Supreme Court Rules Against Moores But Leaves Door Open For Similar Challenges

 

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Taxpayers potentially caught by a tax on unrealized earnings might have reason for optimism after the recent decision by the Supreme Court.

 

The U.S. Supreme Court, voting 7-2, has sided against a constitutional challenge of the 9th Circuit’s decision in Moore et ux vs. United States, which involved a one-time tax imposed by the 2017 Tax Cuts and Jobs Act.

 

The TCJA added the transition tax to prevent accumulated earnings from going untaxed permanently. The tax targeted U.S. shareholders who held 10% or more in a “controlled foreign corporation” that retained and reinvested its prior earnings overseas rather than distributing them to shareholders as dividends. Previously, those shareholders would have incurred a tax liability only when the foreign corporation distributed earnings and they repatriated the gains.

 

The Mandatory Repatriation Tax (MRT) deemed the foreign corporation’s retained earnings as shareholders’ “income” and taxed them according to their proportional ownership stake.

 

The taxpayers in the case, Charles and Kathleen Moore, owned a stake in KisanKraft Machine Tools Private Limited, a small company headquartered in Bangalore, India. The couple invested $40,000 in KisanKraft and retained about 11% of the common shares in the company, the revenues of which grew annually from the company’s founding, in 2006, to 2017.

 

The Moores never exercised control over the company’s earnings or operations or received distributions, dividends or other payments. In 2018, they learned they were responsible for their share of KisanKraft’s lifetime earnings and owed $14,729 in tax. They paid it and filed in federal district court to recover.

 

Observers said their argument could yet impact not just the MRT but taxation of foreign corporations, partnerships and S corporations, among others.

 

The opinion

The Moores argued that the MRT is unconstitutional because it’s not apportioned. (Lower courts rejected the challenge.) Their argument hinged on retained earnings of a corporation not being “income” of a corporation’s shareholders under the 16th Amendment of the U.S. Constitution until that income was “realized” by the shareholders through distribution.

 

The Supreme Court, in its recent decision, held that the income was realized by the corporation but that the income could be attributed to its shareholders.

 

“This case comes down to two questions,” the prevailing High Court judgment reads. “Have the Moores realized income from their KisanKraft shares? And if they have not, may Congress attribute KisanKraft’s income to the Moores?”

 

The Court held that the MRT attributes the realized and undistributed income of an American-controlled foreign corporation to the American shareholders, and then taxes the American shareholders’ portion of this income, and this does not exceed the constitutional authority of the U.S. Congress.

 

“For tax purposes, Congress has long treated some corporations and partnerships as pass-throughs: Congress does not tax the entity on its income, but instead attributes the undistributed income of the entity to the shareholders or partners and then taxes the shareholders or partners on that income,” writes Justice Brett Kavanaugh in the opinion of the court. “Since 1962, Congress has likewise treated American controlled foreign corporations as pass-throughs. That 1962 law (known as subpart F) attributes certain income, mostly passive income, of American-controlled foreign corporations to their American shareholders and then taxes those shareholders on that income.

 

“In 2017, Congress enacted a new law that attributes more income, including active business income, of American controlled foreign corporations to their American shareholders and then taxes those shareholders on that income. The question is whether that 2017 tax (known as the Mandatory Repatriation Tax or MRT) is constitutional under Article I, §§8 and 9 and the Sixteenth Amendment. This Court’s longstanding precedents establish that the answer is yes.”

 

Narrow vote?

In 1913, the U.S. adopted the 16th Amendment to permit Congress to tax “incomes from whatever source derived,” without apportionment. The key question for the High Court was whether the transition tax is a “direct tax” that violates the Apportionment Clause of the Constitution. Deciding for the Moores, observers said, meant the Moores might have received a refund – as would have many large U.S. multinational corporations.

 

The key issue in Moore was not a refund of some $15,000 but the core of the 16th Amendment, which for more than a century has established the ability of the U.S. Congress to levy an income tax. It also laid the bedrock for many other potential taxes that are in headlines, including unrealized capital gains and an American wealth tax.

 

Those potentially affected by the MRT and the taxation mentioned above should note supplemental comments on the vote, which didn’t split along the ideological lines becoming familiar in U.S. Supreme Court decisions. Only Justices Clarence Thomas and Neil Gorsuch dissented but Justices Amy Coney Barrett and Samuel Alito made clear they could see siding with similar challenges.

 

Reads a footnote to the decision, “Our analysis … 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.”

 

“It bears emphasis that the Moores’ case involves the [MRT], which is a specific tax imposed upon the American shareholders of a closely held foreign corporation,” add Justices Barrett and Alito. “A different tax – for example, a tax on shareholders of a widely held or domestic corporation – would present a different case.”

 

The High Court may be just one short of inviting, if not validating, challenges like the Moores’ in the future.

 

Your tax specialist needs to stay on top of this and many other issues of wealth, foreign income and tax enforcement. If we can help, please let us know.

 

About the Author 

Alicea Castellanos is the CEO and Founder of Global Taxes LLC. Alicea provides personalized U.S. tax advisory and compliance services to high-net-worth families and their advisors.

 

Alicea has more than 20 years of experience. Prior to forming Global Taxes, Alicea founded and oversaw operations at a boutique tax firm, worked at a prestigious global law firm and CPA firm.

Alicea specializes in U.S. tax planning and compliance for non-U.S. families with global wealth and asset protection structures which include non-U.S. trusts, estates and foundations that have a U.S. connection.

 

Alicea also specializes in foreign investment in U.S. real estate property, and other U.S. assets, pre-immigration tax planning, U.S. expatriation matters, U.S. persons in receipt of foreign gifts and inheritances, foreign accounts and assets compliance, offshore voluntary disclosures/tax amnesties, FATCA registration, and foreign companies wanting to do business in the U.S.

 

Alicea is fluent in Spanish and has a working knowledge of Portuguese.

 

Alicea is an active member of the Society of Trusts & Estates Practitioners (STEP), the New York State Society of Certified Public Accountants (NYSSCPAs), the American Institute of Certified Public Accountants (AICPA), the International Fiscal Association (IFA), a member of Clarkson Hyde Global, a world-wide association of accountants, auditors, tax specialists and business advisors and the Global Referral Network (GRN).

 

Distinctly, in 2020, Alicea was awarded with a prestigious NYSSCPA Forty Under 40 Award. She was selected as someone that has notable skills and is visibly making a difference in the accounting profession.

 

In 2021 and 2022, Alicea was the Gold and Silver Winner, respectively, of Citywealth’s Powerwomen Awards in the category USA – Woman of the Year – Business Growth (Boutique). In 2023, she continued her winning streak by receiving the Gold award for Company of the Year Female Leadership (Boutique) and the Silver award for Accountancy Firm of the Year at the Magic Circle Awards. Furthermore, Alicea has consistently secured her position in the Global Elite Directory for four consecutive years, being recognized as a Private Client Global Elite Advisor and is currently listed for 2024 as a Non-Legal Adviser. This exclusive directory annually highlights the world’s elite lawyers and outstanding wealth advisors serving ultra-high net-worth clients.

Please note: This content is intended for informational purposes only and is not a replacement for professional accounting or tax preparatory services. Consult your own accounting, tax, and legal professionals for advice related to your individual situation. Any copy or reproduction of our presentation is expressly prohibited. Any names or situations have been made up for illustrative purposes — any similarities found in real life are purely coincidental.