Supreme Court justices expressed consternation over a broad ruling when deciding whether the 16th Amendment has an income realization requirement, but tax experts indicated that the government arguably had the upper hand in oral arguments.
The Supreme Court heard oral arguments in Moore v. United States, No. 22-800, on December 5.
During arguments from Andrew M. Grossman of Baker & Hostetler LLP, who represents the Moores, several justices peppered him with questions about upending other parts of the code. The justices seemed acutely aware of the potentially enormous reach of a taxpayer-favorable ruling requiring realization and repeatedly questioned Grossman on how the transition tax could be distinguished from provisions such as subpart F, partnership taxation, and mark-to-market regimes.
Charles and Kathleen Moore are seeking a refund of $15,000 in taxes that they paid on undistributed earnings from an Indian controlled foreign corporation of which they were minority owners. They have challenged the section 965 transition tax imposed on a taxpayer’s post-1986 accumulated foreign earnings, arguing that it is a direct tax and therefore unconstitutional because it is not subject to apportionment. In June 2022 the Ninth Circuit affirmed a district court’s decision to reject the challenge. In its decision, the Ninth Circuit said that courts have consistently held that taxes like the transition tax are constitutional and that whether income is realized is not determinative. But the Moores have continually argued that realization is a necessary constitutional requirement under the 16th Amendment, which allows for taxation of income without apportionment.
The Moores’ dispute may be over a relatively small sum, but the potential invalidation of the transition tax could have a significant effect on the U.S. coffers, without even considering other provisions that could be caught in the ruling. The Joint Committee on Taxation projected the tax to raise $340 billion over 10 years. In their briefing to the Court as well as in oral arguments, the Moores have argued that the transition tax is uniquely unconstitutional. The government has countered that the transition tax shares the same features as subpart F and that there are many long-standing provisions under which Congress decided to tax individuals on undistributed business earnings.
“Even across the Court’s usual ideological divides, we heard clear, well-grounded skepticism from justices about the petitioners’ radical legal theory, which would shake the pillars of our income tax system built on a bipartisan basis over decades,” Chye-Ching Huang of the Tax Law Center at NYU Law said in a statement.
Steven M. Rosenthal of the Urban-Brookings Tax Policy Center was also comforted by the fact that neither the Moores, nor the government, nor the justices appeared to want to “blow up the tax code.” He was also encouraged that Justice Brett Kavanaugh seemed to support the government’s position, although he was disappointed that Justice Neil Gorsuch favored breathing new life into a realization requirement.
“From the judges’ questions and demeanor, it seemed that the government had the favored position,” Monte A. Jackel of Jackel Tax Law said, arguing that the Court appeared to be leaning toward deciding either that there is no realization requirement under the Constitution or that there is one and it was satisfied in the case.
Jackel added that the Court also seemed to be bothered by a potential ruling that there could be no discernible boundaries to taxing power.
“I know the adage that the impression one gets from the oral argument is, at times and maybe many times, the opposite of where the case ends up. It just seemed that the Court was very troubled by the possibility of doing any damage to the existing taxation regimes today,” Jackel said.
Ilya Shapiro of the Manhattan Institute also argued that the ruling from the Court is likely to be narrow, given concerns voiced by justices during oral arguments, with Justice Amy Coney Barrett and Kavanaugh appearing to look for a compromise.
Isn’t This About Attribution?
As they had during briefing, the Moores sought to rely on Eisner v. Macomber, 252 U.S. 189 (1920), in which the Court held that a stock dividend was not subject to tax under the 16th Amendment. Grossman argued that following that precedent “makes easy work of this case.”
Chief Justice John Roberts was the first to ask about whether the transition tax could be considered applying to realization by the corporation, even if not the taxpayer directly, questioning whether this distinguished it from a tax on the appreciation of property. Justice Sonia Sotomayor also asked why individual partners in a partnership are taxed regardless of whether they have realized anything.
