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Moore Cert Spurs Bets on Supreme Court’s Intention

Posted on July 21, 2023

The Supreme Court’s choice to hear Moore v. United States has observers wondering what piqued the Court’s interest and envisioning everything from nightmare scenarios for the tax code to a modest judicial rebuke.

Taking the case (Sup. Ct. Dkt. No. 22-800) could effectively be a preemptive shot at wealth tax proponents, potentially making it clear that such a future tax would be held unconstitutional by firmly establishing that income must be realized to be taxable.

The case could also inadvertently upend a wide swath of tax law, and — as some envision it — launch a rewrite of the tax code.

Or, the Court may have taken the case simply to reassert its place at the top of the legal pecking order.

At least four justices would have needed to vote for certiorari to take the case, and a wide range of observers agreed that those justices wouldn’t have done so if their intention was simply to affirm the Ninth Circuit (36 F.4th 930 (2022)) and district court (No. 2:19-cv-01539 (W.D. Wash. 2020)) in rejecting a constitutional challenge to the transition tax imposed by the Tax Cuts and Jobs Act. They also agreed it’s a good bet those four or more justices came from the conservative wing of the Court.

Which particular gripe those justices had at the forefront of their minds when they took the case remains the key, unanswered question.

“To hear the case, in my mind, is about reversing the case,” said Steven M. Rosenthal of the Urban-Brookings Tax Policy Center, who was convinced those justices had future progressive tax reforms squarely in their sights when they voted to take the case. He noted that eight different groups filed amicus briefs, all making the same argument, that the 16th Amendment requires income to be realized to be taxable.

Rosenthal further observed that the Court isn’t addressing a split in the lower courts, that the amount of money at stake for the petitioners — just under $15,000 — is a relative pittance, and that the repatriation tax is a temporary transition rule, not a long-term, ongoing problem that would need to be rectified.

“So the case itself is rather modest, other than does it breathe fresh life into the realization doctrine?” Rosenthal said.

If that’s so, the consequences could be enormous, not just for future progressive policymaking, but for many areas of existing tax law.

Case in Point

The case was brought by the conservative Competitive Enterprise Institute and Baker & Hostetler LLP on behalf of Kathleen and Charles Moore, who own shares in KisanKraft, a controlled foreign corporation that provides agricultural equipment to rural farmers in India. They have yet to directly receive any income from the investment because the company has reinvested all profits back into the business.

However, the section 965 repatriation tax — a transitional tax structure enacted as part of the TCJA — imposed a roughly $15,000 tax bill on the Moores’ share of KisanKraft’s reinvested profits.

There were two issues at the core of the Moores’ complaint: first, that taxable income must be distributed to comply with the 16th Amendment’s realization principle; and second, that Congress improperly applied the transition tax retroactively. Both the U.S. District Court for the Western District of Washington and the Ninth Circuit acknowledged that the tax was retroactive, but they argued that it was justified, and the Moores’ petition to the Supreme Court doesn’t challenge that aspect.

Instead, the focus of the Moores’ petition before the Supreme Court is the realization argument. The four dissenting judges on the Ninth Circuit’s rehearing panel were all Republican appointees, and one of them — Patrick J. Bumatay — argued in the dissent that the core issue is the unfairness of taxing income before it’s realized and the constitutional limitation on that, which they argue was reinforced by Eisner v. Macomber, 252 U.S. 189 (1920).

In that case, which involved the taxability of a pro rata stock dividend, the Court majority concluded that realization of income is a constitutional requirement of an income tax under the 16th Amendment.

“I find it very hard to believe that they took this case to say the [Ninth Circuit] majority was right and that this very conservative, Federalist Society-type dissent was wrong,” said Mitchell Gans of Hofstra University’s Maurice A. Deane School of Law. He cited Chief Justice John G. Roberts Jr. himself, who in writing the majority opinion for the 2012 Affordable Care Act case, referenced the Court’s decision in Eisner.

