Moore v. United States

Issues

Can Congress pass a statute under the Sixteenth Amendment taxing income that is not yet realized by the taxpayer without apportioning the tax among the states in proportion to their populations?

Oral argument:

December 5, 2023

Court below:

United States Court of Appeals for the Ninth Circuit

This case asks the Supreme Court to determine whether a taxpayer must realize income under the Sixteenth Amendment before the federal government can tax it without apportionment among the states. In 2017, as part of the Tax Cuts and Jobs Act, Congress enacted a new, one-time Mandatory Repatriation Tax on taxpayers based on their ownership stake in a controlled foreign corporation. The tax applied retroactively on all income earned by the corporation after 1986, regardless of whether the corporation distributed its earnings to its shareholders. Charles and Kathleen Moore argue that the Mandatory Repatriation Tax, which they were forced to pay, is unconstitutional because the Sixteenth Amendment imposes a realization requirement on income for the federal government to tax it without apportionment. The United States contends that no such realization requirement exists, and that Congress has long taxed individuals based on their share of undistributed corporate earnings without constitutional challenge. The outcome of this case has important ramifications for Congress’s power to impose income taxes and on the complexity and certainty of tax planning.

Questions as Framed for the Court by the Parties

Whether the 16th Amendment authorizes Congress to tax unrealized sums without apportionment among the states.

Facts

In 2005, Petitioners Charles and Kathleen Moore bought an 11% stake in KisanKraft, a Controlled Foreign Corporation (“CFC”) based in India. Moore v. United States at 4–5. A CFC is a corporation in which U.S. persons possess more than 50% ownership or voting rights. Id. at 5. KisanKraft made profits every year but never distributed any of those profits to its shareholders. Id. Instead, it reinvested all its earnings back into the company. Id.

In 2017, Congress passed the Tax Cuts and Jobs Act (“TCJA”). Id. at 6. The TCJA transformed U.S. corporate taxation from a worldwide system to a territorial system, in which corporations are taxed only based on their domestically sourced income. Id. The TCJA introduced a new, one-time tax called the Mandatory Repatriation Tax (“MRT”). Id. The MRT taxed all income a CFC earned after 1986. Id. It did so indirectly by taxing U.S. shareholders who hold at least a 10% stake in the CFC, regardless of whether the CFC distributed its earnings. Id.

In 2018, the Moores discovered they were liable to pay the MRT. Id. at 7. Based on their pro rata share of KisanKraft’s retained earnings of $508,000, the MRT increased their annual taxable income by $132,512, subjecting them to approximately $15,000 in additional taxes. Id. The Moores challenged the constitutionality of the MRT in the United States District Court for the Western District of Washington. Id. First, they argued that the MRT violates the Apportionment Clause of the Constitution. Id. The Apportionment Clause provides, “No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.” Id. at 9. Second, the Moores argued that the MRT violates the Fifth Amendment’s Due Process Clause because it taxes earnings retroactively. Id. The district court granted the Government’s motion to dismiss for failure to state a claim and denied the Moores’ cross-motion for summary judgment. Id. at 7. The district court held that the MRT taxes income and that although the MRT operates retroactively, it does not violate the Fifth Amendment’s Due Process Clause. Id.

The Moores appealed the decision to the United States Court of Appeals for the Ninth Circuit, which affirmed the district court’s judgment. Id. Responding to the Moores’ first argument, the court explained that the Apportionment Clause only applies to capitations and land taxes. Id. at 9. The Ninth Circuit pointed out that income is exempted from apportionment under the Sixteenth Amendment, which Congress proposed to overturn the Supreme Court’s holding in Pollock v. Farmers' Loan & Trust Co that income from personal property must be apportioned. Id. at 10. Although the Ninth Circuit acknowledged that “income” is difficult to define, it pointed out that courts have previously held that taxes similar to the MRT are constitutional. Id. at 10. It rejected the Moores’ argument that the Constitution requires income to be “realized” before it can be taxed without apportionment. Id. at 11.

The Ninth Circuit also rejected the Moores’ second argument, holding that the MRT does not violate due process because it serves the legitimate purpose of preventing a tax windfall on earnings that CFCs distribute to shareholders. Id. at 16.

