The U.S. Supreme Court faces a decision of monumental importance, crucial to our nation’s future. The citizenry is poised on the edge of its seat, awaiting the outcome. No, I’m not talking about the recent matters involving the Colorado Supreme Court, insurrection, and the 14th Amendment. I refer to something far more vital — the case argued to the Court on December 5, 2023, concerning the direct tax clause, the mandatory repatriation tax (MRT) of section 965, and the 16th Amendment. We tax folks have our priorities.
Last week, this column parsed through the 2 hours and 4 minutes of oral arguments in Moore v. United States to examine the government’s problems as it urges the Court to affirm the Ninth Circuit’s decision. This week, I examine the petitioners’ problems as they seek a reversal.
The traditional argument supporting a broadly applicable realization requirement is based on the century-old decision in Macomber. That reliance strikes many observers as misguided, but courts are willing to assign great value to dictum when it serves a valuable purpose — like fending off the scary taxes that lawmakers might enact in the future. Nominally, the petitioners in Moore have gone before the Supreme Court to chase a trivial $15,000 refund claim under the MRT, which they failed to plan around. The ulterior motive is to test the boundary of the realization requirement. As I wrote in my column last week, we should be glad they are doing this. It’s one thing to have some anxiety about the Court reaching the wrong result, it’s another thing to be so insecure about the durability of our tax statutes that we don’t want them field tested.
Nor is the prospect of wealth taxation a figment of our imagination. The wealth tax envisioned by Senate Finance Committee Chair Ron Wyden, D-Ore., is a mark-to-market regime that’s narrowly targeted to a few billionaires. Fine, it wouldn’t affect 99.99 percent of the population. There’s a temptation to tax the stuffing out of figures like Jeff Bezos, Mark Zuckerberg, and Elon Musk — out of envy, out of spite, or simply because they can afford it. However, we should tread cautiously here.
A vital principle is at stake regarding congressional authority to tax naked appreciation. If Wyden’s wealth tax is legitimate, then Congress could (theoretically) slap an annual tax on the appreciation of the retirement accounts of middle-income households. Such a proposal would be political suicide, but the Court’s aim is to scrutinize what is permissible rather than what’s likely.
That’s why Moore matters. And it’s why Tax Notes Federal recently named Charles and Katherine Moore its Persons of the Year for 2023. The designation is not an endorsement of the couple’s refund suit, by the way (past honorees have served jail time for their contributions to the global tax community). As you’ll soon see, I’m critical of the petitioners’ legal arguments. I find the MRT entirely unobjectionable. It’s a necessary piece of the transition to a territorial regime under the Tax Cuts and Jobs Act, and I’m not alone in thinking that. Across the tax profession, there’s a general distaste for the petitioners’ attack on the MRT.
What explains that dim view? The field of organizational behavior has a term — the silo effect. It alludes to the segmentation of vocational disciplines into narrowly construed niches with a tendency for adherents to grow insular in their orientation. It has been suggested to me that the tax community is such a niche. I suppose that makes the study of international taxation a silo within a silo.
On the one hand, tax people are uniquely positioned to opine on the merits of Moore. On the other hand, a tax-centric mentality could present an unconscious bias against unorthodox arguments. If a person reads some of the amicus briefs filed in Moore and deems them utter slop, is that because they know too little about constitutional law or because they know too much about tax law? Naturally, I tend to say it’s the latter.
On to the criticism. The headline poses a question: Do the petitioners have a problem? Yes, they have several. The most glaring of them is the proposition that entity-to-owner attribution under the MRT fundamentally differs from the attribution that routinely occurs elsewhere in the tax code, especially within subpart F.
The Moores concede that subpart F is constitutionally valid. With that admission, they paint themselves into a corner. The concession marks the moment they lost the tax bar — if they hadn’t already by characterizing section 965 as a tax on property (corporate shares). As another commentator observed, the petitioners’ case seems to hinge on the Court not bothering to read subpart F.
The Moores’ core problem is that there is no basis for delegitimizing the MRT that lets subpart F off the hook, and neither is there any basis for preserving subpart F that doesn’t validate the MRT. Try as they might, they never get over this hump. That doesn’t mean they won’t prevail before the Supreme Court. The tax bar isn’t deciding the case.
