Frost Law
This past summer, the Supreme Court granted certiorari to the most consequential tax case of our time, Moore v. United States. The case which originated in the District Court presents a challenge to the Mandatory Transition Tax (the “MRT”) under section 965 of the Internal Revenue Code (the “IRC”). At trial, the Moores argued that the tax imposed by MRT is unconstitutional because it is a tax on property (accumulated earnings) rather than a tax on current income (as with subpart F income and GILTI). More specifically, since no income was earned, the Moores claimed that the MRT was an unconstitutional direct tax on property not apportioned by the states by population.
The District Court ruled against the Moores and in favor of the Government. On appeal, the Ninth Circuit affirmed the District Court’s decision.
IRC section 965 was enacted as part of the Tax Cuts and Jobs Act of 2017 (the “TCJA”). It requires U.S. shareholders to pay a transition tax on the untaxed foreign earnings of certain specified foreign corporations as if those earnings had been repatriated to the United States. This transition tax was a one-time tax that taxed the deferred and untaxed income of U.S. shareholders as the U.S. international tax system made a very dramatic change from a largely deferral model to a semi-territorial model beginning on January 1, 2018.
As noted above, the income subject to tax under IRC section 965 was the deferred and untaxed income of certain foreign corporations. More particularly, this income comprised the portion of the foreign company’s earnings and profits (“E&P”) that may or may not have been previously taxed by the local country jurisdiction but not yet taxed by the United States.
The decision by the Supreme Court to grant certiorari in the case came as a surprise to many tax practitioners and academics. This is due to the fact that the constitutionality of income taxation under the IRC is seldom challenged. In fact, there was only one case that was heard by the Supreme Court since the enactment of the Sixteenth Amendment (which provides for the Federal income tax). That case was Eisner v. Macomber, which was decided in 1920. With the legal and constitutional bases of the tax code provisions in the IRC, undisturbed for decades, practitioners and academics alike were baffled by the Supreme Court’s grant of certiorari since there was no split among the Circuits nor a declaration of an unconstitutionality of a statute which are often the bases for taking up a case.
To some observers, the Supreme Court or some of its members may have agendas other than the pure interpretation of law and jurisprudence. Some commentators pointed to the fact that the principal motivation for granting certiorari in this case was espoused by some potentially libertarian organizations devoted to free enterprise, capitalism, and deregulation. These organizations are known to have opposed the imposition of wealth taxes and have vigorously advocated, lobbied, and fought against it. For them, if the MRT was not struck down, it would provide the basis for the possible adoption of a wealth tax in the United States. By granting certiorari in this case and by finding IRC section 965 unconstitutional, the Court would be opening the possibility of millions of dollars of refund claims and litigation regarding the constitutionality of Subpart F, Subchapter K, Subchapter S, and the mark-to-market regime.
The Ninth Circuit found the position advanced by the Moores to be untenable. The Court said, “whether the taxpayer has realized income tax does not determine whether a tax is unconstitutional.” The Supreme Court has made it clear that realization of income is not a constitutional requirement for current federal income taxation. The Ninth Circuit described Moore’s reliance on Eisner v. Macomber and the subsequent case of CIR v. Glenshaw Glass as misplaced. In the long line of decisions on the matter, the courts have maintained that realization is not a requirement for an income to be taxed by the federal government.
But why then did the current Supreme Court grant certiorari?
It appears that in addition to the potential ideological leaning of some members of the Court, these same members were also convinced by the reasoning put forth by the dissenting opinion of the Ninth Circuit ruling. The dissent states that the majority opinion claims that the Sixteenth Amendment authorized an unapportioned tax on unrealized gains because “realization of income is not a constitutional requirement.” According to the dissenters, “neither the text and history of the Sixteenth Amendment nor precedent support levying a direct tax on unrealized gains . . .” Hence, if this is not reined in, this might set the stage for Congress to impose a wealth tax.
Let us examine the decisions of the Supreme Court on the issue of whether realization is a requirement in the taxation of income and whether the imposition of direct taxes is constitutional.
In Hylton v. United States (1796), the court held that the federal tax on carriages to transport humans and cargo was not a direct tax subject to the constitution’s apportionment requirement. Direct taxes are limited to head (capitation) taxes and taxes on land.