The United States Supreme Court granted the Moores’ petition for certiorari on June 26, 2023. Brief for Respondent, United States at 1.

Analysis

DISPUTE OVER THE INCOME REALIZATION REQUIREMENT

The Moores argue that income must be “realized” for it to be exempted from apportionment under the Sixteenth Amendment. Brief for Petitioner, Moore at 16. The Moores assert that this requirement is rooted in precedent—in particular Eisner v. Macomber, in which the Supreme Court held that the distinguishing attribute of “income” is that “a gain, a profit, something of exchangeable value” is “received or drawn by the recipient for his separate use.” Id. at 17. The Moores point out that in Macomber, the Court ruled that a stock dividend issued to shareholders that did not increase their ownership stakes was not taxable under the Sixteenth Amendment because the stockholders did not receive anything out of the company’s assets for their “separate use and benefit.” Id. at 18. The Moores contend that under Macomber, shareholders have no individual share in accumulated profits, and taxing shareholders based on the corporation’s profits would be akin to a taxation on property that must be apportioned. Id. Only upon distribution, the Moores assert, would shareholders “realize” a “separate” taxable profit or gain. Id. The Moores contend that the realization requirement is rooted in both early Sixteenth Amendment jurisprudence, such as Brushaber v. Union Pacific Railroad Co., as well as Macomber’s progeny, Commissioner v. Glenshaw Glass Co., which held that punitive damages are taxable income because they are “accessions to wealth, clearly realized.” Id. at 19, 24.

Next, the Moores argue that a realization requirement is supported by constitutional text and structure. Id. at 26. The Moores point to the word “derived” in the Sixteenth Amendment itself as evidence that a gain is not income until it has been “derived” from its source. Id. at 26–27. The Moores further assert that when the Sixteenth Amendment was ratified, the word “income” was well-defined in case law and included actual cash received but not contemplated or unpaid revenue. Id. at 27. The Moores contend that dictionaries at the time support that definition of income, such as the 1913 edition of Webster’s Dictionary, which defined “income” as a gain that “proceeds” from labor. Id. at 28–29.

The United States counters that the Sixteenth Amendment imposes no realization requirement for income. Brief for United States, at 11. The United States argues that Congress has long taxed shareholders on their pro rata share of undistributed corporate earnings, even before the Sixteenth Amendment was adopted. Id. at 13. The Sixteenth Amendment, the United States asserts, merely restored the power to tax income that Congress possessed before Pollock. Id. at 14. The United States also rejects the Moores’ interpretation of Macomber, arguing instead that Macomber’s definition of income was dictum. Id. at 34. The United States argues that because Macomber involved a stock dividend that increased the number of shares and diluted the value of each share—with zero net effect—Macomber’s true holding is that such a stock dividend, akin to a “book adjustment,” is not income under the Sixteenth Amendment. Id. The United States argues that Macomber cites no authority for the idea that income must be “received or drawn” by the taxpayer for his “separate use.” Id. The United States further contends that subsequent case law has limited Macomber’s relevance to its specific facts. Id. at 35. The United States argues that Glenshaw Glass diminished Macomber because it held that income refers to all gains except if “specifically exempted” by the Code. Id. at 38.

Next, the United States asserts that the Sixteenth Amendment’s text and historical context do not support a realization requirement. Id. at 12. The United States argues that the Internal Revenue Code defines “gross income” as “all income from whatever source derived” and that the Court has always interpreted that term broadly to mean “any accession to wealth.” Id. The United States points out that Congress has enacted various laws that require taxpayers to include corporate gains and profits when estimating the taxpayers’ gains, profits, or income from an ownership interest in those corporations. Id. at 13. The United States asserts that contemporary authorities—dictionaries and tax experts—indicate that income included “all economic gains.” Id. at 14. Lastly, the United States argues that the Sixteenth Amendment itself does not mention realization. Id. at 15.