Distinctions Without a Difference
Once oral arguments commenced, it took little time for the justices to arrive at the crux of the matter. They quizzed the petitioners’ counsel, Andrew M. Grossman of Baker & Hostetler, on why the MRT should be portrayed as a tax on unrealized gain, when it’s abundantly clear the income in question was realized years earlier. The tax base of the MRT is previously deferred income. Logically, it must be earned (realized) before it can be deferred:
CHIEF JUSTICE [John] ROBERTS [Jr.]: Well, there certainly is realization here by the corporation, if not the taxpayers, right? It isn’t a case like appreciation of property where nothing has happened. You know, you buy a property, you’re holding it for 20 years, you haven’t sold it, nothing has happened. Here, something has happened, and income has gone to the corporation, isn’t that right?
MR. GROSSMAN: Yes. The corporation has income, and we don’t dispute that the corporation realized income over the decade, plus years that are being taxed by the MRT. But I think it really is like the instance of simply appreciation of property from the point of view of the shareholders.
See what they did there? When viewed from the perspective of the shareholder, the MRT feels like a tax on property. So what? The same applies to every other instance of attribution to be found in the tax code. The argument negates attribution generally, but it’s styled as a critique unique to the MRT. It should be self-evident that all attribution concerns the assignment — to shareholder or partners — of tax attributes that they don’t already possess.
If our analysis went no further than the Moores’ feelings (“hey, that isn’t my income!”), no type of attribution would withstand constitutional scrutiny because everything then becomes a tax on property, which must be apportioned. It follows that the whole of subpart F, subchapter K, and subchapter S could be understood only as taxes on property and so are invalid. That can’t be correct.
Justice Sonia Sotomayor asked about partnerships. Grossman replied that that kind of attribution was different from the MRT because corporations have a distinct status (legal personhood) that partnerships don’t. Shareholders of corporations have limited liability, while the general partners of partnerships do not.
OK, but if we follow through with that reasoning, the only permissible attribution would involve situations in which the interposed business entity was a noncorporate player. And what about limited partners? Should the Court declare that a tax on the fractional share of profits assigned to general partners is to be regarded as a permissible tax on income (citing the lack of legal personhood), whereas a tax on the fractional share of profits assigned to limited partners is doomed as an impermissible tax on property (citing the presence of limited liability)? That’s a nonviable framework.
The solution is straightforward: It’s beside the point whether the MRT feels to the Moores like a tax on property. Within the silo, this point is so fundamental that it’s hardly worth mentioning.
The transcript continues:
JUSTICE SOTOMAYOR: So, what do you do with Subpart F or Subpart S or all of the other ways in which we have attributed corporate income to individuals?
MR. GROSSMAN: That isn’t at issue in this case.
Wrong. That’s an indispensable element of the analysis due to how the petitioners framed their argument — it’s exactly what the case is about.
JUSTICE SOTOMAYOR: But, in your brief, you don’t appear to be challenging it.
MR. GROSSMAN: We think that Subpart F follows the commonly accepted method that Congress has used to address situations when a taxpayer has interposed a corporate structure between themselves and income that is otherwise theirs to the —
JUSTICE SOTOMAYOR: Well, but that’s the whole purpose of a corporate structure. People do that all the time, particularly for that purpose. You don’t incorporate unless you want the corporate shield. You don’t incorporate unless you want the benefits of the corporate protection. So, under your theory, Subpart F, Subpart S — these are longstanding taxing mechanisms by the government — your theory would undermine those as well, wouldn’t it?
MR. GROSSMAN: I don’t think that’s right. Subpart F, again, works on simply categories of income on a current basis where those categories of income are properly viewed as being — and Congress determined are properly viewed as being earned by the shareholders due to the nature of the categories of income that are addressed under the statute.
JUSTICE SOTOMAYOR: Well, it seems — I’m sorry. Go ahead.
JUSTICE [Amy Coney] BARRETT: So, you concede that Subpart F is constitutional? I just want to be sure that I understand your answer.
MR. GROSSMAN: We think that the defect with the MRT doesn’t really apply to Subpart F. You know — the Court has never considered the constitutionality of Subpart F, but, as we take it, we don’t think that there’s a constitutional issue there.
There’s a lot to unpack here. Subpart F is fine, we are told, because it involves categories of income properly designated by Congress as being “earned by the shareholders.” Really? How did Congress accomplish that designation? And why hasn’t it also designated the categories of income relevant to the MRT as being earned by the shareholders?
Subpart F involves a statutory scheme for determining what is a controlled foreign corporation (the 50 percent test) and who is a U.S. shareholder (the 10 percent test). It then allows for attribution of certain income from the CFC to the shareholder. The statutory scheme of the MRT is identical, apart from minor alterations in the verbiage.
