Supreme Court Ruling Leaves Door Cracked for Future Wealth Tax

For many tax experts and taxpayers, especially US shareholders of controlled foreign corporations, the key issue in Moore v. United States was whether the Supreme Court would uphold the requirement that income must be realized to be taxable.

Disappointingly, the justices indirectly avoided the issue and instead focused their attention on whether the Constitution allowed Congress to tax a controlled foreign corporation’s undistributed income under an “attribution of income” standard.

The extent the parties involved wished to hold off a proposed “wealth tax,” the Moore decision and the attribution-of-income standard may provide a blueprint for such a tax on unrealized gains and/or undistributed income to shareholders and other business owners generally. As a result, any celebration believing it shuts the door on a wealth tax may be premature.

Realization Importance

Taxpayers shouldn’t be taxed on income or gains never actually earned or received. It makes sense—you need the cash to pay the taxes. This point was addressed more than 100 years ago in Eisner v. Macomber, where the purported realization requirement was first established. Eisner centered on the proper tax treatment of a stock dividend.

However, the actual value of the taxpayer’s investment in Eisner didn’t increase. As a result, the court found that the taxpayer didn’t realize any income on the issuance of additional stock because she “received nothing out of the corporation for her separate use and benefit.”

Many tax scholars believe a better reading of the Eisner opinion is that a taxpayer can’t be taxed on the receipt of additional stock (or assets) unless there is an increase in value or an “accession to wealth.” Unironically, the federal tax code has effectively codified Eisner by generally exempting stock dividends from tax under Section 305.

The tax code contains various anti-deferral rules including Subpart F rules; global intangible low-taxed income, or GILTI, rules; and Section 956 covering investments in US property—all tax undistributed earnings. These rules have plagued US shareholders of controlled foreign corporations for years by requiring inclusions of taxable “deemed” income. The mandatory repatriation tax, as written, piggybacks off Subpart F rules with a few major exceptions.

If the MRT had been overturned on the basis that the petitioners didn’t realize any income and therefore couldn’t be taxed, then logically that holding also would apply to the anti-deferral rules listed above—opening a Pandora’s box.

In Justice Brett Kavanaugh’s majority opinion, Subpart F was mentioned to have already been upheld as constitutional, such that overturning the MRT and similar provisions in the tax code (where realization is tenuous at best) would be detrimental to the US Treasury and by extension the IRS. Not surprisingly, the Supreme Court didn’t want to deviate from this determination or be responsible for the fallout.

Practical Questions

If the holding and implied wide-ranging realization standard isn’t disappointing enough, many taxpayers who likely filed refund claims with the IRS—hoping for a reprieve from further annual MRT installment payments—can now expect very little in the way of federal tax relief.

Rejected refund claims, continued payments, potential demands for accelerated payment of remaining MRT in cases of delinquent payments from this pending decision, and the potential application of similar rules to domestic circumstances are all anticipated to come soon.

A wealth tax presumably could be determined by taxing the unrealized annual increase in the fair market value of a taxpayer’s assets. The Moore majority avoided directly addressing the currently nonexistent wealth tax by simply finding that realization had occurred (although at the entity level). However, a reading of the concurrence and majority opinions suggest an argument can be made that the attribution of income standard may be a backdoor to a wealth tax.

For example, various standards of realization already exist within the tax code. These include the mark-to-market system under Section 475 for dealers in securities and Section 1296 for passive foreign investment companies.

The tax code also treats death (estate tax), donations (gift tax), expatriation under Section 877A, and loans from controlled foreign corporations to US shareholders under Section 956 as realization events. Even corporate transactions involving exchanges of stock are realization events, although not recognized. Because realization has been defined so broadly, the threshold necessary to satisfy this standard is low.

In the domestic corporate context (as opposed to the current regime with foreign entities), Congress could pass a law that treats all shareholders owning or controlling a certain percentage of stock (by vote or value) as passthrough entities. Congress also could modify the existing accumulated earnings tax such that income is deemed distributed on an annual basis. Based on the reasoning provided by the majority in Moore, Congress has broad authority to attribute income of a business entity to its owners.

Silver Lining?

The MRT has offered benefits to multinational corporations with large foreign tax pools associated with untaxed, accumulated earnings. Those corporations were able to take advantage of it to use as much of these foreign tax pools as possible via deemed-paid foreign tax credits.

The MRT was the proverbial last bite at the apple, because foreign tax credits under Section 902 were eliminated under the 2017 Tax Cut and Jobs Act. The use of deemed paid foreign tax credits allowed an election to reserve 100% of the pre-2018 net operating losses (which the new rules limited to 80%).

The MRT also allowed certain taxpayers to receive deemed MRT dividends at a lower tax rate and, if timely made, elect to pay the MRT over time. S corporation shareholders even qualified for an indefinite deferral, subject to certain exceptions. Taxpayers who intended to distribute dividends or exit S corporation investments altogether could argue that the MRT is a good deal.

Overturning the MRT by siding with the Moore petitioners would have been detrimental—putting those taxpayers in an unenviable position of losing foreign tax credits, deferral, reduced tax rates, and net operating losses all at once. The Supreme Court’s punt allowed the MRT, for now, to survive another day.

The case is: Moore v. United States, U.S., 22-800, 6/20/24.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Farid Khosravi is a shareholder in the tax controversy practice of Chamberlain, Hrdlicka, White, Williams & Aughtry in Atlanta.

Jennifer D. Lindy is a partner in tax litigation and controversy of Akerman in Atlanta.

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