In Collector v. Hubbard (1871), the court noted that during the Civil War, the government taxed corporate income, whether distributed or not, and taxed other unrealized gains such as the appreciation of the value of livestock, whether the livestock was sold or not.
The court in Springer v. United States (1881) ruled that Civil War income tax was held to be constitutional in line with the decision in Hubbard.
However, there seems to be a break in the Court’s doctrinal orientation.
Hubbard remained a “good law” until Pollock v. Farmer’s Loan and Trust Co. (1895). The court in Pollock held that the Civil War income taxes are "direct taxes" and not constitutional stating that income taxes are direct taxes and thus must be divided among states according to population. Pollock struck down the income tax in 1895 as a direct tax, holding that a tax on income from real or personal property had to be apportioned to the states. This may be the only case that may support Moore but that case was struck down in subsequent cases brought to the Supreme Court.
Then came the case of Eisner v. Macomber (1920). In Eisner, the court held that the income tax imposed on the proportionate increase of stocks via the distribution of stock dividends was unconstitutional. Speaking for the Court, Justice Pitney, reasoned that tax upon rents and profits of real estate and upon returns from investments of personal property were in effect "direct taxes" from property from which income arose. Congress could not impose such taxes without apportioning them among the states according to population. Stock dividends were not income and imposing tax thereon was unconstitutional. It is worth noting that Justice Brandeis dissented and opined that the stock dividend is equivalent to the receipt of cash followed by reinvestment and argued that they were equivalent to taxable income under the Sixteenth Amendment.
The most important implications of Eisner’s definition of income were:
Each of these corollaries of Eisner has heavily influenced the basic framework of the U.S. federal income taxation but are no longer accepted as constitutional limits on the taxing power of the federal government.
In United States v. Kirby Lumber (1931), the court found for the government saying that income was realized by a corporation on the purchase of its own bonds for less than the issued price despite the argument that it did not produce any gain that was “severed” from its capital.
The next step in decimating the authority of Eisner was in 1940. The court in Helvering v. Bruun held that a landlord realized gain on the forfeiture of a leasehold where a tenant added about $50,000 to the value of the property. The court stated that the event generated taxable income because “it is not necessary to recognition of taxable gain that the taxpayer should be able to sever the improvement begetting the gain from his original capital.”
In the 1943 case of Helvering v. Griffiths, the court described Eisner as “limited to the kind of dividend” particularly presented in that case.
There were other cases that reduced the significance of Eisner, but the most important one was the 1955 case of CIR v. Glenshaw Glass. The court stated that while Eisner said that the taxpayer had “received” nothing out of the company’s assets for his separate use and benefit . . . the distribution (of corporate stock) was concluded to be a taxable event. In that context, “distinguishing gain from capital, the definition served a useful purpose. But it was not meant to provide a touchstone to all future gross income questions.” Perhaps, the final nail in the Eisner coffin.
This survey of the decisions of the Supreme Court appears to show that realization is not a requirement for the imposition of a tax on income and that Congress is given a broad and plenary power to tax. As the Ninth Circuit put it, Moore’s reliance on Eisner is “misplaced.”
As stated at the outset, the income in contention in Moore had already been taxed. The post-1986 E&P that was taxed under the MRT had already been subjected to tax in a foreign jurisdiction (i.e., India). The foreign corporation’s profits therefore were taxed, but the tax on the U.S. shareholders (on those profits) was deferred until actual distribution under prior law. At issue is whether there is a realization in the income being taxed under the MRT.
There is no doubt that sustaining Moore’s position could potentially be disruptive to an otherwise stable system of U.S. federal taxation, open the gates of litigation, and possibly cause more confusion and serious financial harm to the U.S. government.
Many federal taxes in the IRC do not require realization. And, as noted above, if the Court requires realization as a constitutional matter for a tax on income to be imposed, it may impact the many provisions of the IRC that could be rendered unconstitutional – subpart F, GILTI, branch profits tax, section 1256 and section 877A, the PFIC rules, Check-the-Box election rules under section 7701 are only some of the provisions that could be rendered unconstitutional.
The Justices’ decision will undoubtedly affect future legislation in this area. With a majority of Justices lacking significant background and experience in taxation, it will be interesting to see the outcome.
Note: The foregoing is solely the opinion of the author and does not, in any way, reflect the position of the firm and any other organizations the author is associated with. If you have any questions about this case please contact our team at (410) 497-5947 or contact our team here.
