Reuven S. Avi-Yonah (email@example.com) is the Irwin I. Cohn Professor of Law at the University of Michigan Law School. He would like to thank Jake Brooks and David Gamage for helpful comments.
In this installment of Reflections With Reuven Avi-Yonah, Avi-Yonah explores the history of the corporate tax as an excise versus income tax and explains potential effects from the Moore and Altria cases.
Does the corporate tax require realization as a constitutional matter?
If one assumes, as most observers do, that the Supreme Court will rule for the government in Moore1 on the narrow grounds that the income subject to section 965 was realized and can be attributed to U.S. shareholders of a controlled foreign corporation, it is likely there will be more constitutional challenges to tax provisions that are not based on realization. I have previously suggested that the most plausible challenge to the constitutionality of a federal mark-to-market tax (the real target of Moore, as the oral argument showed2) is section 877A.3 But it would require several years to develop a case.
In the meantime, there is a case pending that could raise this challenge.
In Altria Group Inc.,4 a case filed earlier this year in the U.S. District Court for the Eastern District of Virginia, Altria is challenging the downward attribution rule for determining CFC status as enacted by the Tax Cuts and Jobs Act. Altria’s argument is similar to the Moores’: Realization is a constitutional requirement for an income tax. Altria argues that, as a mere 10.2 percent shareholder in a Belgian corporation, it could not influence dividend policy and actual control is required for constructive realization. But Altria’s argument is narrower than the Moores’ because it only challenges the consequences to a noncontrolling U.S. shareholder of the repeal of the ban on downward attribution by the TCJA.5 Altria is not challenging all of subpart F as it existed before the TCJA. The case has recently been stayed pending the Supreme Court’s decision in Moore.6
As Mindy Herzfeld has argued, a taxpayer victory in Altria could have broader implications than just invalidating the downward attribution requirement.7 Altria’s argument reads a constructive receipt requirement into subpart F, which a court could interpret to mean that subpart F, the global intangible low-taxed income regime, and the mandatory repatriation tax cannot apply in situations in which the U.S. shareholder does not control the CFC. Moreover, as Herzfeld also points out, adopting this control requirement as a constitutional matter would make it difficult for Congress to adopt pillar 2 because the UTPR (formerly known as the undertaxed payments rule) applies taxation without control (by taxing a U.S. subsidiary on earnings of a foreign parent).
But there is another consideration, which strangely was not raised by the government in its reply brief. Altria is challenging a provision of the corporate tax as unconstitutional because it does not involve realization, and according to Altria, realization is an essential constitutional requirement for an income tax under Macomber.8 But the Supreme Court held in Stone Tracy,9 that the corporate tax is not an income but an excise tax and therefore not subject to any realization requirement. That would seem to doom Altria’s argument in the district court and in a circuit court because they are bound to follow decisions of the Supreme Court.
However, if it wanted to address the realization issue in this context, the Supreme Court could grant certiorari in Altria and reverse Stone Tracy. This raises the interesting question of how valid is Stone Tracy today?
When the corporate tax was enacted in 1909, its proponents were aware that the Court in Pollock (1895) had invalidated the individual income tax as an unapportioned direct tax.10 The enactment of the corporate tax was a compromise between proponents of overturning Pollock and its supporters. President William Taft and Senate Majority Leader Nelson Aldrich were reluctant to challenge the Court directly. They therefore proposed a constitutional amendment to overturn Pollock, which neither expected to be enacted, and a corporate tax, which they believed could be defended as an excise tax not subject to apportionment. As Sen. Aldrich stated, “I shall vote for a corporation tax as a means to defeat the income tax.”11
The Tariff Act of 1909 imposed “a special excise tax with respect to the carrying on or doing business” of 1 percent of net income over $5,000 of “every corporation, joint stock company or association organized for profit” under U.S. law, and every foreign corporation engaged in business in the United States.12 This excise tax is the antecedent of today’s corporate tax.13
The legislative history of the corporate tax shows clearly that its purpose was to tax the income of all corporations, both to indirectly tax their shareholders and to directly provide for some federal control over potential abuses by large monopolies like Standard Oil, which the government was at the same time trying to break up (it succeeded in 1911). The “excise tax” label was only added to prevent the Court from declaring the tax unconstitutional under Pollock.
