In brief

What happened?

Today the United States Supreme Court released its opinion in Moore v. United States, upholding the constitutionality of the Section 965 transition tax (the Mandatory Repatriation Tax (MRT)) per the Court) under the Tax Cuts and Jobs Act (TCJA). The decision affirmed the judgment of the US Court of Appeals for the Ninth Circuit. Five justices joined in the majority opinion of the court; two justices joined a separate opinion concurring in the judgment of the court, and two justices dissented.  

Why is it relevant?

The majority opinion emphasized that its holding is narrow and limited to entities treated as pass-throughs. The opinion does not suggest Congress must tax all pass-through entities in the same manner. Additionally, the opinion does not address or resolve other issues, such as whether realization is a constitutional requirement for an income tax, whether Congress can tax both an entity and its shareholders on the same income, or whether other kinds of taxes (including those on holdings, wealth, net worth, or appreciation) may raise constitutional issues. 

The majority opinion stressed that “Congress has long taxed shareholders of an entity on the entity’s undistributed income, and it did the same with the MRT. This Court has long upheld taxes of that kind, and we do the same today with the MRT.” 

Action to consider

Taxpayers should reconsider any positions affected by the Court’s decision. 

Court’s analysis

The majority opinion characterized the MRT as a tax that attributes the realized and undistributed income of a US-controlled foreign corporation (CFC) to the entity’s shareholders, and then taxes the US shareholders on their portions of that income. Based on the characterization, the Court held the MRT does not exceed Congress’s constitutional authority. The Court was clear that its holding is narrow and limited to entities treated as pass-throughs (i.e., where the income of an entity is attributed to its owners). The Court stated that nothing in the opinion should be read to authorize any hypothetical congressional effort to tax both an entity and its shareholders or partners on the same undistributed income realized by the entity.  

The majority opinion based its holding on the following assertions:  

• Taxes on income are indirect taxes, and the Sixteenth Amendment confirms that taxes on income need not be apportioned. 
• Based on longstanding precedents, Congress may attribute an entity’s realized and undistributed income to the entity’s shareholders or partners and then tax the shareholders or partners on their portions of that income. Examples of these instances include the taxation of partners in a partnership and shareholders of an S corporation.  
• The Court’s longstanding precedents establish that, when dealing with an entity’s undistributed income, Congress may either tax the entity or tax its shareholders or partners. Whichever method Congress chooses, the tax remains a tax on income. 
• The Moores’ reading of Eisner v. Macomber to mean that a tax is not a tax on income if it is imposed on income attributed to a taxpayer is implausible, as Eisner did not address attribution whereas other cases addressed attribution and allowed it. 
• The prior federal and state treatment of partnerships as separate legal entities for tax purposes contravenes the Moores’ theory that taxes on partnerships are distinguishable from the MRT and not controlled by precedent because partnerships are not separate entities from their partners. 
• The Moores’ ‘constructive-realization’ theory does not distinguish the MRT from subpart F and other pass-through taxes. 

Observation: The Court’s emphasis on taxing either the entity or its owners, but not both, may call into question circumstances where income is taxed at both levels (such as when a foreign corporation is engaged in a US trade or business but still subject to a CFC tax). 

Observation: Justice Thomas, in a dissenting opinion joined by Justice Gorsuch, noted the Court’s decision upholds the MRT, but it did not endorse the Ninth Circuit’s view that “realization of income is not a constitutional requirement.” Justice Thomas notes that the majority acknowledges that the Sixteenth Amendment draws a distinction between income and its source and does not dispute that realization is what distinguishes income from property. From this, Justice Thomas states, “those premises are sufficient to establish that realization is a constitutional requirement.” In contrast, Justice Jackson asserted in her concurring opinion that prior cases had limited the application of any realization requirement set forth in Eisner v. Macomber, resulting in her conclusion that “there is no constitutional requirement . . . that a taxpayer be able to sever . . . the gain from his original capital in order to be taxed on it.” Justice Barrett, joined by Justice Alito, concurred in the judgment of the Court but asserted that realization is a constitutional requirement for a tax on income.  

Observation: Taking all the opinions together, four justices (Barrett, Alito, Thomas and Gorsuch) expressed the view that realization is a constitutional requirement for a tax on income; one justice (Jackson) joined the majority opinion but separately expressed the view that realization is not a constitutional requirement for a tax on income; and the four remaining justices (Roberts, Kavanaugh, Kagan, and Sotomayor), all of whom joined the majority opinion, declined to address the issue explicitly, though the majority opinion does state that the foreign corporation in which the Moores were shareholders did realize income. Thus, the potentially important question of whether realization is constitutionally required for a tax on income remains unanswered by the Court.  

Observation: Had the Court ruled in favor of the Moores, the majority opinion asserts numerous sections of the Internal Revenue Code would be deemed unconstitutional, including deemed stock distributions (Section 305(c)), accrual accounting (Sections 446, 448), partnership taxation (Section 701); subpart F (Sections 951–965), global intangible low-taxed income (Section 951A), certain future contracts (Section 1256(a)), original-issue discount instruments (Section 1272(a)), S Corporations (Sections 1361–1379), and gift taxes (Sections 2501–2524). If those provisions were suddenly eliminated the US Government would lose trillions of dollars in tax revenue, and Congress would be forced to find additional funding or make drastic cuts to government programs. In the Court’s view, this would have caused ‘fiscal calamity.’