This past summer, the Supreme Court granted certiorari to the most consequential tax case of our time, Moore v. United States. The case which originated in the District Court presents a challenge to the Mandatory Transition Tax (the “MRT”) under section 965 of the Internal Revenue Code (the “IRC”). At trial, the Moores argued that the tax imposed by MRT is unconstitutional because it is a tax on property (accumulated earnings) rather than a tax on current income (as with subpart F income and GILTI). More specifically, since no income was earned, the Moores claimed that the MRT was an unconstitutional direct tax on property not apportioned by the states by population.
The District Court ruled against the Moores and in favor of the Government. On appeal, the Ninth Circuit affirmed the District Court’s decision.
IRC section 965 was enacted as part of the Tax Cuts and Jobs Act of 2017 (the “TCJA”). It requires U.S. shareholders to pay a transition tax on the untaxed foreign earnings of certain specified foreign corporations as if those earnings had been repatriated to the United States. This transition tax was a one-time tax that taxed the deferred and untaxed income of U.S. shareholders as the U.S. international tax system made a very dramatic change from a largely deferral model to a semi-territorial model beginning on January 1, 2018.
As noted above, the income subject to tax under IRC section 965 was the deferred and untaxed income of certain foreign corporations. More particularly, this income comprised the portion of the foreign company’s earnings and profits (“E&P”) that may or may not have been previously taxed by the local country jurisdiction but not yet taxed by the United States.
The decision by the Supreme Court to grant certiorari in the case came as a surprise to many tax practitioners and academics. This is due to the fact that the constitutionality of income taxation under the IRC is seldom challenged. In fact, there was only one case that was heard by the Supreme Court since the enactment of the Sixteenth Amendment (which provides for the Federal income tax). That case was Eisner v. Macomber, which was decided in 1920. With the legal and constitutional bases of the tax code provisions in the IRC, undisturbed for decades, practitioners and academics alike were baffled by the Supreme Court’s grant of certiorari since there was no split among the Circuits nor a declaration of an unconstitutionality of a statute which are often the bases for taking up a case.
To some observers, the Supreme Court or some of its members may have agendas other than the pure interpretation of law and jurisprudence. Some commentators pointed to the fact that the principal motivation for granting certiorari in this case was espoused by some potentially libertarian organizations devoted to free enterprise, capitalism, and deregulation. These organizations are known to have opposed the imposition of wealth taxes and have vigorously advocated, lobbied, and fought against it. For them, if the MRT was not struck down, it would provide the basis for the possible adoption of a wealth tax in the United States. By granting certiorari in this case and by finding IRC section 965 unconstitutional, the Court would be opening the possibility of millions of dollars of refund claims and litigation regarding the constitutionality of Subpart F, Subchapter K, Subchapter S, and the mark-to-market regime.
The Ninth Circuit found the position advanced by the Moores to be untenable. The Court said, “whether the taxpayer has realized income tax does not determine whether a tax is unconstitutional.” The Supreme Court has made it clear that realization of income is not a constitutional requirement for current federal income taxation. The Ninth Circuit described Moore’s reliance on Eisner v. Macomber and the subsequent case of CIR v. Glenshaw Glass as misplaced. In the long line of decisions on the matter, the courts have maintained that realization is not a requirement for an income to be taxed by the federal government.
But why then did the current Supreme Court grant certiorari?
It appears that in addition to the potential ideological leaning of some members of the Court, these same members were also convinced by the reasoning put forth by the dissenting opinion of the Ninth Circuit ruling. The dissent states that the majority opinion claims that the Sixteenth Amendment authorized an unapportioned tax on unrealized gains because “realization of income is not a constitutional requirement.” According to the dissenters, “neither the text and history of the Sixteenth Amendment nor precedent support levying a direct tax on unrealized gains . . .” Hence, if this is not reined in, this might set the stage for Congress to impose a wealth tax.
Let us examine the decisions of the Supreme Court on the issue of whether realization is a requirement in the taxation of income and whether the imposition of direct taxes is constitutional.
In Hylton v. United States (1796), the court held that the federal tax on carriages to transport humans and cargo was not a direct tax subject to the constitution’s apportionment requirement. Direct taxes are limited to head (capitation) taxes and taxes on land.