President Taft’s message of June 16, 1909, gives three reasons for enacting a corporate tax. The first and least-emphasized reason is that “this is an excise tax upon the privilege of doing business as an artificial entity and of freedom from a general partnership liability enjoyed by those who own the stock.”14 Taft was aware that it is difficult to make this argument for a federal tax when the privileges enjoyed by the corporation derived from state law, and when the tax also applied to unincorporated “associations.”15 The reason he made the argument nevertheless was that this formulation was necessary to defend the tax’s constitutionality, because the Supreme Court had upheld the excise tax on sugar and oil companies in the Spreckels case.16 The real reason for the enactment is revealed when Taft added that, nevertheless, the excise tax “accomplishes the same purpose as a corporation income tax.”17
The second reason given by Taft was that the corporate tax “imposes a burden at the source of the income at a time when the corporation is well able to pay and when collection is easy.”18 This is clearly a reference to the corporate tax as an indirect way of imposing a withholding tax on shareholders (referred to at the time as “stoppage at source”). But Taft did not emphasize the nature of the tax as an indirect tax on shareholders because that would have made it more suspect to the opponents of the income tax as well as more vulnerable to a constitutional challenge.
Instead, the principal reason Taft gave for enacting a corporate tax was the third one — that it will enable the federal government to exercise some degree of supervision, primarily by obtaining information about the business affairs of corporations. Taft devotes a whole paragraph of his message to this argument, much more than he gave to the first two.19
Thus, the emphasis in President Taft’s message was on the corporate tax as an income tax, not as an excise tax. The same emphasis can also be seen in the congressional debate over enactment.
The excise tax characterization was expressed primarily by those proponents who sought to defend it from a constitutional attack.20 Sen. Elihu Root, for example, who was one of the main drafters of the bill, defended the tax in part as based on the privilege of limited liability.21 Opponents, however, were quick to point out that since corporations were created under state law, and limited liability also derived from state law, the federal government had no right to tax them on that basis.22 In addition, opponents pointed out that unincorporated businesses obtained from the federal government the same benefits as corporations.23
Most of the debate, however, concentrated on the other reasons for enacting a corporate tax. Proponents argued that the corporate tax was an indirect way of taxing wealthy shareholders. Opponents argued that the tax did not discriminate between wealthy and less wealthy shareholders.24 Sen. Albert B. Cummins stated that “so far as taxes are concerned, corporations are mere trustees for their shareholders; and their shareholders must pay the tax.”25
By far the most significant debate centered on the argument that the tax was a regulatory device. For example, Sen. Francis G. Newlands stated: “I favor also present legislative action imposing an excise tax in such form as to reach the great accumulated wealth of the country, or its earnings, engaged in corporate enterprise.”26 Nor did he mean by this indirect taxation of wealthy shareholders, because he went on to state that “there was no reason why the great combinations monopolizing these industries [protected by the tariff] should not pay some part of national expenses as well as the masses of the people who use and consume [their products].”27
Sen. Robert L. Owen likewise spoke of the “enormous volume of corporate wealth”:
The most important need of the people of the United States of this generation requires the abatement of the gigantic fortunes being piled up by successful monopoly . . . which have brought about a grossly inequitable distribution of the proceeds of human labor.28
Root, a principal draftsman of the tax (and personal friend of the president), likewise emphasized the potential of the tax to reach the wealth accumulated in the hands of corporations, because he favored taxing wealth over earned income:
Mr. President, it has so happened that in the development of the business of the United States the natural laws of trade have been making the distinction [between earned and unearned income] for us, and they have put the greater part of the accumulated wealth of the country into the hands of corporations, so that when we tax them we are imposing the tax upon the accumulated income and relieving the earnings of the men who are gaining a subsistence for their old age and for their families after them.29
Opponents of the tax, on the other hand, also stressed the regulatory aspect, but suggested that it had the potential of giving the federal government too much power over corporations. Cummins, for example, stated:
