition for something to meet the requirements to qualify as income. (That said, there are some who believe that there are no constitutional limitations on what Congress may define as income.)

Income must have some objective meaning and limitation.

The identification of existing income vs the creation of new income

Can Congress create income on a retroactive basis? Note that this is a very different question from whether Congress can impose retroactive taxation on existing income. A reading of the 16th Amendment (leaving aside the question of realization) implies that:

– If there is income Congress may or may not tax that income (for example in the case of a ROTH IRA Congress is refraining from taxing the income earned inside the ROTH IRA); but

– If there is no income Congress does not have the jurisdiction to impose taxation.

The retroactive taxation of retroactively legislated income vs. The taxation of existing income retroactively

Taxation of existing income retroactively: There is a difference between something that would normally be taxable income but is exempt from taxation (for example income earned in a ROTH IRA or the first $250,000 in gains on the sale of a principal residence) and a present day designation/creation of a new kind of income (possibly the “Deferred Income” § 965 Transition Tax).

Retroactive taxation of retroactively legislated income:

Effective December 22, 2017 Congress gave birth to § 965 of the Internal Revenue Code which created the concept of “Deferred Income”. The title of § 965 reads as follows:

26 U.S. Code § 965 – Treatment of deferred foreign income upon transition to participation exemption system of taxation

The § 965 Transition Tax first created the concept of “Deferred Income” and second imposed 31 years of retroactive taxation on that newly created “Deferred Income”.

Although retroactive taxation is always problematic, there is a huge difference between the retroactive taxation of something that was normally taxable but exempt from taxation and the retroactive taxation of something that it is a newly created form of income and was never previously income. The idea of first creating a new form of income and then imposing retroactive taxation on that income (which is exactly what the § 965 Transition Tax is designed to do) seems extraordinarily unjust. Although corporate shareholders of CFCs may have received sufficient benefits in return, individual shareholders of CFCs experienced the § 965 Transition Tax as a confiscation of their assets.

This brings us to the question of “Deferred Income” and the § 965 Transition Tax.

“Deferred income”: A newly created form of income or previously existing income exempt from taxation

Did the concept of “deferred income” exist before the § 965 Transition Tax? If not, does this matter? To what extent does “retroactivity” bear on whether something meets the 16th Amendment requirement of “income”? Can Congress create a brand new tax and apply the tax retroactively for a 31 year period? If so, it would seem that there is no limitation on the power of Congress to “snap its legislative fingers” and impose retroactive taxation on newly created income. While agreeing that the concept of “realization” is important, I question whether the creation of a new form of income and applying that definition retroactively for 31 years does/can meet the constitutional requirement of income. If so, I see no limits on any “accessions to wealth” (actual or deemed) that Congress can designate as income. Whether one is politically on the left, the right, or the middle, this should be a concern for everybody. Let’s consider what the enactment of the § 965 Transition Tax actually did.

Summarizing the § 965 Transition Tax

The § 965 Transition Tax is not about actual “deferred income”. It is about Congress’s creating the concept of “deferred income” in 2017, deeming the newly created “deferred income” to have existed retroactively back to 1986 and then imposing present day taxation retroactively on on 31 years of that income that was NOT income during that 31 year period.

Part B – The Moore’s visit the Supreme Court Of The United States

Although interesting, the government’s response is somewhat devoid of substance and analysis. Some thoughts divided into categories …

I. The Government appears to assume “income” rather than analyze whether there is “income”

The Government’s Brief filed in opposition to Moore Cert petition including the following:

Page 7:

Applying those principles here, the court of appeals determined that the MRT is a permissible income tax under the Sixteenth Amendment. “[T]here is no dispute,” the court explained, “that KisanKraft actually earned significant income.” Pet. App. 13. And even “[b]efore the MRT, U.S. persons owning at least 10% of a CFC were already subject to certain taxes on the CFC’s income.” Id. at 14. “The MRT,” the court reasoned, simply “builds upon these U.S. persons’ preexisting tax liability attributing a CFC’s income to its shareholders” by “assign[ing] only a pro-rata share of that income to the [petitioners].” Ibid.

https://www.supremecourt.gov/DocketPDF/22/22-800/267027/20230516164014148_22-800%20Moore%20v.%20USA.pdf

(The relevant excerpts from the the 9th Circuit decision are included as an *Appendix below …)

Generally, the government appears to assume the “Deferred Income” was income rather than analyze whether there was income.

