Key Takeaways

• The Supreme Court upheld the constitutionality of the so-called mandatory repatriation tax (MRT) in a narrow ruling, stating that the MRT taxes realized income and attributes that corporate income to shareholders.
• A team of BakerHostetler attorneys, led by Partners Andrew Grossman and Jeffrey Paravano, represented Charles and Kathleen Moore at the U.S. Supreme Court, arguing that realization is required for federal taxation of income pursuant to the 16th Amendment and that the MRT was a tax on property, not income.
• The Supreme Court concluded that it “need not resolve” the parties’ disagreement over realization, leaving those “potential issues for another day.” But portions of the majority opinion, as well as two separate opinions, signal that a majority of the justices would disapprove an unapportioned tax on wealth or federal taxation of unrealized asset appreciation.

Discussion

The U.S. Supreme Court today upheld the constitutionality of the so-called “mandatory repatriation tax” in a narrow ruling, stating that the MRT taxes realized income — income earned by the offshore corporation — and attributes that corporate income to shareholders and taxes the shareholders on their portions of that income. The majority opinion also states, in footnote 2, that its “analysis today does not address the distinct issues that would be raised by (i) an attempt by Congress to tax both the entity and the shareholders or partners on the entity’s undistributed income, (ii) taxes on holdings, wealth, or net worth; or (iii) taxes on appreciation.”

The MRT, enacted as part of the Tax Cuts and Jobs Act of 2017, raised more than $300 billion of revenue for the federal government. The MRT deems undistributed earnings and profits reinvested abroad by certain businesses going back to 1986 to be “income” in 2017 of certain U.S. shareholders.

The Moores, in 2017 owned about 13% of the stock of KisanKraft, a controlled foreign corporation operating in India focused on manufacturing low-cost farm equipment. The Moores asserted that income must be realized to be taxed without apportionment under the 16th Amendment and that the MRT imposed on them, as shareholders, an impermissible unportioned tax on property. How could income earned 30 years ago by a foreign corporation and reinvested abroad by that corporation in property and equipment be “income” to a U.S. shareholder in 2017?, asked the Moores.

The Ninth Circuit Court of Appeals held that an “income tax” does not require that a “taxpayer has realized income under the 16th Amendment.” The Supreme Court agreed to review that decision.

In a majority opinion authored by Justice Kavanaugh, the Court held that the 16th Amendment authorizes Congress to attribute income realized by an entity to its owners in certain circumstances: “We emphasize that our holding today is narrow. It is limited to (i) taxation of the shareholders of an entity, (ii) on the undistributed income realized by the entity, (iii) which has been attributed to the shareholders, (iv) when the entity itself has not been taxed on that income. In other words, our holding applies when Congress treats the entity as a pass-through.”

Although the majority opinion, representing the views of five justices, determined that it need not resolve the issue of realization in Moore, it also specifically noted that the Supreme Court in Macomber ”stated that income requires realization.” The opinion also takes pain to note that an “unapportioned tax on an individual’s holdings or property (for example, on one’s wealth or net worth)” would “raise different issues” than the MRT. Further, Justice Barrett’s opinion concurring in the judgment, joined by Justice Alito, states that “[r]ealization may take many forms, but our precedent uniformly holds that it is required before the Government may tax financial gain without apportionment.” And Justice Thomas’s dissent, joined by Justice Gorsuch, states that “16th Amendment ‘incomes’ include only income realized by the taxpayer.” Thus, the majority opinion recognizes that prior Supreme Court precedent requires realization, and four justices stated they would hold that realization is necessary for "income” to be taxed as such without apportionment.

The majority opinion further states that nothing in the opinion should be read to suggest that Congress could tax both an entity and its owners on the same income, and that the Due Process Clause ‘proscribes arbitrary attribution’ — which gives tax practitioners food for thought on whether any current taxes might violate that holding.

The BakerHostetler team in the Moore case included Partners Grossman, Paravano, David B. Rivkin and Counsel Kristin A. Shapiro.

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