Supreme Court Considers Constitutional Limits on Federal Taxing Power

A retired couple says a 2017 tax on income they never actually received from an investment abroad violates the 16th Amendment.
Supreme Court Considers Constitutional Limits on Federal Taxing Power
United States Supreme Court Associate Justice Neil Gorsuch poses for an official portrait at the East Conference Room of the Supreme Court building in Washington, on Oct. 7, 2022. (Alex Wong/Getty Images)
Matthew Vadum

A retired Washington state couple urged the Supreme Court on Dec. 5 to strike down a 2017 tax on “unrealized” income from overseas investments, a move some say could jeopardize current tax code provisions and handcuff Congress.

Legal observers are watching the case, Moore v. United States (court file 22-800), because the court could use it to strike down the Mandatory Repatriation Tax (MRT), also known as the Section 965 transition tax, which was part of the Tax Cuts and Jobs Act approved by the Republican-controlled Congress in 2017 and signed into law by then-President Donald Trump.

Conservative constitutionalists say if the Supreme Court finds that the MRT violates the 16th Amendment to the Constitution, which allowed an income tax without having to determine it based on population, such a legal precedent could prevent Congress from enacting legislation to tax wealth.

The amendment, ratified in 1913, states: “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.”

Wealth tax proposals routinely come up in Congress. For example, Sen. Ron Wyden (D-Ore.) introduced a plan last month to tax the unrealized capital gains of high earners.

Most Important Tax Case in a Century?

Liberal groups say invalidating the tax law could wreak havoc. The left-leaning Institute on Taxation and Economy Policy said the case “could become the most important tax case in a century.”

That’s because “a broad ruling could destabilize our tax system, enrich many profitable corporations, and widen existing economic and racial inequalities.”

Since the 1960s, corporations have been able to move income across borders to avoid taxation. If the law is erased, “the floodgates to offshore tax dodging” could be opened “on a scale never seen before,” the group said in recent commentary.

The 2017 law changed the way foreign income of U.S. corporations was taxed. Lawmakers created the tax because, in their view, too much money was being invested abroad and not benefiting U.S. tax coffers.

Before the change, much of that income wasn’t taxed until it returned, or was repatriated, to the United States. To transition to the new system, Congress imposed a one-time tax on outstanding unrepatriated foreign earnings of U.S. corporations.

The law taxes U.S. corporate earnings abroad going back 30 years, even if the earnings haven’t been distributed. The statute also applies to U.S. taxpayers with 10 percent or more of shares in an overseas corporation as of the end of 2017. The Congressional Budget Office estimated in 2018 that the law would lead corporations to have a one-time tax liability of $347 billion.

Charles and Kathleen Moore made a modest investment in India-based KisanKraft, which supplies power tools to small-scale, individual Indian farmers with the aim of helping to make their operations more productive. The Moores had owned KisanKraft shares for more than a decade but never received any income from the shares because the company plowed all its profits back into the business.

But after the MRT was enacted, the Moores received a bill from the IRS for $14,729 for additional income tax they owed, despite having never received any payments from KisanKraft.

Although such profits aren’t ordinarily considered income unless shareholders either receive dividends or sell the shares for a capital gain, the MRT attempts to tax these funds as income by simply declaring them to be taxable income, which is a legal fiction, according to the Competitive Enterprise Institute, which is providing the couple with legal representation.

A divided U.S. Court of Appeals for the 9th Circuit ruled against the Moores in 2022.

“There is no constitutional prohibition against Congress attributing a corporation’s income pro-rata to its shareholder,” the appeals court ruled in 2022.

The 16th Amendment

The Moores’ attorney, Andrew Grossman, told the justices during the oral argument that when the 16th Amendment was adopted, the word “income” referred to “gains coming into the taxpayer, like wages, rents, and dividends.”

“A gain is not income unless and until it has been realized by the taxpayer,” he said.

That was the finding of the Supreme Court in Eisner v. Macomber, “and the court’s decisions have held that line for a century.”

“This is a tax on the ownership of property. It, therefore, must be apportioned,” he said.

Apportionment is a tough burden for tax-writing lawmakers to meet. Article I, section 2 of the Constitution mandates that direct taxes must be apportioned among the states by population. To be apportioned, a tax has to be the same amount for every person in every state.

