Today, the Supreme Court heard oral arguments in a challenge to a provision in the 2017 tax law that authorized income taxes on 10 percent shareholders of controlled foreign corporations despite the absence of shareholder distributions. The case (Moore v. United States) has been widely followed because it could potentially reject or affirm the constitutionality of "wealth taxes" on stock based on appreciation without actual income realization.
The Sixteenth Amendment of the Constitution authorizes Congress "to lay and collect taxes on incomes, from whatever source derived." The plaintiffs in the case did not receive income distributions from a foreign corporation but were nonetheless subject to a mandatory repatriation tax amounting to roughly 15,000. They challenged the tax as unconstitutional asserting income must be "realized" before it can be taxed under the Sixteenth Amendment. The lower appellate court upheld the tax and the Supreme Court granted review.
For the record, the government (through DOJ Solicitor General Elizabeth Prelogar) argued that a tax on appreciated stock value -- even without realization of that appreciation through a stock sale -- would indeed be constitutional under the Sixteenth Amendment. However, the government said such a tax was unlikely due to administrative complexities of implementation absent an income realization requirement. The government argued, however, that the Court need not resolve whether the Constitution demands actual income realization because existing Court precedents establish that the plaintiff shareholders realized income that was constitutionally attributed to them under the repatriation tax rules.
Several Justices -- including conservatives Neil Gorsuch, Brett Kavanaugh, and Amy Coney Barrett -- seemed inclined to take the off-ramp offered by the Solicitor General. Justice Samuel Alito led the big fight to seek clear limits on the federal government's constitutional taxing power, but it appears likely that a majority of the Justices will recognize that the repatriation tax at issue, in this case, can be sustained as a reasonable attribution of income earned at the corporate level to significant shareholders of the corporation (in this case, shareholders holding at least a 10 percent stake in the company). The latter portion of today's oral arguments involved a dialogue among several Court members with the Solicitor General to develop a list of factors that would ensure shareholder attribution of corporate income -- even without actual distributions by the corporation -- would comport with past precedents that presume an income "realization" requirement.
A decision following this approach also avoids a possible challenge to existing taxes already imposed on pass-through entities, including partnerships and S Corporations. Counsel for the plaintiff taxpayers explained such taxes are distinguishable -- and thus raise no issues -- because shareholders ultimately control how income is received and distributed within such entities and shareholders consent to the associated tax consequences. Still, the government cautioned that a sweeping Supreme Court ruling articulating an income realization requirement under the Sixteenth Amendment could trigger undesirable disruptions in existing tax administration and enforcement and encourage new tax avoidance schemes.
We expect a decision in this case in the second quarter of next year. If, as we anticipate, the Court affirms the legality of the repatriation tax without reaching the income realization issue, the larger debate over wealth taxes will continue unabated. Indeed, with a structural federal deficit exceeding 33 trillion, progressive calls for wealth taxes will likely intensify in the years ahead.
For now, challenges to the constitutionality of wealth appreciation taxes will likely be punted to a future Court, keeping alive a political battle of rising fiscal significance.
