Supreme Court upholds MRT, declines to address broader questions

While some were thinking the U.S. Supreme Court would use its decision on Moore v. United States to address broader issues in the tax system, the court kept it simple in upholding the constitutionality of the Mandatory Repatriation Tax (MRT) in its June 20 ruling. The decision was significant because a ruling that the tax was unconstitutional might have invalidated various federal tax provisions taxing unrealized income. Some organizations had also hoped the court would use the case as an opportunity to rule on the constitutionality of a “wealth tax,” an issue the court declined to address.

The MRT was included in the 2017 Tax Cuts and Jobs Act to impose a one-time pass-through tax on some U.S. shareholders in American-controlled foreign corporations (CFCs). The tax was imposed at 8-15.5% on the pro rata shares of U.S. shareholders in CFCs and raised more than $300 billion in revenue. The taxpayers in Moore contended the MRT violated the U.S. Constitution’s Direct Tax Clause as an unapportioned tax on property, not income.

In finding that Congress had not exceeded its powers in enacting the tax, the court ruled that the MRT taxes the income realized by a corporation. It then addressed the “precise and narrow question” of whether Congress can tax shareholders for a corporation’s realized, but undistributed income. The court found that it could.

Taxpayers owned stock in Indian CFC

The taxpayers in the case, Charles and Kathleen Moore, owned roughly 13% of the stock of KisanKraft, a CFC manufacturing low-cost farm equipment in India. They purchased their shares in 2006 for $40,000. The company reinvested all of its earnings and never made any distributions to shareholders. When the MRT was implemented, the couple ended up with a $15,000 tax bill.

The Moores filed suit against the U.S. government, claiming that the income must be taxed without apportionment under the 16th Amendment and that the MRT was an impermissible unapportioned tax on their property. According to their arguments, the 16th Amendment authorizes the government to levy an income tax without apportioning among the states. Thus, a direct tax that is not an income tax must be apportioned among the states in proportion to their populations. According to the Moores, they did not have income from KisanKraft, therefore the MRT is not an income tax and is unconstitutional because it is not apportioned.

Additionally, the 16th Amendment includes a realization requirement that income must be realized by the taxpayer to be subject to tax. The Moores contended that they had unrealized gains, but those gains are not income. However, the district court and U.S. Court of Appeals for the 9th Circuit disagreed, finding that an income tax does not require that the taxpayer have realized income.

MRT authorized by 16th Amendment

The Supreme Court found that Congress is authorized under the 16th Amendment to attribute income realized by an entity to its owners in certain circumstances. However, the court emphasized that its decision is limited to:

• The taxation of shareholders in an entity
• On the undistributed income realized by the entity
• Which has been attributed to the shareholders
• When the entity itself has not been taxed on that income

“In other words, our holding applies when Congress treats the entity as a pass-through,” the court said.

The Moores argued that the MRT was different from other taxes that have previously been upheld by the Supreme Court, but the court did not agree. It found the MRT operates the same as Congress’s longstanding taxation of partnerships, S corporations and subpart F income.

Possible implications of a taxpayer win

The Supreme Court ultimately chose to uphold the MRT, but if the taxpayers had won, the decision could have affected a substantial portion of the tax code, including the taxation of pass-through entities. In most cases, the annual gains or losses of a pass-through business are divided among the owners and reported on their individual returns, even if no cash payments were made. A Supreme Court finding that the gains must be realized by the taxpayers before they are subject to tax could have resulted in investors not being required to report those earnings until they sell their equity interests in the businesses.

Other provisions in the tax code that could have been affected are “deemed realizations,” where income is recognized for tax purposes, despite it not having been received. Examples of deemed realization include:

• Imputed rental income
• Below-market loans where interest payments are imputed
• Investment vehicles where the debt holders pay no interest until maturity are deemed to pay the interest annually

Wealth tax not addressed

Some parties who submitted briefs to the court on behalf of the Moores were concerned that a taxpayer win would clear the way for Congress to enact a wealth tax that is based on the market value of assets. Some politicians have recently proposed a wealth tax for the United States to address the country’s increasing wealth disparity.

The Supreme Court’s decision on Moore includes a footnote, saying it chose not to resolve the issue of the constitutionality taxes on “holdings, wealth or net worth.”