“A lot of people have thought that Eisner had effectively been overruled,” including the Ninth Circuit, which cited a series of cases that the judges argued showed a retreat from Eisner, said Gans. He wrote an article in 2021 predicting that the constitutional arguments for realization could find a receptive audience among at least some on the Court’s conservative wing.

But the Court has never explicitly overruled Eisner, Gans continued, and with Roberts’s reference to it in 2012, “I certainly inferred he was at least interested in exploring the ramifications of that case and wasn’t prepared to say it was entirely overruled.”

Rosenthal counted himself among those who believed Eisner was dead. “It was a pretty dumb decision from the start,” he said.

In Cottage Savings Association v. Commissioner, 499 U.S. 554 (1991), the Supreme Court majority described the realization doctrine as a matter of administrative convenience. And subsequently, Rosenthal recalled, as a staffer for the Joint Committee on Taxation in the 1990s, he drafted tax legislation involving financial products with the expectation that the realization principle was indeed an administrative consideration, not a constitutional limitation.

Rosenthal noted that it was Roberts himself who tried to breathe life into the realization doctrine in Cottage Savings. As acting solicitor general on that case, Roberts argued — on behalf of the IRS — that there was no realization on the mortgage swaps at issue in the case.

“He lost 7-2 in 1991, and I don’t think he ever forgot it,” Rosenthal said.

The constitutional originalism argument is also likely to hold a lot of sway with the conservative majority on the Supreme Court, Gans observed. The 16th Amendment was adopted in 1913, and with Eisner coming just seven years later, an originalist could argue that was a contemporary decision. It was also one that relied on the dictionary definition of income, and using contemporary dictionaries is a common precept of originalism, he noted.

“I think the stars are aligned here,” Gans said. “It’s hard for me to believe that this group of justices took this case to make it clear that all these progressive kinds of taxes are going to be OK.”

However, one former congressional tax staffer interpreted those same stars differently, telling Tax Notes that they believed a conservative, originalist Court would be philosophically inclined to be deferential to Congress. Upending settled legislative principles could open a legal can of worms, they warned.

“I’m a creature of the legislature. I don’t like regulators to overstep. I don’t like courts to overstep. If Congress says something, they’re accountable to the people,” the former staffer said.

Know Your Place

Not all observers agree that the Court had the tax code on its mind when it granted cert.

“I imagine there’s a substantial chance they’re reacting more to the language than the holding itself,” said David Gamage of the Indiana University Maurer School of Law. The language and reasoning in the Ninth Circuit’s majority opinion “went much further than was needed to get the results they wanted,” and the Supreme Court could be concerned primarily with that rather than the question of when taxable income is realized, he said.

The Ninth Circuit “came out with guns blazing,” agreed Andy Grewal of the University of Iowa College of Law, pointing out that the lower court concluded that the Supreme Court’s decision in Eisner had effectively been overruled over the past century.

That kind of thinking is nothing new for the Ninth Circuit. When asked about the Supreme Court’s frequent reversals of Ninth Circuit holdings, Judge Stephen Reinhardt from that circuit famously replied that the Supreme Court “can’t catch them all,” Grewal noted.

But as recently as 2016, the Supreme Court reminded litigants that “it is this Court’s prerogative alone to overrule one of its precedents.”

According to Grewal, the Supreme Court’s justices may have decided it was time to send another message.

Collateral Damage

Requiring realization for income to be taxable could have implications for far more than just the section 965 transition tax.

If the Supreme Court decides to reinvigorate the realization principle as a constitutional requirement, “I think it’ll blow up a lot of the financial products statutes that I helped draft,” Rosenthal said. And that’s just the start.

A broad interpretation of the realization principle could also upend partnership taxation. Subchapter K is predicated on taxing partners’ income before it’s actually distributed — a point emphasized by the dissent in Eisner, Rosenthal noted. And if partnership taxation falls, so too would the taxation of controlled foreign corporations and S corporations under subparts F and S, he added.

It would also put a major dent in efforts to enact a wealth tax and other progressive tax proposals, like the mark-to-market proposal envisioned by Senate Finance Committee Chair Ron Wyden, D-Ore. Wyden said in a statement he was confident his proposal could survive legal challenges.

