Moore v. United States – Hand Grenade or Much Ado About Nothing? – Corporate income tax

In December, the nation’s highest court will hear oral arguments to decide whether a taxpayer will owe a tax bill of $14,729, a relatively small amount but given the possibility of seeking $271 billion in taxpayer refunds and challenging Internal Revenue chapters. (IRC) code that affects millions of Americans.

In this article we will discuss why Moore v. United States is a critically important tax case and its implications for the lives of ordinary Americans. Charles and Kathleen Moore (The Moores) are challenging the mandatory repatriation tax (MRT) enacted as part of the Tax Cuts and Jobs Act of 2017 (TCJA), a cornerstone achievement of the previous administration.

MRT background

Before discussing the MRT, it is important to briefly discuss the TCJA. From a macro perspective, the TCJA sought to incentivize corporations to remain in the United States and repatriate foreign-sourced earnings and profits by lowering the corporate tax rate to 21% and using a territorial tax system. The territorial system taxes income according to where it is earned. That way, if a U.S. corporation repatriates foreign-sourced earnings and profits, it owes no additional taxes on those amounts. A Joint Committee on Taxation estimate valued accumulated foreign source earnings and profits at $2.6 trillion as of 2015.

However, to avoid a significant windfall on US corporations, the TCJA imposed a one-time tax on undistributed foreign earnings and profits. Deemed Repatriation, or MRT, applies to US shareholders who own 10 percent or more (by value or voting power) in a controlled foreign corporation (CFC) – a foreign entity with more than 50% US ownership. The tax is assessed to the shareholders on a pro rata basis of the CFC’s relevant income at a rate of 15.5% and is payable over a period of eight years, without interest. Therefore, from a micro-perspective, the TCJA classified retained earnings and profits of foreign source companies as realized taxable income.

In 2005, the Moores invested in KisanKraft, an Indian corporation that supported small farmers, and acquired 11% of the company’s shares without participating in the decisions. After the enactment of the TCJA, and by extension the MRT, the Moores were given a share of KisanKraft’s accumulated earnings, leaving them with an additional $132,512 in taxable income in 2017 and an additional $14,729 in income taxes.

Case history

The Moores challenged the constitutionality of the MRT, but the district court dismissed the action for failure to state a claim. The Moores appealed the lower court’s decision to the 9th Circuit, arguing that MRT violated the Appointments Clause and the Due Process Clause of the Fifth Amendment. However, the 9th Circuit affirmed the lower court’s decision, holding that the MRT was permissible under the Sixteenth Amendment and “(w)hether the taxpayer realized the income does not determine whether the tax is constitutional.” However, a dissenting opinion from the 9th Circuit held that realization is part of income and without it, the appointment provision is effectively a dead letter, a “only the people have the power to declare” right.

The Supreme Court granted cert and is scheduled to hear oral arguments in December. While the Moores presented numerous issues to the Court of Appeals, their brief to the Supreme Court addresses only whether the Sixteenth Amendment authorizes Congress to tax unrealized amounts without appointment among the states.

However, before discussing the arguments and their nuances, it is important to mention the Sixteenth Amendment.

“Congress shall have power to lay and collect taxes on income, from whatever source, without apportionment among the several states, and without regard to any census or enumeration.”

Arguments of the petition

Simply put, the Moores argue that the Sixteenth Amendment requires that income be realized before it can be taxable. Because the MRT assessed a tax on Moore’s share of the foreign corporation’s income, regardless of whether the Moores realized that income, the MRT is an unconstitutional tax under the Sixteenth Amendment.

Moore’s basic argument – ​​income must be realized – comes from Eisner v. Macombera 1920 Supreme Court decision behind the proposition that “mere growth or increase in the value of a capital investment is not income,” but rather income from property is that which is “received or drawn by the recipient (taxpayer) for its separate use, benefit and disposition.” In other words, the income must be realized.

Moores argument is supported by references to historical definitions of income at the time the United States ratified the Sixteenth Amendment, including a Supreme Court decision four years after ratification that understood income as “actual cash as opposed to deemed due but unpaid income.” ” They also refer to dictionaries and academic writings.

These historical definitions and academic writings help support the claim that Congress’s power to tax without apportionment is limited to income taxation. If income were understood only as that which is realized, then the original interpretation of the intent would require holding the MRT as an unconstitutional tax on unrealized profits.

Arguments of the opponent

In response, the United States argues that while income under the Sixteenth Amendment may include a realization event, income has a broader definition, allowing Congress to tax unrealized gains.

The United States’ argument relates more to a 1955 Supreme Court decision, Commissioner v. Glenshaw Glass, for the proposition that “gross income” includes “any `access(es) to wealth.’” Along these lines, Congress argues a long history of similarly structured income taxes that do not require realization. For example, the Supreme Court upheld a tax on a “pro rata share of (a) company’s net income” even where the share was not “actually apportioned, either by agreement of the parties or by operation of law.” A shareholder in an S corporation is effectively taxed on the shareholder’s pro rata share of the corporation’s items of income.

But even if the Supreme Court were to rule that income requires realization, the United States offers an alternative argument for why the MRT is constitutional. If realization is a requirement of income, then the Court must look to the corporation, not the Moores. Neither party disputes that KisanKraft made profits, not just appreciation of its assets, and Congress has a long history of ignoring the corporate form to make it easier to tax shareholder income. So while the Moores may be upset that the corporate form was overlooked, this is ultimately a policy decision by Congress.

Impacts

The United States’ alternative argument leads to a broader and less defined discussion of the consequences of how this case is decided. If the Supreme Court were to fully accept Moore’s argument and take it to its logical conclusion, other sections of the Internal Revenue Code would be susceptible to similar claims that they are unconstitutional under the Sixteenth Amendment.

Pass-through entities such as limited liability companies, partnerships, and s-corporations likely represent America’s workforce. Together, they employ more than 60% of Americans, generate more net income, and pay a larger share of federal business income taxes than C-corporations. However, the collective power of pass-through entities overshadows the fact that the vast majority of them are small businesses that rely on a predictive tax structure.

The chapter on taxes for sole proprietorships, limited liability companies (subchapter K), and s-corporations (subchapter S) shares many of the same characteristics as the MRT. In each structure, individual owners are taxed on their share of the entity’s income, regardless of whether the income is distributed. If the Supreme Court were to adopt Moore’s reasoning—undistributed business income cannot be taxed under the Sixteenth Amendment—it would undoubtedly create uncertainty in subchapters K and S. It is not beyond the realm of possibility that these chapters would be successfully challenged. conversion from a single tax structure to a double tax structure may be required.

Conclusion

Moore v. United States calls into question a key part of the American tax system and threatens to create more uncertainty in the future. If the MRT is unconstitutional and the concept that corporate profits not otherwise distributed to shareholders or members cannot be taxed, the US tax system would undergo a profound change. While this problem may have started with a tax bill of less than $15,000, the ramifications stretch into the trillions.

The TCJA went through a process known as reconciliation. This required that the deficit not increase beyond the ten-year budget window. The MRT was one of several provisions necessary to offset the reduction in tax revenue collected. Pub. L. 115-97.

The content of this article is intended to provide a general guide to the issue. Professional advice should be sought regarding your particular situation.

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