This week, the US Supreme Court denied a $15,000 refund to stockholders Charles and Kathleen Moore for taxes they paid on their share of undistributed profits from an offshore corporation. The Court upheld Congress’s taxing authority, at least for taxing undistributed offshore profits. But what about Congress’s authority to tax other unreceived profits, like unrealized capital gains or other capital income? Because of the narrowness of the Court’s holding, and the split in views, a cloud of uncertainty now hangs over our tax code.
The scope of Moore v. United States is narrow.
As part of the 2017 restructuring of international tax rules, Congress imposed a one-time levy on earnings that had been stockpiled offshore by US firms and investors. Without this transitional mandatory repatriation tax, about $2.6 trillion of offshore earnings would have escaped US tax permanently because of other changes enacted in the 2017 law. But the Moores contended that Congress could not tax US shareholders on the undistributed income of offshore corporations, as the shareholders had not received, or “realized” the income.
To ordinary taxpayers, the idea of taxing unreceived income may well sound unfair and unconstitutional. Wages aren’t taxed until they’ve been received, and investment income generally is not taxed until interest or dividends are paid or the investment is sold at a profit.
And indeed, Congress generally waits to tax income until it’s received—because Congress views that as an “administrative convenience” (it’s easier to count that way), not a Constitutional requirement. Yet sometimes Congress taxes “paper profits” and other forms of unreceived income because that’s the only way to fairly tax certain economic events. These instances include many capital-market and international transactions, including, as with the Moores, the unreceived profits attributed to shareholders of offshore corporations.
Justice Brett Kavanaugh, writing for the majority, upheld Congress’s authority to tax undistributed profits. He observed that Congress, from the beginning of the income tax, taxed owners of certain entities (so-called pass-through entities) on the income of those entities, rather than tax the entities themselves. But Kavanaugh refrained from holding that the practice of delaying taxation until realization is founded on administrative convenience rather than a Constitutional demand, notwithstanding prior Court pronouncements.
A Constitutional requirement for income to be “realized” remains unresolved, but will resurface.
Kavanaugh distinguished the case at hand—taxing undistributed offshore corporate profits—from taxing unrealized gains on appreciated personal property, a distinction he noted the Government itself had acknowledged. He and three other justices who joined in his opinion (Chief Justice John Roberts, and Justices Elena Kagan and Sonia Sotomayor) took no position on whether such appreciation was taxable. Only Justice Ketanji Brown Jackson, in a concurring opinion, declared realization is not a constitutional requirement.
But four Justices (Amy Coney Barrett, Samuel Alito, Clarence Thomas, and Neil Gorsuch) expressly declared that realization is a constitutional requirement. President Biden and Senate Finance Committee Chair Ron Wyden (D-OR) have proposed taxes on the unrealized gains of the nation’s wealthiest households. Based on their opinions, these four Justices would find taxing the unrealized gains of billionaires unconstitutional. So, if either Roberts or Kavanaugh (the most likely candidates) joined them in a case challenging a billionaires’ tax, the tax would fail.
And Moore will certainly spur new challenges to existing tax rules, especially the tax rules for capital income, many of which are on paper profits (like zero coupon bonds, contingent debt, futures contracts, swaps, and constructive sales). Absent these rules, sophisticated taxpayers could structure their investments to derive economic benefits without the realization events that normally create a tax liability. How would Kavanaugh and his co-authors respond to these new challenges to the tax code?
Only Congress can, with its resources and expertise, balance revenue demands, administrative convenience, and fairness when constructing taxes, including those on unrealized gains. And Congress has, after careful consideration over the decades, identified certain types of such income that must be taxed for the nation’s revenue system to work properly.
Despite ruling in favor of Congressional taxing power in Moore, the Court still may undermine Congress’s taxing authority. More litigation is likely—and the Court may very well infringe upon Congress’s prerogatives in future related cases.
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