According to Grossman, partnership taxation is fundamentally different because there is no separate personhood, unlike corporations.
Sotomayor pressed him further, asking how he would distinguish subpart F or taxation of S corporations. She expressed hesitation at undermining such long-standing provisions. Grossman argued, however, that subpart F works on a current basis, concerns some categories of income, and is designed to address income shifting regarding an ability to control and redirect income.
Kavanaugh wondered if it wasn’t more a question of timing as the entity could be considered to have realized income. He also appeared skeptical about why the type of income would matter if attribution is allowed.
On rebuttal, Grossman argued that simply allowing a corporation’s earnings to be attributed to a shareholder is “staggeringly broad,” given the lack of carveouts under the code and the amount of retained earnings held by many corporations.
“Apparently, Congress could simply tax backwards, reaching back as far as it would care to do so to attribute those earnings going back many years to current shareholders,” Grossman said.
During Grossman's initial argument, Sotomayor wondered if his distinctions were more an attack on due process and a question of how far back Congress can tax. She argued that the concept of realization was well established when the 16th Amendment was adopted and that nowhere in the text of the amendment is realization expressed.
Throughout the arguments, there was no specific mention of the global intangible low-taxed income provision or section 956. Sotomayor was not alone, however, in questioning Grossman’s distinction from subpart F, with Barrett also asking about that, and Justice Elena Kagan wondering how it could be considered different from this well-settled area of law in which Congress sought to tax shareholders of foreign corporations to keep them from avoiding taxation. Barrett also wondered whether attributing income to the Moores was better understood as a due process question rather than a definitional question about income.
Sotomayor suggested it would be dangerous to announce what realization is out of context and come up with a working definition for every piece of property.
But Grossman cautioned the Court against ruling in the government’s favor in finding that the question was really one of attribution since the corporation realized income, because it would open the door to many types of taxation. He argued that all property is the fruit of income at some time.
Based on questions to Grossman, Mark Berg of Klehr Harrison Harvey Branzburg LLP said that the justices could be sympathetic to the argument that ruling for the Moores would jeopardize other tax provisions, though he hoped they would see fundamental differences between the transition tax and the other provisions that would allow the Court to uphold realization under Macomber.
“While the attribution of an entity’s income to shareholders or partners under subpart F, subchapter K, and subchapter S is, consistent with Macomber, an attribution only of the entity’s current income, the [transition tax] at issue in Moore taxed shareholders on a corporation’s previously accumulated and capitalized income (that is, its capital) in a manner that is in direct violation of the principles clearly articulated in Macomber,” Berg said in an email (emphasis in original). “Moreover, the argument that the accrual method of accounting results in the taxation of unrealized income, and therefore would be at risk were the Court to uphold Macomber’s realization principle, simply misunderstands the accrual method of accounting and conflates realization with receipt of cash.”
Giving a Little Ground on Wealth Taxes?
John Brooks of Fordham University School of Law said it was clear that the justices were concerned with wealth taxes, and he expected the opinion to have some language addressing it, regardless of who wins. He also said that the taxpayers’ arguments about the original historical meaning of income were not given much weight by the Court.
According to Donald Susswein of RSM US LLP, “the headline of the day” could be the government stating that a tax levied on property’s value rather than its appreciation would be a direct tax, which would be unconstitutional unless apportioned. Susswein also contended that arguments from the Moores’ attorney over concerns with subpart F were not forcefully advanced in oral arguments. Regarding realization, Susswein said that the Moores’ counsel had difficulty defining the concept or what it requires.
“Macomber, at times, seemed to be treated as almost meaningless on its own terms, and meaningful only for any ongoing meaning that might be ascribed to its use of the term ‘realization.’ Indeed, near the end, the government was asked by one of the justices whether Macomber should simply be overruled, as most of the argument seemed to assume it had little ongoing relevance outside of stock dividends or stock splits,” Susswein said.