The best outcome, according to Rosenthal, would be for the Court to simply announce this fall that it had changed its mind and decided not to hear the case after all. That being unlikely, he said his next best hope — and expectation — was that the Court’s decision would be narrow, although he admitted he wasn’t sure what exactly that would look like.

“The Court may rule against the Moores in terms of requiring a cash distribution, but in describing the realization doctrine, they could take Congress to task and say that it still has life in it,” Rosenthal suggested.

That could conceivably leave taxation of partnerships, CFCs, S corps, and the like alone but still have implications for capital markets rules regarding constructive sales, zero-coupon bonds, and more, which were drawn up to prevent investors from deferring income and converting it to lower-taxed capital gains, Rosenthal observed.

“That upsets me, but I think that it heartens the Supreme Court justices,” Rosenthal added.

Gamage similarly predicted a narrow holding, one that perhaps rules against the Moores but includes language in dicta “hand waving at all the broader stuff.” To him, Moore is an international corporate tax law case, and since the corporate income tax both precedes the 16th Amendment and has been upheld as an excise tax, that could make the case different from the wider question of what is considered taxable income to an individual under the 16th Amendment.

“Are they planning on blowing up subchapter K? I doubt it,” he said, adding that that would be “unprecedentedly dramatic” in tax.

Grewal also predicted that the justices would shy away from stomping all over the tax code.

“Every party before the Court, in every case, says the world is going to end if they lose,” so merely listing a “parade of horribles” that could come from a decision won’t be enough to sway the justices, Grewal said. However, he predicted the Court would receive a litany of briefs on the case explaining the potential consequences, and if those arguments are convincingly presented, that could shape the outcome, he said.

Congressional Audience

If the Court went big and opted to broadly require realization for income to be taxable, it would undoubtedly get the attention of lawmakers.

One potential scenario is that Congress could unite to resolve the issue. Something akin to that happened in the aftermath of Gitlitz v. Commissioner, 531 U.S. 206 (2001).

In Gitlitz, the Court approved 8 to 1 the deduction of the petitioner’s phantom S corporation losses. Congress promptly responded later that year by amending section 108, and lawmakers went further by including a subtle jab at the Court in their conference committee report on the legislative fix, in which they said that when the plain text of a tax statute creates an ambiguity, “the provision should be read as closing, not maintaining, a loophole.”

But where fixing Gitlitz required tweaking a tax statute, fixing a broad ruling in Moore to clarify the taxability of income could require a constitutional amendment, and that’s not something observers think is probable.

“Anything’s possible, I guess,” Jorge Castro of Miller & Chevalier Chtd. told Tax Notes. “But given current political dynamics . . . probably unlikely.”

The former congressional tax staffer observed that Congress has shown it can sometimes move quickly in response to judicial decisions, as it did after Gitlitz, or in its legislative response to the Ninth Circuit when that court limited the parsonage allowance in 2002. But the constitutional question at the heart of Moore makes it a much different consideration, the staffer said.

For now, lawmakers have yet to unite behind a message. Wyden’s statement in response to the grant of certiorari warned that the petitioners’ desire to reverse the Ninth Circuit would upend settled law and interfere with congressional authority. He added that he had expected his billionaire’s tax proposal to face a well-funded legal challenge but maintained that he was “totally confident that it’s constitutional.”

Other Senate taxwriters weren’t so certain when asked by Tax Notes about their reaction to Moore. Both Finance Committee members Mark Warner, D-Va., and Ron Johnson, R-Wis., said they weren’t aware of the case yet, although Johnson suggested he wouldn’t mind seeing the Court drop a bomb on the tax code.

The Supreme Court generally doesn’t like disruptive things too much, which in some respects is unfortunate,” Johnson said. “When it comes to taxes, we gotta blow up the status quo."

Follow Jonathan Curry (@jtcurry005) on Twitter for real-time updates.

Doug Sword contributed to this article.

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