THEORY OF CONSTRUCTIVE REALIZATION JUSTIFYING OTHER TAX PROVISIONS

The Moores contend that other tax provisions for taxing income similar to the MRT do not conflict with the realization requirement because the theory of “constructive realization” justifies those provisions. Brief for Petitioner, at 47. The theory of constructive realization, the Moores argue, analyzes whether taxpayers have control over the benefit being taxed, or whether they received it in cash. Id. at 48. The Moores assert that Congress relied on this doctrine when it enacted Subpart F of the tax code, which imputes some categories of income earned by CFCs to their controlling U.S. shareholders. Id. at 50. The Moores argue that Congress can tax such income without realization because owners of CFCs could have demanded to receive such income but chose not to and thus had “constructive receipt” of income. Id. The Moores posit that the theory cannot justify the MRT because shareholders of a CFC have no control over the taxed CFC’s income and the MRT taxes the CFC’s retained earnings going back thirty years. Id. at 51. The Moores further argue that other tax provisions, such as taxation of undistributed partnership income and of profits of S corporations, pass muster because partnerships have no separate existence from partners and S corporation shareholders must unanimously elect for taxation on profits. Id.

The United States disputes that the constitutionality of Subpart F of the tax code rests on the theory of constructive realization. Brief for United States, at 27. The United States argues that the Moores, by recognizing the theory, concede that Congress has the authority to draw reasonable lines about what constitutes taxable income. Id. The United States asserts that Subpart F is just one example of Congress’s power to bypass the corporate entity and tax shareholders on undistributed profits. Id. at 28. Even under the Moores’s definition of constructive realization, the United States argues, Subpart F would not pass muster because 10%-shareholders taxed on CFC income do not enjoy unqualified control over that income. Id. The United States maintains that if Subpart F does pass muster under a form of constructive realization, the same theory should apply equally to the MRT because both taxes share the same essential features. Id. at 28–29. The United States argues that in some states, partnerships have separate legal existence, but the partners are still taxed on partnership income without apportionment. Id. at 24. Furthermore, the United States contends that mere shareholder consent to be taxed on S corporation profits would not overcome the constitutional requirement of apportionment, if taxing undistributed corporate income were indeed a property tax. Id. at 29.

DISPUTE OVER THE TAX TYPE OF THE MRT

The Moores argue that the MRT is a property tax, which must be apportioned under the Apportionment Clause. Brief for Petitioner, at 44. The Moores contend that tax liability under the MRT is predicated on ownership of specific property on a specific date: even if a shareholder purchased shares of a CFC in 2017, he or she would still be taxed on the corporation’s accumulated earnings going back to 1986. Id. at 44–45. The Moores also distinguish the MRT from other taxes predicated on CFC ownership under Subpart F, pointing out that those provisions tax “actual or de facto” distributions to U.S. shareholders. Id. at 45–46. Lastly, the Moores argue that the language of the MRT signals that it is a property tax because it differentiates between “earnings held in cash or cash equivalents” taxed at 15.5% and “other assets” at 8%. Id. at 46.

The United States maintains that the MRT is an income tax, but even if it were not, it would nonetheless be constitutional as an excise tax. Brief for United States, at 46. The United States points out that Congress has the power to enact excise taxes on particular privileges, business transactions, or use of property, so long as the taxes are uniform throughout the country. Id. at 46–47. The United States argues that the MRT would be an excise on the privilege of doing business through a CFC, which includes deferring taxes on foreign income. Id. at 47. Lastly, the United States contends that the MRT does not tax shareholders for mere ownership of property but for income from business activities in a CFC with income earned and stored abroad. Id. at 48.

Discussion

EFFECT ON CONGRESSIONAL POWER AND OTHER TAX CODE PROVISIONS

The Buckeye Institute and the National Federation of Independent Business Small Business Legal Center (“Buckeye and NFIB”) assert, in support of the Moores, that affirming the Ninth Circuit’s decision would open the door for Congress to tax unrealized gains. Brief of Amici Curiae The Buckeye Institute and National Federation of Independent Business Small Business Legal Center, Inc., in Support of Petitioners at 15. Buckeye and NFIB argue that such taxes would affect millions of people with retirement and investment accounts as well as small businesses. Id. at 15, 17. Former Attorney General Edwin Meese III and Professors Steven G. Calabresi and Gary S. Lawson add, in support of the Moores, that a tax on unrealized income on investment portfolios would be a wealth tax. Brief of Amici Curiae Former Attorney General Edwin Meese III et al., in Support of Petitioners at 13. The Manhattan Institute for Policy Research and Professors Erik M. Jensen and James W. Ely caution, in support of the Moores, that wealth taxes have a chilling effect on entrepreneurship, innovation, and social mobility. Brief of Amici Curiae The Manhattan Institute for Policy Research et al., in Support of Petitioners at 18.