“Dispensing with the need for realization sweeps away what the Framers regarded as the essential check on Congress’s power to tax property. The government cannot identify a single thing that Congress couldn’t tax as income under its position that realization is unnecessary. Without realization, there is no limiting principle,” Mr. Grossman said.

Justice Elena Kagan said, “There is quite the history in this country of Congress taxing American shareholders on their gains from foreign corporations.”

Mr. Grossman replied that the MRT “operates as a tax on property. It doesn’t take account of any power that the shareholder had over the income as it was coming in the door to the corporation.”

Justice Brett Kavanaugh interjected, saying, there was “realization in this case” by the foreign company.

“The question then is attribution, and we’ve long held that Congress may attribute the income of the company to the shareholders or the partnership to the partners, and the only real wrinkle, I think, here is that it goes back and captures prior years’ income.”

Mr. Grossman replied, saying, “Congress has never reached so far as to tax shareholders of foreign corporations on the active business income of those corporations.”

Picking up on a line of questioning begun by Justice Samuel Alito, Justice Neil Gorsuch asked, “If the court were to hold that the only realization requirement is some realization somewhere along the chain by a corporation antecedent to the taxpayer, what would be the consequences of a holding like that?”

Mr. Grossman responded, “The consequences would be to open the door to taxation of practically everything. I mean, all property that a person owns is the fruit of income at some point in time, whether it might be income … that they received long in the past.”

Some critics, including Senate Judiciary Committee Chairman Dick Durbin (D-Ill.), who is pushing legislation to impose a code of conduct on the Supreme Court, previously said Justice Alito should have recused himself from Moore v. United States.

The complaint was based on the fact that the justice was interviewed by attorney David Rivkin, who was participating in the case, for an unrelated Wall Street Journal article. Justice Alito rejected the complaint as “unsound,” writing in an official court statement (pdf) on Sept. 8 that Mr. Rivkin interviewed him as a journalist, not as an advocate, and that the resulting articles did not reference the case.

Tax ‘Firmly Grounded’

U.S. Solicitor General Elizabeth Prelogar told the justices, “The MRT is firmly grounded in the 16th Amendment’s text and history. The amendment allows Congress to impose taxes on incomes.”

The very first income tax law Congress passed after ratification of the 16th Amendment “taxed certain shareholders on their pro rata shares of undistributed corporate earnings.”

The Macomber precedent doesn’t apply here because the Supreme Court has limited its application “to taxes on particular stock dividends that are not at issue here.”

If, based on Macomber, the court were to “invalidate all taxes on undistributed business earnings, it would cause a sea change in the operation of the Tax Code and cost several trillions of dollars in lost tax revenue,” Ms. Prelogar said.

Justice Gorsuch pushed back, asking Ms. Prelogar if her argument had any limits, because “it seems to me there are none.”

She replied, saying, “Congress has broad taxing power. … The court has said Congress has plenary power. It can tax people just for existing.”

Justice Gorsuch said Ms. Prelogar was willing “to overturn a hundred years’ worth of precedent.”

Justice Sonia Sotomayor suggested the parties in the case remain far apart.

“I don’t fault the parties for shooting for the stars and … but I guess the tenor of the questions is that nobody’s happy with anybody’s definition of anything.”

Mr. Grossman added that “the government’s position would make a hash of existing law and cause enormous confusion with respect to how our tax system functions.”

The approach to realization, his side argued, “is the thread that runs through the court’s jurisprudence, going back over a century, and is the glue that holds together the Tax Code as it exists today,” he said.

After the hearing, Mr. Grossman told The Epoch Times that he believed the court “understands the issues and understands the problems with the government’s position that … any type of property could be taxed, any type of appreciation can be taxed without actually the taxpayer having the money in hand.”

“I think Justice Alito recognized correctly that if the government’s position in this case is correct—Katy bar the door—Congress could tax pretty much anything on the face of the earth, anything that moves or anything that doesn’t do so, without apportionment, which would mean a slew of new taxes and liability that has no basis in our nation’s history.”

The court is expected to rule on the case by June 2024.

Sam Dorman contributed to this report.