Grossman draws our attention to the “nature” of these categories of income. Note the reference to taxation on a current-year basis. The Moores assign great importance to this feature. It is a point of differentiation between subpart F and the MRT. The petitioners encourage the Court to find that subpart F is appropriate because it attributes current-year income, whereas the MRT is defective because it attributes accrued income. The view from the silo is that this gets them nowhere.
There’s no doubt that Congress is authorized to enact retroactive taxes. True, retroactive taxes aren’t always ideal as a policy matter. It’s unwise for lawmakers to attempt to promote or discourage behavior that’s already taken place. That said, retroactive treatment is more than justified when the alternative is a fiscal forfeiture of colossal proportion. The alternative to the MRT was the permanent exemption of previously deferred and untaxed income. Anyone who has studied the TCJA knows that the retroactivity of the MRT was no legislative whim. It was an essential component of the transition to a territorial corporate regime. It’s the quid pro quo for the participation exemption.
What’s behind the Moores’ concern with timing? What about it supposedly makes a subpart F inclusion more noble and defensible than the MRT?
The petitioners think there’s a fairness aspect to be exploited. We can imagine a scenario consisting of two similarly situated shareholders in a CFC with vastly different holding periods. Let’s say that one of them is an original investor who has held their shares since the business was founded decades earlier, while the other acquired theirs more recently, perhaps just days before the MRT’s effective date.
Subpart F and the MRT treat the two shareholders identically, despite their different holding periods. The Moores ask us to accept that any deviation from current-year attribution is unfair to the latter shareholder because it scoops up taxable income that didn’t accrue to the company during their watch. That’s a due process objection. It ignores the reality that when any investor buys into an enterprise, they do so inclusive of whatever is carried on the books — the whole bundle of receivables, liabilities, and tax attributes.
The Moores contend that the legitimacy of subpart F is flavored by this timing dimension, while the infirmity of the MRT is demonstrated by how it stretches back to the past. That’s what Grossman means when he refers to the “nature” of subpart F income being different from that of the MRT. Among tax people, this argument is received with a yawn and a roll of the eyes. It’s a distinction without a difference.
Why not be more transparent about this dispute — that’s it’s really about retroactivity and due process? One reason might be that the case law isn’t so favorable. If the Moores had framed their appeal as being about due process or retroactivity, it’s unlikely the Court would have granted certiorari. Opponents of the wealth tax need the case to be about realization.
There’s a bit more to the Moores’ effort to contrast subpart F with the MRT. At times during oral arguments, they urged the Court to consider subpart F an antiabuse rule, specifically as a measure that responds to the profit-shifting inclinations of large multinational corporations. Recall that the CFC in question, KisanKraft, is a relatively small-scale operation.
The Moores suggest that the attribution that occurs under subpart F can be separately justified as an anti-profit-shifting measure, whereas the attribution we see under the MRT lacks that element. To tax people, this seems a bizarre suggestion. It might be the first time in 60 years that anyone has thought to describe subpart F as a general antiabuse rule. Nobody is going to believe that the architects of subpart F (circa 1962) drew inspiration from the OECD’s base erosion and profit-shifting project (circa 2015):
JUSTICE BARRETT: So, what is the distinction? Is it just that other parts of Subpart F, to the extent that they tax income, do it on an annual basis and the MRT was a one shot that went backwards?
MR. GROSSMAN: I think that’s part of it. But, again, I think what it really is . . . is that Subpart F addresses this fundamental income-shifting concept, whereas the MRT doesn’t.
And later:
JUSTICE [Brett M.] KAVANAUGH: Well, why is that different analytically? I mean, this was all part of a big change from a worldwide tax system to a territorial tax system, and this is one piece of that, but I guess I’m not sure why the — which kind of income is at issue matters for the ultimate analysis of whether the attribution is permissible.
MR. GROSSMAN: Because all of these attribution schemes going back to the very beginning have focused on effectively the fraudulent or improper availment of the corporate form to avoid income, and they’ve always done that historically by focusing on particular categories of income that are susceptible to that type of abuse. Congress took that to the max as it amended Subpart F over the years to capture more and more types of that sort of income avoidance.
Let’s get this straight. The petitioners contend that subpart F is acceptable because it prevents taxpayers from getting away with inappropriate tax savings — namely, shifting income that produces assets to foreign corporations to lie beyond the jurisdictional reach of the U.S. tax net. And this same characteristic is supposedly missing from the MRT, although the direct consequence of invalidating the MRT is to allow legions of previously untaxed income to permanently escape taxation?