Professor Theodore E. Seto counters, in support of the United States, that adopting the Moores’ proposed realization requirement would jeopardize other provisions in the tax code and harm Congress’s robust fiscal capacity. Brief of Amicus Curiae Professor Theodore P. Seto, in Support of Respondent at 17, 29–30. Professor Seto contends that many provisions rely on “indirect realization” to tax income that has not been distributed to the taxpayer. Id. at 16–17. Professor Seto points to Subchapter K—in Subtitle A of Chapter 1 of the tax code—which taxes partnership or LLC income as allocated to partners or members regardless of actual distribution. Id. at 19–20. Main Street Alliance, Small Business Majority, and Anne Zimmerman (“Main Street Alliance et al.”) add, in support of the United States, that stockholders of Subchapter S corporations are also taxed on their share of the corporation’s income. Brief of Amici Curiae Main Street Alliance et al., in Support of Respondent at 13. Professors Reuven Avi-Yonah, Clinton G. Wallace, and Bret Wells (“Professor Avi-Yonah et al.”) note, in support of the United States, that Subpart F imposes a similar tax on shareholders of controlled foreign personal holding companies. Brief of Amici Curiae Reuven Avi-Yonah et al., in Support of Respondent at 13–14.

COMPLEXITY AND UNCERTAINTY FOR STAKEHOLDERS IN THE TAX SYSTEM

The Chamber of Commerce of the United States asserts, in support of the Moores, that a realization requirement provides certainty and predictability for taxpayers of when their income will be taxed. Brief of Amicus Curiae The Chamber of Commerce of the United States, in Support of Petitioners at 9–10. Without that requirement, the Chamber of Commerce contends, businesses cannot understand the tax impact of business decisions without the help of lawyers and accountants. Id. at 15. Saving America’s Family Enterprises and Former Senator John Breaux argue, in support of the Moores, that family businesses are particularly vulnerable to that uncertainty because they have assets that are difficult to appraise or sell. Brief of Amici Curiae Saving America’s Family Enterprises and Former Senator John Breaux, in Support of Petitioners at 20, 26. The Independent Women’s Law Center adds, in support of the Moores, that the same reasoning applies to female entrepreneurs. Brief of Amicus Curiae Independent Women’s Law Center, in Support of Petitioners at 10. Individual Taxpayers also maintain, in support of the Moores, that the MRT caught passive investors, global entrepreneurs, and retirees by surprise. Brief of Amici Curiae Individual Taxpayers, in Support of Petitioners at 10–11, 14, 16–17.

Tax Economists counter, in support of the United States, that the Moores’ proposed realization requirement allows for tax avoidance and creates economic inefficiency. Brief of Amici Curiae Tax Economists, in Support of Respondent at 19. Professor Avi-Yonah et al. explain that large categories of income would escape taxation, disproportionately benefiting “well-resourced” people. Brief of Reuven Avi-Yonah et al. at 29. Tax Economists argue that a realization requirement would disrupt “pass-through businesses” because LLCs would face an annual tax burden of $50 billion, which would make them less attractive to investors. Brief of Tax Economists at 16, 18. Main Street Alliance et al. posit that small businesses in general would suffer a “long-lasting and detrimental uncertainty,” especially in a constantly changing legal landscape. Brief of Main Street Alliance et al. at 16, 18. The American Tax Policy Institute cautions, in support of the United States, that a “wave of constitutional tax claims” would burden courts and the IRS if the Moores win. Brief of Amicus Curiae The American Tax Policy Institute, in Support of Respondent at 28–29.