In Collector v. Hubbard (1871), the court noted that during the Civil War, the government taxed corporate income, whether distributed or not, and taxed other unrealized gains such as the appreciation of the value of livestock, whether the livestock was sold or not.
The court in Springer v. United States (1881) ruled that Civil War income tax was held to be constitutional in line with the decision in Hubbard.
However, there seems to be a break in the Court’s doctrinal orientation.
Hubbard remained a “good law” until Pollock v. Farmer’s Loan and Trust Co. (1895). The court in Pollock held that the Civil War income taxes are "direct taxes" and not constitutional stating that income taxes are direct taxes and thus must be divided among states according to population. Pollock struck down the income tax in 1895 as a direct tax, holding that a tax on income from real or personal property had to be apportioned to the states. This may be the only case that may support Moore but that case was struck down in subsequent cases brought to the Supreme Court.
Then came the case of Eisner v. Macomber (1920). In Eisner, the court held that the income tax imposed on the proportionate increase of stocks via the distribution of stock dividends was unconstitutional. Speaking for the Court, Justice Pitney, reasoned that tax upon rents and profits of real estate and upon returns from investments of personal property were in effect "direct taxes" from property from which income arose. Congress could not impose such taxes without apportioning them among the states according to population. Stock dividends were not income and imposing tax thereon was unconstitutional. It is worth noting that Justice Brandeis dissented and opined that the stock dividend is equivalent to the receipt of cash followed by reinvestment and argued that they were equivalent to taxable income under the Sixteenth Amendment.
The most important implications of Eisner’s definition of income were:
Each of these corollaries of Eisner has heavily influenced the basic framework of the U.S. federal income taxation but are no longer accepted as constitutional limits on the taxing power of the federal government.
In United States v. Kirby Lumber (1931), the court found for the government saying that income was realized by a corporation on the purchase of its own bonds for less than the issued price despite the argument that it did not produce any gain that was “severed” from its capital.
The next step in decimating the authority of Eisner was in 1940. The court in Helvering v. Bruun held that a landlord realized gain on the forfeiture of a leasehold where a tenant added about $50,000 to the value of the property. The court stated that the event generated taxable income because “it is not necessary to recognition of taxable gain that the taxpayer should be able to sever the improvement begetting the gain from his original capital.”
In the 1943 case of Helvering v. Griffiths, the court described Eisner as “limited to the kind of dividend” particularly presented in that case.
There were other cases that reduced the significance of Eisner, but the most important one was the 1955 case of CIR v. Glenshaw Glass. The court stated that while Eisner said that the taxpayer had “received” nothing out of the company’s assets for his separate use and benefit . . . the distribution (of corporate stock) was concluded to be a taxable event. In that context, “distinguishing gain from capital, the definition served a useful purpose. But it was not meant to provide a touchstone to all future gross income questions.” Perhaps, the final nail in the Eisner coffin.
This survey of the decisions of the Supreme Court appears to show that realization is not a requirement for the imposition of a tax on income and that Congress is given a broad and plenary power to tax. As the Ninth Circuit put it, Moore’s reliance on Eisner is “misplaced.”
As stated at the outset, the income in contention in Moore had already been taxed. The post-1986 E&P that was taxed under the MRT had already been subjected to tax in a foreign jurisdiction (i.e., India). The foreign corporation’s profits therefore were taxed, but the tax on the U.S. shareholders (on those profits) was deferred until actual distribution under prior law. At issue is whether there is a realization in the income being taxed under the MRT.
There is no doubt that sustaining Moore’s position could potentially be disruptive to an otherwise stable system of U.S. federal taxation, open the gates of litigation, and possibly cause more confusion and serious financial harm to the U.S. government.
Many federal taxes in the IRC do not require realization. And, as noted above, if the Court requires realization as a constitutional matter for a tax on income to be imposed, it may impact the many provisions of the IRC that could be rendered unconstitutional – subpart F, GILTI, branch profits tax, section 1256 and section 877A, the PFIC rules, Check-the-Box election rules under section 7701 are only some of the provisions that could be rendered unconstitutional.
The Justices’ decision will undoubtedly affect future legislation in this area. With a majority of Justices lacking significant background and experience in taxation, it will be interesting to see the outcome.
Note: The foregoing is solely the opinion of the author and does not, in any way, reflect the position of the firm and any other organizations the author is associated with. If you have any questions about this case please contact our team at (410) 497-5947 or contact our team here.
