On June 20, 2024, in Moore v. United States, the Supreme Court held that the Mandatory Repatriation Tax (MRT), a corporate tax on foreign earnings, is constitutional under the Sixteenth Amendment. Justice Kavanaugh authored the opinion for the Court. Justice Jackson wrote a concurring opinion. Justice Barrett filed an opinion concurring in the judgment, joined by Justice Alito. Justice Thomas authored a dissenting opinion, joined by Justice Gorsuch.
As summarized in Dykema’s January 2024 edition, in 2006, the Moores invested $40,000 in a foreign company majority-owned by U.S. persons in exchange for common shares. At the time they invested, shareholders were taxed on foreign earnings only when those earnings were repatriated (sent) to the U.S. For more than 10 years, the company generated considerable income without distributing that income to U.S. shareholders, and neither it nor the Moores paid U.S. income tax on the income. The tax law changed in 2017, and the MRT retroactively taxed foreign earnings even if they had not been repatriated. Thereafter, the Moores received a tax bill for approximately $15,000 based on their pro rata share of the company’s income dating back to 2006. The Moores paid the tax and then sued for a refund, arguing that taxation of the foreign company’s retained earnings as their income violated the Direct Tax Clause, found in Article I, Section 9 of the Constitution, as an un-apportioned direct tax on their shares of the company’s stock. They also argued that the MRT’s retroactive application violated their Fifth Amendment Due Process rights. The district court dismissed the action, and the Ninth Circuit affirmed, holding that the MRT is a tax on income permissible under the Constitution. The Ninth Circuit also rejected the Moores’ due process argument.
Affirming the Ninth Circuit, the Supreme Court bypassed the much-anticipated question of whether unrealized income may be taxed. Instead, the Court limited its decision to whether Congress exceeded its constitutional authority by enacting the MRT. On that narrow question, the Court concluded that “when Congress treats an entity as a pass-through,” it may “attribute an entity’s realized and undistributed income to the entity’s shareholders… and then tax the shareholders… on their portions of that income.” Leaning on precedent and Congress’s historical taxing practices, Justice Kavanaugh explained that Congress may attribute realized and undistributed income to shareholders and then tax those shareholders on their portion of that income or it can tax the entity itself. The Court has held that the tax remains a tax on income no matter if it is the shareholders or the entity being taxed, and that this indirect tax need not be apportioned. The Court compared the MRT to how Congress taxes partnerships and S corporations, stating that these entities have all been taxed in the same way. The Court emphasized that its decision is limited to the taxation of shareholders of an entity on the undistributed income realized by the entity when the income has been attributed to shareholders and the entity itself has not been taxed on the income. The Court did not address whether a gain must be realized to be considered income under the Constitution or whether Congress can tax both the shareholders and the entity on undistributed income.
Justice Jackson concurred, asserting that the Court’s role in tax disputes should be limited and that remedies for the disputes are to be found “at the ballot-box.” Justice Barrett, joined by Justice Alito, also concurred in the judgment but not in the Court’s reasoning and argued that Congress’s power to attribute income of closely held corporations to their shareholders is an issue that was barely addressed by the parties. Justice Thomas, joined by Justice Gorsuch, dissented and agreed with the Moores that a tax on unrealized investment gains is not a tax on income, so the apportionment clause must be followed. Justice Thomas also reasoned that the Court does not have the power “to fashion an emergency escape” for Congress’s errors and that the majority applies dicta as a flimsy safeguard against unconstitutional taxes.
Takeaway:
- Congress is able to attribute income that a pass-through entity has realized but not distributed to is shareholders and tax that income.
For more information, please contact Chantel Febus, James Azadian, Cory Webster, Christopher Sakauye, Monika Harris, Puja Valera, or A. Joseph Duffy, IV.