If this tax is intended not to create revenue, but if it is intended for the purpose of supervising and regulating corporations, that is quite a different proposition. I should like to know before we get through with this whether it is proposed through this tax to impose supervisory regulation upon all the corporations of the United States. . . . You know there is just a little intimation in the message of the President that that is the end which is finally to be reached . . . I think that before the Government of the United States enters upon the work of supervising and regulating all those corporations . . . we had better stop and think a while.30
Cummins was not opposed to any federal regulation through the corporate tax, just to a tax that indiscriminately applied to all corporations, big or small, as opposed to those corporations that should be the proper target — the great trusts:
If we can regulate our corporations simply through the medium of taxation, we can destroy every trust in a fortnight. It would be a great deal better for the Finance Committee to turn its attention to the imposition of such a tax upon corporations and the persons who actually need regulation, who are exercising powers that are injurious to the American people, destroying competition and invading our prosperity, than to attempt to levy a revenue tax upon all the little shareholders of all the little corporations throughout the length and breadth of the United States.31
Thus, the legislative history of the corporate tax shows that the tax was not primarily an excise tax on the privilege of doing business in corporate form but was seen as either an indirect way of taxing rich shareholders when they could not constitutionally be taxed directly, or as an alternative to antitrust in regulating corporate monopolies.
The excise tax label was appealing because the Court had upheld a federal excise tax on oil and sugar corporations enacted in 1898. As a contemporaneous observer explained in 1910, the label attached to the tax was considered important:
On this point the phraseology of the act is of great importance. It provides that corporations, etc., ‘shall be subject to pay annually a special excise tax with respect to the carrying on or doing business of such corporation . . . equivalent to one per centum upon the entire net income over and above,’ etc. Manifestly this purports to be a tax upon the business and not upon the income as such, though it is true that the amount of the tax is to be measured by the amount of income.
In 1898 Congress passed an act providing ‘That every person, firm, corporation, or company carrying on or doing the business of refining petroleum, or refining sugar, or owning or controlling any pipe line for transporting oil or other products, whose gross annual receipts exceed two hundred and fifty thousand dollars, shall be subject to pay annually a special excise tax equivalent to one quarter of one per centum on the gross amount of all receipts.’
The Spreckels Sugar Refining Co. resisted the payment of the tax, and the question was finally determined in Spreckels . . . the Court holding that the tax imposed was valid and constitutional. It was contended on behalf of the Refining Co. that the act provided for a direct tax. The court, by Mr. Justice HARLAN, on page 411, said:
Clearly the tax is not imposed upon gross annual receipts as property, but only in respect of the carrying on or doing the business of refining sugar. It cannot be otherwise regarded because of the fact that the amount of the tax is measured by the amount of the gross annual receipts. The tax is defined in the act as ‘a special excise tax,’ and, therefore, it must be assumed, for what it is worth, that Congress had no purpose to exceed its powers under the Constitution, but only to exercise the authority granted to it of laying and collecting excises.
This case is very persuasive upon this point, for the corporation tax act was modeled upon the act of 1898 and the language of Mr. Justice HARLAN, just quoted.32
The same argument was adopted by the Court in Stone Tracy33 — is it still persuasive?
One problem with the argument is that it contradicts a much more recent precedent. As we learned from Chief Justice John Roberts in NFIB v. Sebelius, the label applied by Congress to a provision is not controlling, so what Congress calls a penalty may in fact be a tax.34 The fact that Congress called the corporate income tax an excise tax on doing business in corporate form in 1909 does not make the tax constitutional, especially since the legislative history shows they did not really mean it.35
Moreover, the corporate tax is harder to characterize as an excise tax than the tax upheld in Spreckels.36 In Stone Tracy, the Court defined an excise tax as “taxes laid upon the manufacture, sale, or consumption of commodities within the country, upon licenses to pursue certain occupations, and upon corporate privileges.”37 Spreckels involved a gross receipts tax on oil and sugar refiners. As such, it was a close substitute to a tax on oil and sugar, which is clearly an excise tax. As a gross receipts tax, it was also likely to be shifted to consumers, especially because the taxpayers were monopolies. This would make it an indirect tax.
