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Election 2024

Moore v. United States

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Jane G. Ditelberg

Jane G. Ditelberg

Director of Tax Planning, The Northern Trust Institute

Recent Democratic proposals, including the taxation of unrealized gains, have called into question what is considered income, and when — constitutionally — it can be taxed. The Supreme Court’s ruling in Moore v. United States gives us insight on the court’s potential views if these proposals were to become legislation.

On June 20, 2024, the United States Supreme Court ruled in the case of Moore v. United States that the Mandatory Repatriation Tax (MRT) enacted as part of the 2017 Tax Cuts and Jobs Act passes constitutional muster. It did so on narrow grounds and, despite the seven votes to uphold the MRT, the opinions reveal that there is not unanimity in the court. Although the majority opinion does not directly tackle the question of whether unrealized gains (the growth in value of an asset in the hands of the taxpayer) are income that Congress can tax, other written opinions provide insight into the potential views of the Supreme Court on the Biden administration’s current tax proposals related to taxation of unrealized gains.

Potential implications of the Moore case

The case garnered interest among tax professionals and the financial press speculating as to whether the Court would rule on whether income must be realized (received by the taxpayer) for it to be taxed. This is part of the fundamental question of “what is income” both generally and in the context of the 16th Amendment to the U.S. Constitution, which is the provision that grants Congress the power to impose an income tax.

Commentators speculated that a decision that the taxpayer must realize income to be subject to the tax would upend portions of the Internal Revenue Code, or at the very least preclude the enactment of several tax proposals advanced by the Biden administration.

The majority opinion did not opine on this issue of whether unrealized gain can be taxed as income. The Court analyzed the tax from the perspective of pass-through entities and specifically limited their opinion to that context – whether Congress can impose on the U.S. shareholders a tax on income realized by a foreign corporation. The opinion expressly states that it does not reach the question of whether income must be realized to be taxed as it was not necessary to decide this case.

What did the Supreme Court decide?

The MRT was a one-time tax on the post-1986 accumulated earnings of foreign corporations controlled by U.S. taxpayers. It applied to U.S. shareholders holding 10% or more of foreign corporations in 2017 and was reportable on a 2017 or 2018 tax return, depending on the applicable fiscal year. For purposes of understanding the nuances of the Supreme Court decision, it is important to understand that the MRT was a tax specifically on income that was earned and accumulated by the corporation, but not distributed to the owners of the company. The MRT was not assessed on the value of the assets owned by the foreign corporation. The taxpayers argued they could not be taxed on this income because they never received a distribution of income from the foreign corporation. Seven of the Justices did not find this argument persuasive, and they upheld the MRT.

The tax code imposes tax on the owners of an entity – instead of on the entity itself – in a variety of contexts known as pass-throughs. Partnerships, LLCs, S-corporations, and grantor trusts are examples of situations where the owner is taxed on the income earned, whether or not such income is distributed to them. Another of those situations is the taxation of U.S. controlled foreign corporations. In the Moore case, the majority opinion concludes that with respect to a pass-through entity, Congress has the power to decide whether to tax realized income to the entity or to the owners. In other words, the MRT was a constitutionally permitted tax imposed on the U.S. shareholders on income previously realized by the corporation.

How did the majority limit their opinion?

The majority limited the application of its decision in four specific ways. The MRT is constitutional because (1) it is a tax on the shareholders of an entity, (2) on income that has been realized by the entity, (3) that has been allocated to the shareholder rather than the entity, and (4) the entity has not been taxed on the same income. In addition, the majority opinion notes that the Due Process Clause of the Constitution requires that any allocation of income to the shareholders not be arbitrary. It remains an open question whether a tax on the U.S. owners of foreign entities would be constitutional if it did not meet one or more of these criteria.

What do the other opinions reveal?

In addition to the majority opinion written by Justice Kavanaugh, joined by Justices Kagan, Sotomayor, Roberts, and Jackson, there were three other written opinions: A concurring opinion by Justice Jackson (agreeing with the majority but adding some additional comments), an opinion by Justice Barrett joined by Justice Alito concurring in the judgment (agreeing with the outcome but for different reasons), and a dissent by Justice Thomas, joined by Justice Gorsuch who would have struck down the MRT as unconstitutional.