Preventing the mother of all windfalls apparently doesn’t cut it as an antiabuse concept. Go figure.
The Moores go further, suggesting that Congress’s ability to impose further taxes (via attribution) on the U.S. shareholders of CFCs is maxed out and can proceed no further. With subpart F, they say, Congress has depleted the full potential for taxation permitted under the 16th Amendment — meaning there is no room left for taxing the profits of foreign corporations. Every inch of constitutional possibilities has been extinguished.
Within the silo, we’re giggling. If subpart F represents maximal taxation, what are we to make of the TCJA’s international guardrail provisions, such as the global intangible low-taxed income regime or the base erosion antiabuse tax?
MR. GROSSMAN: Congress has never reached so far as to tax shareholders of foreign corporations on the active business income of those corporations.
That statement is demonstrably false. The GILTI regime does not distinguish between active and passive income of foreign corporations; it distinguishes between returns derived from tangibles and intangibles. It’s as if the petitioners assume the justices aren’t up to speed on the GILTI regime.
What we learn from these verbal exchanges is that the Moores are grasping. They elevate any hint of a difference between subpart F and the MRT. They turn molehills into mountains. They do so out of desperation, fearing the Court will summarily determine that the MRT is just another subpart F inclusion (which it is) and be done with further analysis.
Summation
The legacy of Macomber might be different if the drafters of the 16th Amendment had bothered to insert the word “realization” somewhere in the text. For better or worse, they didn’t. The usefulness of Macomber is that it makes up for that omission — in the same way that Griswold v. Connecticut makes up for the omission of the word “privacy” from the Bill of Rights. The constitutional roots of the realization requirement aren’t spelled out in black and white; they’re hidden in the penumbra and emanations of other objects. In the era of textualism, those shadows aren’t what they used to be.
The path of least resistance in Moore is for the Court to uphold the MRT and punt on trickier issues that aren’t properly before it. The pivotal question that lurks in the back of our minds — whether Congress can impose a tax on naked appreciation — need not be answered to dispose of this case, so it probably won’t be. The issue is better suited to a controversy involving one of the tax code’s mark-to-market provisions. Moore is not the test case some people want it to be.
As I read the tea leaves, we have three justices [Justices Elena Kagan, Sotomayor, and Ketanji Brown Jackson] who seem ready to affirm the Ninth Circuit. They are happy to bury Macomber once and for all, or to declare that it means absolutely nothing beyond certain stock dividends and stock splits. Functionally, those two positions amount to the same thing.
We have two other justices [Justices Clarence Thomas and Samuel A. Alito Jr.] who are ready to reverse the Ninth Circuit. They regard Moore primarily as a proxy for a federal wealth tax. They’d like to nip the concept in the bud, before the public’s appetite for it spreads. That’s not to suggest they want to disrupt large chunks of the tax code, but their tolerance for collateral damage sets them apart from the others.
One justice [Roberts Jr.] seems to be on the fence. He appreciates the defects in the Moores’ case and is inclined to agree with most of the government’s case, but he too frets about the implications of an unconstrained federal taxing power.
Another justice [Justice Neil M. Gorsuch] is reluctant to affirm or to reverse. He teases the idea of an order to vacate and remand, hoping the issue on appeal would be framed slightly differently the second time around. Worse, he hints that the government may have waived certain arguments supporting the MRT by not raising them more directly in briefs. A remand could result in the matter being sent all the way back to the U.S. district court for trial and a new series of appeals. It would be a tedious and repetitive exercise.
A remand would waste years, with no guarantee that the key issues would look different than they do today. I suspect the Court didn’t grant certiorari so that it could further postpone the resolution of these issues.
The two remaining justices [Kavanaugh and Barrett] seek a practical solution with minimal fuss. They’d uphold the MRT for the same reasons that entity-owner attribution was upheld in Heiner. They appreciate that it’s extremely rare for the Court to invalidate a federal income tax. It’s happened only once since ratification of the 16th Amendment, and there’s insufficient justification to deviate from the tradition. They don’t need to overrule Macomber, so they won’t. Instead, they’d squeeze its residual echo into a small box, to be opened later in an emergency. There’s an intuitive simplicity to that approach.
As always, caveats apply to these inferences. There’s no assurance that a justice will rule a certain way because he or she asked a certain question or pushed back against a particular argument. We draw premature conclusions at our own risk.
