Court Faces the Mandatory Repatriation Tax

In Moore v. United States, Charles and Kathleen Moore invested $40,000 in an Indian company that supplies tools to small farming businesses, in exchange for more than 10% of the common shares. The company is a Controlled Foreign Corporation (CFC), meaning it is majority-owned by U.S. persons but operates abroad. Shareholders of CFCs were generally taxed on foreign earnings only when those earnings were repatriated to the United States according to a provision called “Subpart F.”  However, the Tax Cuts and Jobs Act (TCJA) of 2017 changed this and introduced a one-time Mandatory Repatriation Tax (MRT) that retroactively taxed CFC earnings after 1986 even if they had not been repatriated.

The Moores received a tax bill for about $15,000 based on their share of the company’s retained earnings: profits were reinvested into the business and shareholders did not receive income through distributions or dividends. The Moores challenged the constitutionality of the tax, arguing that it violated the Constitution’s apportionment clause. The apportionment clause requires taxes to be imposed in such a way that every state’s share of the tax is proportional to its population, however, the Sixteenth Amendment gave Congress the power to impose income taxes without apportioning it among the states. The Moores argue the MRT violated the clause because it taxed their personal property, their shares in the company, rather than any income from the corporation. The district court dismissed the action, holding that the MRT is a taxation of income permissible under the Sixteenth Amendment. The Ninth Circuit affirmed, holding that a realization of income is not a constitutional requirement.

The central issue before the Supreme Court is whether the Sixteenth Amendment authorizes Congress to tax unrealized gains without apportionment among the states. If so, the Moores would have to pay the tax bill and this could expose others to liability as well. On the other hand, if the Court determines that Congress cannot tax unrealized gains without apportioning the tax among the states, then this decision could affect other tax laws.

During oral argument, U.S. Solicitor General Elizabeth Prelogar relied on the Sixteenth Amendment’s text and history in defending the MRT, and the Justices seemed to be persuaded by her argument. Justice Sotomayor noted that the concept of “realization” was well established during the drafters’ time and that they could have included the concept in the Amendment but chose not to. Andrew Grossman, representing the Moores, argued that when the amendment was adopted, the term “income” was commonly understood to refer to gains that had been realized. Justice Jackson questioned this position and inquired why the Justices should rely on the common meaning rather than the legal meaning.

Justices Kavanaugh and Barrett also questioned whether the income here was realized by the corporation and then attributed to the shareholders by Congress. If so, the Court could sidestep the Sixteenth Amendment question altogether and focus on the question of fairness: when Congress can attribute a corporation’s income to its shareholders. The Justices also focused on the broader implications of the case—whether a ruling for the government may open the door to taxation on everything.

This case was argued on December 5, 2023. A decision is expected later in the term. Stay tuned for Dykema’s client alert discussing the Court’s opinion.

For more information, please contact Chantel Febus, James Azadian, Christopher Sakauye, McKenna Crisp, Monika Harris, or Puja Valera.