Asked about it by Roberts, Solicitor General Elizabeth B. Prelogar, representing the government, argued that Macomber is limited to its narrow facts.
Prelogar was also pressed by the Court over whether her position that there is no realization requirement could lead to taxation on appreciation of wealth through real estate or security holdings.
Justice Clarence Thomas asked her whether an increase in the value of real property would be taxable. And Justice Samuel Alito followed up by asking whether an appreciation on stock value could be taxed. In both instances, Prelogar admitted that these would be more difficult questions. But she pointed to other taxes previously imposed by Congress, such as mark-to-market taxes, as examples of taxation on appreciation. She admitted, however, that if Congress did not have the same tradition of levying taxes on something, it would make for a more difficult case than arguing for the constitutionality of the transition tax, which falls in line with many other taxes historically. She urged the Court to take each tax as it comes and not be overly concerned with hypothetical taxes that may never come to be.
Asked by Barrett if the Moores' concession that subpart F is constitutional was significant, Prelogar said it was “incredibly significant” because the different kinds of income being taxed don’t constitute a distinction.
Alito acknowledged the far-reaching consequences of a ruling in favor of the Moores, but he also questioned Prelogar on the consequences of her position and the argument that realization is just a matter of administrative convenience. He wondered whether Congress could be opening the door to taxation of retirement funds.
“The door is already open,” Prelogar said, again arguing that hypotheticals should not be used to announce bright-line rules that would take down existing provisions of the code, especially when many practical and policy considerations may stand in the way of such hypothetical taxes.
Kavanaugh asked whether a federal tax on the value of a person’s property or holdings would be a direct tax that would have to be apportioned. Prelogar agreed that it would be.
“That is a quintessential tax on property because it is looking to the total value of the asset, and it’s doing it at a particular point of time," Prelogar said. "That’s totally different from an income tax where you are taxing the increment of gain over time and generally only doing it one time, with any future tax looking to a new increment of gain over a new period of time.”
Prelogar acknowledged that the Court could rule narrowly by finding that the corporation realized earnings.
Sotomayor said that she didn’t fault the parties “for shooting for the stars,” but she posed two ways that the Court could rule narrowly for the government: It could say that there is a realization requirement and the corporation realized income, or it could assume realization was met here. Prelogar cautioned against the Court ruling in favor of any realization requirement as it could still wreak havoc on provisions such as mark-to-market taxation and expatriation taxation. She also did not want the Court to use the phrase “constructive realization” in its ruling, arguing that the phrase is “inherently amorphous” and that the Moores invented it to save other provisions.
Prelogar also argued that none of Grossman’s purported distinctions between the transition tax and other provisions held up to scrutiny. Arguments that S corporation taxation involved the consent of taxpayers to be taxed that way wouldn’t cure constitutional defects, she said. Further, control was the same with the rest of subpart F, and the transition tax was also drafted in response to tax avoidance concerns, she argued. The length of the lookback period wouldn’t change the question of what is being taxed as income either, she said.
“This was actual income brought in by the company, kept in its coffers. If it was income in year 1, then I don’t think there is any expiration date as classifying it as income in a future year. And I think it would be anomalous for Congress to lose its ability to tax that as income just because it has granted it a period of tax deferral,” Prelogar said.
Prelogar added that the lookback period was a retroactivity concern arising under due process and turning on whether Congress had a rational basis for the tax. She argued that rational basis is clearly satisfied and that the earlier due process argument had already been rejected by the Ninth Circuit and was not raised again in the Supreme Court.
“The heart and strongest part of the government argument seemed to be that realization, if it is constitutionally required, happened at the entity level — and all that was involved was the ‘attribution’ of that entity income to the owners — much as routinely occurs in passthrough entities,” Susswein said. “The government all but said that the foreign corporation here was a de facto passthrough entity — pointing out it was a foreign entity with no U.S. tax imposed (or imposed only with great difficulty). The main issue, in questioning, seemed to be how broadly or narrowly a win for the government might be reached.”