As the U.S. Supreme Court winds down its term, today it issued a list of orders - including one case they have agreed to hear next term Moore v. United States. What's that case?
The case is brought by a couple from Washington State represented by the Competitive Enterprise Institute. Mr. & Mrs. Moore invested in a friend's business in India supplying power tools to farmers. The business has been successful and the Moores' shares in the company have grown in value. They never took any distributions; the company reinvested its earnings into the business. They are challenging the constitutionality of the one-time Mandatory Repatriation Tax passed as part of the 2017 Tax Cuts & Jobs Act.
For decades until the TCJA, the U.S. taxed "worldwide" corporate profits. The rest of the world instead taxes where profits were earned, a "territorial" system. This inherently puts U.S. companies at a disadvantage, paying U.S. taxes to the U.S. and foreign taxes to the foreign countries wherever they operated, versus foreign companies that only had to pay one set of taxes to wherever they operated. President Kennedy pushed through a release valve in the 1960s that allowed deferral of tax until the profits were returned to the U.S., known as "repatriation." But this release valve grew increasingly inadequate at addressing the competitive disadvantage.
Hence the 2017 reform, which among other things switched the U.S. from worldwide corporate taxation to territorial corporate taxation. The question then was what to do about accumulated assets overseas that tax was legally due on but hadn't yet been paid. Keep it all tax free? Tax just distributions at the old rate of 35%? Tax it at the new rate of 21%? Congress decided on a one-time 15.5% U.S. tax on accumulated assets, payable over 8 years. The tax was "deemed" - paid whether you liquidated assets or not in order to prevent forced sales. After that, overseas profits are only taxed by the host country with no additional U.S. tax.
Back to the Moores: they got a tax bill as part of this mandatory repatriation tax (MRT). This surprised them because they never cashed anything out. The tax was due to the shares they hold in their friend's business. They paid under protest and sued for a refund.
They allege the MRT is a direct tax but not an income tax and not apportioned. This would arguably make it unconstitutional: the Constitution requires direct taxes to be apportioned to be valid. The Sixteenth Amendment allowed income taxes by exempting them from this requirement.
In short, the Moores say it's not income. If it is income, the tax is valid under the 16th Amendment. If it's not income, but still a direct tax and not apportioned, then it is unconstitutional. The Ninth Circuit Court of Appeals ruled against the Moores, holding that the MRT was taxing income.
Questions the Court will need to answer now that they've accepted the case:
1. Does "income" require "realization" (selling for cash)? Or can the U.S. tax unrealized income?
2. Does it matter that the Moores are shareholders and not the company itself?
3. What is a direct tax?
You may ask why it matters, since it's a one-time transition tax. One factor: the tax raised $340 billion for the federal government, which is a big number to refund. Another factor: if the Court rules that unrealized gains cannot be constitutionally taxed as income, that prohibits a federal wealth tax.
Stay tuned.