The U.S. Supreme Court appeared interested in reaching a narrow ruling to avoid the consequences of blowing up the federal tax code in the blockbuster tax case of Moore v. U.S. as it heard oral arguments Tuesday.
The case, challenging a key element of the tax cuts signed by President Donald Trump in 2017, presents a novel tax question to the court. Could Congress impose a tax on U.S. shareholders’ unrealized gains (profits that are earned but not paid out, either as dividends or by other means) from foreign-controlled corporations?
Justices Brett Kavanaugh and Amy Coney Barrett appeared to be the most skeptical among the court’s six conservatives of the argument put forward Tuesday by the plaintiffs’ lawyers. They could join the three liberal justices, who were not buying the plaintiffs’ arguments, to form a five-vote majority and rule narrowly to spare the tax (and reserve the question of the constitutionality of a wealth tax for a later date).
The case centers on the tax payments of a couple in Washington state, Charles and Kathy Moore. In 2006, Charles Moore, a former Microsoft software engineer, invested $40,000 in KisanKraft, an Indian corporation that sells farm equipment to small farmers, for an 11% stake in the company. The Moores profited from their investment but did not cash out those profits.
At the time, U.S. shareholders could defer tax payments on these kinds of profits earned by foreign companies until they were paid out as dividends. But in 2017, Republicans passed the Tax Cuts and Jobs Act, which included a Mandatory Repatriation Tax (MRT) that required U.S. shareholders, like the Moores, to pay a one-time tax on all undistributed income from foreign companies in which they held more than a 10% stake. And it was retroactive, applying to earnings after 1986. The total income believed to be held overseas in such corporations exceeded $2 trillion in 2015 and would generate $339 billion in tax revenue by 2027, according to the congressional Joint Committee on Taxation.
After paying nearly $15,000 in taxes under the MRT, the Moores sued, arguing that taxing unrealized profits violates the 16th Amendment, which gives the power to levy income taxes to Congress. They argued that a tax on unrealized gains amounted to a tax on property, rather than an income tax or an excise tax, and therefore couldn’t be applied under the 16th Amendment. After losing in a U.S. District Court in Washington state and then again before the U.S. Court of Appeals for the 9th District, they asked the Supreme Court to take up the case.
The case has massive ramifications, both real and theoretical.
First, a decision finding that it is unconstitutional to tax corporate-level gains before they are distributed to individual shareholders would immediately threaten more than $6 trillion in revenue raised by existing taxes that do just that. This includes taxes on S corporations, the global minimum income tax on intangible assets, the corporate alternative minimum tax and certain taxes on controlled foreign corporations (known as CFCs), according to the nonpartisan Tax Foundation.
And second, such a decision would threaten the ability of Congress to enact future taxes on the wealth of billionaires. A wealth tax would not just tax income but also total net worth, necessarily including unrealized gains and property, which is at the heart of the case.
That impact on net worth is a big reason why the Moores have received significant support from rich and powerful conservatives for their lawsuit. Their lawyers, Andrew Grossman and David Rivkin Jr. (who has interviewed Justice Samuel Alito multiple times, drawing recusal calls), stated as much in a 2021 Wall Street Journal opinion piece, writing that “the couple’s constitutional challenge stands to slam shut the door on a federal wealth tax like the one Sen. Elizabeth Warren wants to enact.”
Grossman argued on Tuesday that the MRT is unconstitutional because it is “a tax on the ownership of property” and that the Constitution only allows “direct taxes” to be levied when they are “apportioned among the several states.” He also argued that the 16th Amendment, which legalized direct taxes from “whatever source derived,” only applies to realized income, saying “a gain is not income unless and until it has been realized by the taxpayer.”
Solicitor General Elizabeth Prelogar, on the other hand, argued on behalf of the federal government that Congress has long enacted taxes that closely resemble or are nearly identical to the MRT, and the court has not questioned them.
A good part of the arguments revolved around the 1919 tax case of Eisner v. Macomber, an early 16th Amendment case which found that unrealized dividends to shareholders were not income and therefore taxes on them were unconstitutional. Prelogar argued that the court’s decision in Macomber was “misguided” and had been superseded by cases that departed from its finding.
Where Grossman argued that unrealized gains were not income, Prelogar argued that there is no “bright line” test used to determine the realization of income and that realization is not “always” a requirement for Congress to impose a tax on gains.
“We don’t have to agree with you for you to prevail,” Kavanaugh said during the arguments. ”Leaving open whether realization was a constitutional requirement, there was realized income here to the entity and then it’s attributed to the shareholders in a manner consistent with how Congress has done that and this court has allowed?”
“That’s correct,” Prelogar replied. “We think that here the constitutional question is actually quite easy, and it doesn’t require the court to consider some of the foundational questions about the meaning of the 16th Amendment.”
While the case featured debate over novel questions on the tax code, a subplot involved the still simmering questions about the court’s ethics problems and lack of an enforceable code of conduct.
Leading up to the case, Democrats in Congress, including Senate Judiciary Committee chair Dick Durbin (D-Ill.), had called on Alito to recuse himself from the case after he sat down for interviews with Rivkin, one of the Moores’ lawyers, for The Wall Street Journal editorial page. Alito refused calls for his recusal in a rare public letter.
Alito did not shy away from asking questions during the arguments, homing in on the wealth tax question by asking whether Congress could tax all of the gains made from when a person started a company after college to when that person later became a billionaire.
Justice Neil Gorsuch also joined in presenting hypothetical tax schemes as potential consequences of upholding the MRT. Gorsuch asked if the government could impose a tax on stocks held by every American in their retirement accounts.
Prelogar said that such a tax could theoretically be constitutional and that the court could rule on it at some point, but it would be unlikely to happen because it would be nearly impossible to administer.
Kavanaugh presented another reason why Gorsuch’s hypothetical was unlikely to happen.
“Members of Congress want to get reelected,” Kavanaugh said. “So some of the hypos, that’s why they’re far-fetched.”