What about an excise tax as a tax upon corporate privileges? In Stone Tracy, the Court stated that:
The tax under consideration, as we have construed the statute, may be described as an excise upon the particular privilege of doing business in a corporate capacity, i.e., with the advantages which arise from corporate or quasi corporate organization; or, when applied to insurance companies, for doing the business of such companies. As was said in the Thomas case, 192 U. S. 363, supra, the requirement to pay such taxes involves the exercise of privileges, and the element of absolute and unavoidable demand is lacking. If business is not done in the manner described in the statute, no tax is payable.38
But as the opponents of the tax have pointed out, it seems strange for the federal government to impose a tax on privileges granted by the states. Moreover, the modern corporate tax is also imposed on businesses that do not enjoy corporate privileges, like publicly traded partnerships, and even the 1909 tax was imposed on “association(s) organized for profit,” even if they were not incorporated.
Thus, it is not implausible that if Altria were to reach the Court, it would reverse Stone Tracy because the corporate tax was not an excise tax and calling it an excise tax was a subterfuge designed to shield it from Pollock by mislabeling what was an income tax. After all, even the Stone Tracy Court would probably not have accepted an individual income tax imposed as an “excise tax” on the privilege of being a U.S. citizen or resident as a valid way of avoiding Pollock. In that case, Altria could in fact serve as a vehicle for the Court to revisit the realization requirement, and the whole Moore saga would be repeated.
Moore involves a section that has no ongoing consequences. Altria involves a relatively minor drafting mistake in the TCJA. It would be truly ironic if the constitutionality of realization were to be determined in these contexts rather than in a context like the exit tax of section 877A, which directly raises the issue actually concerning the Court — taxing unrealized appreciation.
2 See Robert Goulder, “Oral Arguments in Moore: Does the Government Have a Problem?” Tax Notes Int’l, Jan. 1, 2024, p. 157; Goulder, “The Excise Power: Altria Waits Its Turn,” Tax Notes Int’l, Jan. 15, 2024, p. 395.
3 Reuven S. Avi-Yonah, “What Is the Best Candidate for a Post-Moore Constitutional Challenge?” Tax Notes Int’l, Jan. 1, 2024, p. 17.
4 Altria Group Inc. v. United States, No. 3:23-cv-00293. See also Michael Smith, “Altria Challenges IRS Downward Attribution Control Analysis,” Tax Notes Int’l, May 8, 2023, p. 808; Mindy Herzfeld, “Moore Is Not the End of TCJA Challenges,” Tax Notes Int’l, Nov. 27, 2023, p. 1215.
5 Section 958(b)(4).
6 See Andrew Velarde, “Altria’s Case Stayed Pending Realization Decision in Moore,” Tax Notes Int’l, Nov. 13, 2023, p. 1018.
7 See Herzfeld, supra note 4.
9 Flint v. Stone Tracy Co., 220 U.S. 107 (1911).
11 44 Cong. Rec. 3929 (June 29, 1909).
12 Tariff Act of 1909, section 38, 36 Stat. 112.
13 The following is based on the extensive discussion of the legislative history in Avi-Yonah, “Corporations, Society and the State: A Defense of the Corporate Tax,” 90 Va. L. Rev. 1193 (2004).
14 44 Cong. Rec. 3344 (June 16, 1909).