Justice Jackson’s concurring opinion reaches two issues the majority opinion does not. First, Justice Jackson concludes that there is not a requirement that income be realized to be taxed, which would eliminate one of the elements of the majority’s four-part test. Secondly, she holds a different view on the necessary parameters to avoid arbitrary allocations of income, which Justice Barrett emphasizes would be unconstitutional.

Justice Barrett’s opinion, joined by Justice Alito, agreed with the majority decision that the MRT is constitutional. Justice Thomas, joined by Justice Gorsuch, disagreed with the majority of the court and issued a dissenting opinion. Both Justice Barrett’s and Justice Thomas’ opinions directly tackle the question of whether unrealized gains (the growth in value of an asset in the hands of the taxpayer) are income that Congress can tax. Both opinions conclude that at some level the constitutional authorization for an income tax does not stretch to a tax on unrealized gains. Justices Thomas and Gorsuch argue that based on a lack of realization by the Moores themselves, they would find the MRT unconstitutional.

Reading the tea leaves

For now, the decision means only that Mr. and Mrs. Moore will not get a refund for the $15,000 in MRT they paid before claiming a refund in the lead up to this case. Since the MRT was a one-time tax imposed for a single tax year beginning in 2017, the due date for which has already come and gone, only taxpayers who are currently undergoing audits or who have mounted similar challenges will be directly impacted. Those who have paid the tax, or who are paying it in installments, need not take any new actions. However, the decision will likely have a broader impact based on the issues it did not reach.

The opinions reveal that at least four justices believe that income must be realized to be taxed (Thomas, Gorsuch, Barrett, and Alito). Justice Jackson does not agree, and the others have not gone on record on that issue. This is notable because the administration has released several proposals that involve taxing unrealized gains. The first is the so called “Billionaire’s Tax” that would include certain unrealized gains in the definition of income for a 20% minimum tax imposed on taxpayers with more than $100 million in assets. The second is a tax on unrealized gains upon a transfer by gift or at death. If these provisions make it into legislation, it is likely they would face a challenge based on what the Barrett and Thomas opinions reveal about the views of members of the court.

Another ancillary topic that may arise in a future case relates to the grantor trust rules, which cause the income and capital gains earned by a trust to be treated as received by the grantor. Some commentators have questioned whether certain grantor trust powers can be challenged on the grounds that the allocation of pass-through income to an underlying owner cannot be arbitrary, considering the statements from Justice Barrett in particular. While that is an interesting theory, it is not clear how that would reach the court procedurally given that the IRS is bound by the regulations it issues and most taxpayers these days seek to intentionally create grantor trusts.

Key Takeaways:

In the future, the Supreme Court may be called upon to decide whether it is constitutional to impose a tax on unrealized gains. However, for now they have determined that the MRT is constitutional. Here are some considerations to keep in mind:

  • If you were subject to the MRT, it has been found constitutional and there is no action needed if you paid it. If you are paying in installments, you should continue to pay them.
  • If the outcome of the election indicates that a wealth tax may be on the table, consider making lifetime gifts to multiple separate individuals or trusts to reduce the amount subject to a wealth tax.
  • Include flexibility in the terms of any trusts you are making gifts to, to allow adjustments if tax rules change.
  • If you are considering challenging a tax decision in court, review your case with your tax and legal advisors considering the Moore opinion.
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Disclosures

© 2024 Northern Trust Corporation. Head Office: 50 South La Salle Street, Chicago, Illinois 60603 U.S.A. Incorporated with limited liability in the U.S

This information is not intended to be and should not be treated as legal, investment, accounting or tax advice and is for informational purposes only. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal, accounting or tax advice from their own counsel. All information discussed herein is current only as of the date appearing in this material and is subject to change at any time without notice.

The information contained herein, including any information regarding specific investment products or strategies, is provided for informational and/or illustrative purposes only, and is not intended to be and should not be construed as an offer, solicitation or recommendation with respect to any investment transaction, product or strategy. Past performance is no guarantee of future results. All material has been obtained from sources believed to be reliable, but its accuracy, completeness and interpretation cannot be guaranteed.

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