In so doing, the Government brief appears (following the lead of the 9th Circuit) to assume that the Moores as a “US Shareholder” of a CFC had a “preexisting tax liability” with respect to the income earned by the CFC (that was never subject to taxation before). I believe that this assumption (which appears to be based on the 9th Circuit decision in Moore) cannot be justified. The idea of a “preexisting tax liability” may have its genesis in the title of § 965 which reads:

26 U.S. Code § 965 – Treatment of deferred foreign income upon transition to participation exemption system of taxation

By creating § 965 Congress gave birth to the concept of “deferred foreign income”. “Deferred foreign income” did not exist before the creation of § 965. Congress said:

“Let there be income and there was income.”

The Government’s reasoning appears to be that:

If the income was deferred and income (unless specifically exempted) comes with a tax liability then the fact that income was deferred must mean that a tax liability has been deferred.

This reasoning diverts attention from the obvious (to anybody except a tax professional) fact that the § 965 transition tax is:

1. A newly created tax enacted for the specific purpose of retroactive taxation

2. A deeming of the past earnings of a foreign corporation to have been received in present day time to a U.S. shareholder, and

3. The imposition of a current tax on the US shareholder based on the attribution of those previous earnings of a (foreign) corporation to a US shareholder, representing income that;

4. The United States does not and has never had right to directly tax, and

5. Was NEVER attributed to the US shareholder in any previous tax year under U.S. law.

Income earned by the corporation but not distributed to the shareholders:

In previous years the undistributed income earned by the Foreign Corporation was either attributed to the U.S. shareholder under the Subpart F regime or it was NOT. Therefore, in previous years the undistributed income was either taxable to the US shareholder (under the Subpart F regime) or it was NOT taxable to the US shareholder (under the Subpart F regime). There was not any “Deferred Income”.

Income earned by the corporation that was distributed to the shareholders:

If the corporation’s income was distributed to the shareholder the income was taxable to the shareholder at the time of distribution. Distributed income was not considered to be a distribution of “deferred income”.

II. The government assumes that Subpart F has been in existence since 1962 that including a previously included form of income under Subpart F insulates the Government from the claim that the “transition tax is a new tax”

This claim is laughable and is contrary to the “substance over form doctrine” rather than “form over substance”. Starting at the bottom of page 9 the Government claims:

Under that definition, the MRT plainly qualifies as a tax on income. It applies to U.S. shareholders owning at least 10% of a CFC that has “accumulated post-1986 deferred foreign income.” 26 U.S.C. 965(a)(1)-(2) (emphasis added). Before the MRT, those same U.S. shareholders were already required to pay taxes on their “pro-rata share” of a CFC’s annual “subpart F income”—and were required to do so even when that income had not been distributed to the shareholders. 26 U.S.C. 951(a)(1)(A); see Pet. App. 14. Now, under the MRT, those same shareholders must simply pay taxes on their “pro-rata share” of the CFC’s deferred income between 1986 and 2017. Pet. App. 14. “[T]here is no constitutional prohibition against Congress attributing a corporation’s income pro-rata to its shareholders” in that manner, id. at 13—as Congress has long done in Subpart F. See Helvering v. National Grocery Co., 304 U.S. 282, 288 (1938) (explaining that a business owner “could not by conducting it as a corporation, prevent Congress, if it chose to do so, from laying on him individually the tax on the year’s profits”).

In other words, as long as Subpart F is/was constitutional then the retroactive addition of a new kind of income to the Subpart F regime is somehow constitutional.

III. In identifying instances where income is attributed from an “entity” to an individual the Government ignores the possible relevance that income is attributed from an entity that the United States does NOT have the right to tax to a “U.S. Person”

Starting at the bottom of page 10:

Beyond Subpart F, the MRT is similar to other longstanding income taxes. See, e.g., Chiafalo v. Washington, 140 S. Ct. 2316, 2326 (2020) (“ ‘Long settled and established practice’ may have ‘great weight in a proper interpretation of constitutional provisions.’ ”) (citation omitted). For instance, Congress has long taxed an individual partner’s “proportionate share of the net income of [a] partnership,” even where that share is not “currently distributable, whether by agreement of the parties or by operation of law.” Heiner v. Mellon, 304 U.S. 271, 281 (1938); see id. at 277-281 (upholding such a tax against various statutory challenges); United States v. Basye, 410 U.S. 441, 453 (1973) (“[I]t is axiomatic that each partner must pay taxes on his distributive share of the partnership’s income without regard to whether that amount is actually distributed to him.”); see also 26 U.S.C. 702(a). And for the 65 years since it recognized S corporations, Congress has imposed an analogous requirement on shareholders of S corporations. 26 U.S.C. 1366(a)(1)(A) (taxing “the shareholder’s pro rata share of the corporation’s * * * items of income”); see Subchapter S Revision Act of 1982, Pub. L. No. 97-354, § 2, 96 Stat. 1677; Technical Amendments Act of 1958, Pub. L. No. 85-866, § 64, 72 Stat. 1652. Nothing in the Sixteenth Amendment’s text or history suggests that the undistributed income of a
CFC must be treated differently from the undistributed income of a partnership or S corporation.

