In the next Supreme Court term beginning in October 2023, the Justices will hear argument on whether the Mandatory Repatriation Tax (MRT), passed as part of the Trump administration’s 2017 Tax Cuts and Jobs Act (TCJA), violates the Sixteenth Amendment. Depending on how and in what depth the Court addresses this issue, the case could be the most important tax case in decades as it requires the Court to address Congress’s power to levy taxes.
The MRT, codified in section 965 of the Internal Revenue Code, deemed the post-1986 deferred foreign income of a controlled foreign corporation (CFC)—a foreign corporation owned more than 50% by U.S. persons—to be income subject to a one-time tax in 2017 (or sometimes in 2018, depending on the taxpayer’s tax year). Both corporate and individual U.S. shareholders who owned more than 10% of a CFC were subject to a one-time income tax in 2017 on their proportional share of that income.
The case before the Court, Charles G. Moore et al. v. United States, Case No. 22-800, involves the MRT on individual taxpayers. Charles and Kathleen Moore’s argument is two-fold: 1) that Congress cannot tax undistributed and non-repatriated CFC earnings because those earnings are not “realized” income and realization is a requirement for taxation under the Sixteenth Amendment, and 2) that MRT’s taxation of over 30 years’ of unrealized income violates the Fifth Amendment’s Due Process Clause. The Ninth Circuit rejected both
The Supreme Court’s Grant of Writ of Certiorari
Even though there are no conflicting MRT appellate decisions, the Supreme Court granted the Moores’ Petition for Writ of Certiorari of the Ninth Circuit decision on June 6, 2023. Votes of only four Justices are required to grant certiorari (and those votes are not made public), but the grant without a circuit split signals that some Justices have a particular interest in the scope of the government’s taxing power and a possible willingness to invalidate the MRT. The Court will likely issue its decision by the end of the current term in late June 2024.
The Moores’ brief on the merits was filed August 30, 2023, and the government’s brief in opposition is due October 16, 2023. The issues before the Court have, however, already been briefed extensively before the Ninth Circuit, in the Moore’s Petition for Writ of Certiorari, and in the Brief of the United States in Opposition—as well as in no less than eight amicus curiae briefs in support of the petition for certiorari, filed by Americans for Tax Reform, the Buckeye Institute, the Cato Institute, the Landmark Legal Foundation, the Manhattan Institute for Policy Research, the Pacific Research Institute, the Southeastern Legal Foundation, and the United States Chamber of Commerce, all arguing for reversal of the Ninth Circuit’s decision because realization of income is a constitutional requirement.
The Sixteenth Amendment and the Mandatory Repatriation Tax
The Apportionment Clause of the U.S. Constitution, Art. I, Section 2, provides that no “direct” tax, which includes income tax, may be imposed unless it is apportioned among the states by population, meaning that each state must pay tax proportionately to the number of its residents. The Sixteenth Amendment, ratified on February 3, 1913, makes an exception for income tax. It provides that “Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States … .”
Section 965’s MRT was enacted after the TCJA moved taxation of U.S. corporations away from a global system of taxation (taxing corporations on their worldwide income, regardless of where their profits were derived), to a territorial system (taxing corporations where they do business, so U.S. corporations are taxed only on their domestic source income). Under this new system, the foreign-source portion of dividends received by a U.S. corporation from a foreign CFC subsidiary is no longer subject to U.S. tax because a U.S. corporation is taxed only on its domestic source income. The rate of U.S. taxation of corporations was also lowered to 21 percent. This territorial system significantly reduces the U.S. taxes paid by U.S. corporations.
Subpart F is the primary method used to tax U.S. shareholders of a CFC on foreign earnings heldBefore the MRT, U.S. shareholders who owned at least 10% of the voting stock of a CFC could be taxed on a proportionate share of limited categories of the CFC’s undistributed earnings such as dividends, interest, and earnings invested in certain U.S. The CFC’s active business income from the CFC’s operations outside the U.S was only taxable, however, if and when it was repatriated to the U.S. through a distribution to U.S. shareholders, a loan to U.S. shareholders, or an investment in U.S. property. This Subpart F regime created a strong incentive for CFCs to separately incorporate their foreign operations and keep those earnings offshore as undistributed retained earnings. The government estimated that, by 2015, CFCs had parked $2.6 trillion offshore in undistributed retained earnings that were not presently subject to U.S. taxation.
The TCJA countered the future loss of corporate taxes under the new territorial system with section 965’s one-time tax on those massive previously untaxed earnings for the years 1986 to 2017. The Ninth Circuit considered this appropriate since otherwise those earnings, supposedly only deferred under the prior worldwide taxation regime, would escape taxation completely under the new territorial regime. The government estimated that the MRT would raise $339 billion in taxes.
The effect of the MRT’s one-time tax is mitigated by section 965(c), providing for favorable tax rates of 15.5 percent for earnings held in cash and 8 percent on illiquid earnings, and by section 965(h), allowing shareholders to pay the tax in interest-free installments over eight years.
Facts of the Moores’ Case
The Moores owned 11 percent of Kisankraft, an Indian CFC that provides affordable equipment to small-scale farmers, and took no part in Kisankraft’s day-to-day operations orDuring the ten years that the Moores owned Kisankraft stock, the company made no dividend distributions of its profits. In 2017, Kisandraft had $508,000 of retained earnings, and the Moores were subject to the MRT tax on their proportionate share of this sum, resulting in an increase to their U.S. income tax liability of approximately $15,000. The Moores paid the MRT on their share of the CFC’s reinvested profits and sued for a refund, arguing that they had not “realized” the income and that unrealized income was not included in the understanding of “income” when the Sixteenth Amendment was adopted.
The Ninth Circuit Opinion Upholding the MRT
The Ninth Circuit affirmed the U.S. District Court for the Western District of Washington’s grant of the government’s motion to dismiss the taxpayers’ complaint, basing its decision on three principles. First, it noted that “the Supreme Court has made clear that realization of income is not a constitutional requirement,” citing, inter alia, the Court’s 1940 holding in Helvering v. Horst that “the rule that income is not taxable until realized .... [is] founded on administrative convenience,” and “does not mean that a taxpayer can ‘escape taxation because he did not actually receive theConsequently, “[w]hether the taxpayer has realized income does not determine whether a tax is Second, it confirmed that “[w]hat constitutes taxable gain is also broadly For this proposition, the court relied on cases from the 1970s upholding the constitutionality of a precursor to the current Subpart F that taxed “a corporation’s undistributed current income to the corporation’s controlling Third, it held that “there is no blanket constitutional ban on Congress disregarding the corporate form to facilitate taxation of shareholders’ income” so Congress may “attribut[e] a corporation’s income pro-rata to its
The Ninth Circuit rejected the Moores’ reliance on realization arguments from Eisner v.a 1920 Supreme Court decision, and Comm’r v. Glenshaw a 1955 Supreme Court decision. The Ninth Circuit held that the McComber Court only provided a definition of what “‘[i]ncome may be defined as,’ not a universal Likewise, “Glenshaw Glass reiterated the limited scope of Macomber’s definition of income by emphasizing that, while the definition served a useful purpose ..., it was not meant to provide a touchstone to all future gross income The Ninth Circuit noted that “[t]he Court in Glenshaw Glass never stated or suggested that the definition it used was a universal (or even broadly applicable)
The Ninth Circuit also rejected the Moores’ argument that the MRT violated the Due Process Clause, noting that “retroactive tax legislation is oftenThe Ninth Circuit found that the MRT serves a legitimate purpose by preventing CFC shareholders from obtaining a windfall by never having to pay taxes on their undistributed offshore