15 Arguably, the Court had decided in Nicol v. Ames, 173 U.S. 509, 519 (1899), that a tax on the Chicago Board of Trade was an excise tax even though the board was created by the state of Illinois. But Taft’s reference to “artificial entity” refers to the view that the tax can be imposed by a state on corporations because they are created by it in exchange for the benefits of incorporation, and that is why the congressional debate discussed below focused on which level of government created corporations. For the contrary position, see the excellent article by John R. Brooks and David Gamage, “‘From Whatever Source Derived’: The Sixteenth Amendment and Congress’s Income Tax Power,” Fordham Law Legal Studies Research Paper No. 4595884 (Oct. 8, 2023) (available on SSRN).
16 Spreckels Sugar Refining Co. v. McClain, 192 U.S. 397 (1899), cited by Taft in 44 Cong. Rec. 3344 (1909).
17 44 Cong. Rec. 3344 (1909).
19 Id.: “Another merit of this tax is the federal supervision which must be exercised in order to make the law effective over the annual accounts and business transactions of all corporations. While the faculty of assuming a corporate form has been of the utmost utility in the business world, it is also true that substantially all of the abuses and all of the evils which have aroused the public to the necessity of reform were made possible by the use of this very faculty. If now, by a perfectly legitimate and effective system of taxation, we are incidentally able to possess the Government and the stockholders and the public of the knowledge of the real business transactions and the gains and profits of every corporation in the country, we have made a long step toward that supervisory control of corporations which may prevent a further abuse of power.”
20 See, e.g., 44 Cong. Rec. 4237 (July 7, 1909) (Sen. Daniel).
21 44 Cong. Rec. 4006 (July 1, 1909).
22 “The United States did not create these corporations.” (Sen. Cummins, 44 Cong. Rec. 3977 (June 30, 1909).)
23 “I deny the right of Congress to levy a tax upon the business of corporations as such.” (Sen. Cummins, 44 Cong. Rec. 3976 (June 30, 1909).)
24 “Shall we levy an income tax upon the stockholders of all corporations for pecuniary profit, without respect or regard to the extent of the income earned or enjoyed by those stockholders?” (Sen. Cummins, 44 Cong. Rec. 3955 (June 29, 1909).) See also 44 Cong. Rec. 4008 (July 1, 1909) (statement of Sen. Clapp to same effect).
25 44 Cong. Rec. 3975 (June 30, 1909). See also the Bureau of Corporations Report on State Taxation (May 17, 1909): “Obviously a tax on the corporation is really a tax upon its stockholders, for otherwise than as a matter of legal reasoning a corporation and its stockholders are one.”
26 44 Cong. Rec. 3761 (June 24, 1909). The repeated references to the corporate tax as a tax on “accumulated wealth” would seem to characterize it as a direct tax on wealth, which would have made it unconstitutional under Pollock even if imposed on corporate income.
28 44 Cong. Rec. 3950 (June 29, 1909).
29 44 Cong. Rec. 4003 (July 1, 1909); see also 44 Cong. Rec. 4006 (distinguishing between earned income and “accumulated capital” which should be taxed). Sen. Cummins argued that the corporate tax would not achieve this purpose since it would fall on all shareholders, rather than just on management. 44 Cong. Rec. 4038 (July 2, 1909).
30 44 Cong. Rec. 3978 (June 30, 1909).
32 Ralph W. Aigler, “The Constitutionality of the Federal Corporation Tax,” 8(3) Mich. L. Rev. 206-220 (1910).
33 Stone Tracy, 220 U.S. 107, at 145: While the mere declaration contained in a statute that it shall be regarded as a tax of a particular character does not make it such if it is apparent that it cannot be so designated consistently with the meaning and effect of the act, nevertheless the declaration of the lawmaking power is entitled to much weight, and in this statute, the intention is expressly declared to impose a special excise tax with respect to the carrying on or doing business by such corporation, joint stock company, or association, or company.
35 See Stone Tracy, 220 U.S. 107. Moreover, the corporate tax is included in the Internal Revenue Code, Subtitle A, relating to income taxes, and not in Subtitle D, relating to excise taxes, so even the label has changed.
36 Spreckels, 192 U.S. 397.
38 Stone Tracy, 220 U.S. 107, at 219-220.