The government is listing examples where the Government has the right subject both the entity (partnership, S corp, etc.) and the individual to worldwide taxation. This is arguably a different situation from attributing the income that from the CFC (an entity that the Government has the right to tax) to a “U.S. Person individual. In the first case the government has the clearly right to tax all the income. The only issue is which U.S. person will be responsible for payment of the tax. In the Moore case the Government has no right to tax the earnings of the corporation. The Government is finding a “U.S. person” (the Moores) which it has the right to tax and deeming the income of the CFC to have been received by the U.S. person. Even if allowable, no cases have been cited where this has been done retroactively.

Conclusion

It is disingenuous to refer to the previous earnings of a foreign corporation as “deferred income”. It is simply income that was NOT under the Subpart F rules (that existed at the time) attributed to the “US shareholder” for taxation

Therefore:

1. The § 965 transition tax is NOT a present day tax on deferred income.

2. The § 965 transition tax is a present day tax on income that was created by § 965 for the purpose of the TCJA.

To put it simply:

The § 965 transition tax is a present day tax on RETROACTIVE “fake income”!

Interested in Moore about the § 965 transition tax?

Read “The Little Red Transition Tax Book“.

*Appendix

Moore 9th Circuit:

Page 5 and 6 making it clear that the income was NOT deferred and was not taxable:

Before 2017, the primary method used to tax a CFC’s U.S. shareholders on foreign earnings held offshore was a provision of the tax code called Subpart F. See 26 U.S.C. § 951 (2007). Subpart F permitted the taxation of certain types of a U.S. person’s CFC earnings when that U.S. person owned at least 10% of a CFC’s voting stock. Id. Specifically, U.S. shareholders who owned at least 10% of a CFC could be taxed on a proportionate share of particular categories of its undistributed earnings such as dividends, interest, and earnings invested in certain U.S. property. Id. § 951(a). Neither Subpart F nor any other provision of the tax code permitted the U.S. Government to tax U.S. shareholders on the CFC’s active business income attributable to the CFC’s own business held offshore, such as when a CFC manufactures and sells products to a third party in a foreign country. Such income was only taxable if and when repatriated to the U.S. through a distribution to
U.S. shareholders, loan to U.S. shareholders, or an investment in U.S. property.

In 2017, Congress passed, and President Trump signed into law, the Tax Cuts and Jobs Act (“TCJA”). See 131 Stat. 2054 (2017). The TCJA transformed U.S. corporate taxation from a worldwide system, where corporations were generally taxed regardless of where their profits were derived, toward a territorial system, where corporations are generally taxed only on their domestic source profits. As part of this change, the TCJA created a new, one-time tax: the MRT. The MRT modified Subpart F by classifying CFC earnings after 1986 as income taxable in 2017. See 26 U.S.C. §§ 965(a), (d) (2017). Under this revised version of Subpart F, U.S. persons owning at least 10% of a CFC are taxed on the CFC’s profits after 1986 at either 15.5% for earnings held in cash or 8% otherwise. Id. § 965(c). The MRT imposes this tax regardless of whether the CFC distributed earnings. It also modified CFC taxes going forward: effective January 1, 2018, a CFC’s income taxable under Subpart F includes current earnings from its business.

The TCJA also included tax benefits for shareholders of CFCs. When CFCs repatriate untaxed earnings as dividends to U.S. shareholders subject to the MRT, those earnings are generally not taxed. See 26 U.S.C. § 245A(a). Further, the TCJA effectively eliminated any other taxes on a CFC’s undistributed earnings and profits before 2018.

Page 12:

Given this background, we hold that the revised Subpart F is consistent with the Apportionment Clause. As modified by the MRT, Subpart F only applies to U.S. persons owning at least 10% of a CFC. The MRT builds upon these U.S. persons’ preexisting tax liability attributing a CFC’s income to its shareholders. Before the MRT, U.S. persons owning at least 10% of a CFC were already subject to certain taxes on the CFC’s income. Minority owners like the Moores were, and after the passage of the MRT continue to be, treated as individuals who have some ability to control distribution. See id. (“In subpart F, Congress has singled out a particular class of taxpayers . . . whose degree of control over their foreign corporation allows them to treat the

https://cdn.ca9.uscourts.gov/datastore/opinions/2022/06/07/20-36122.pdf

Have a question? Contact John Richardson,Citizenship Solutions.