Status Quo for States as U.S. Supreme Court Upholds Federal Mandatory Repatriation Tax

The U.S. Supreme Court yesterday, in a 7-2 decision in Moore v. U.S., upheld the one-time federal transition tax on accumulated earnings of U.S.-controlled foreign corporations that are treated as pass-through entities under subpart F of the Internal Revenue Code.¹ Enacted as part of the Tax Cuts and Jobs Act of 2017 (TCJA), the “mandatory repatriation tax” was a tax on certain previously untaxed amounts of already accumulated deferred foreign earnings. The Court rejected a challenge characterizing the tax as one on property rather than income, ruling that the mandatory repatriation tax is consistent with Court precedent establishing that Congress may impose a tax on an entity’s undistributed income by taxing either the entity or the entity’s partners, and that the tax remains one on income either way.

State tax implications.

For state tax purposes, the decision effectively preserves the status quo for states that elected to include deemed repatriated income in their tax bases; however, the extent to which states chose to include this income or otherwise conform to the provisions of IRC § 965 varied significantly before the Moore decision. Florida and Texas do not conform, for example, and California generally does not conform, except to the extent applicable in connection with a water’s edge election. New York’s approach depends on the type of entity involved. Even states that generally conform, such as Vermont, pose complexities in application as a practical matter. For instance, Vermont’s rules for apportioning affiliated dividends received from overseas businesses in a combined return effectively result in the receipts being apportioned separately; in addition, the state does not allow installment payments, while the IRS does.

Noted scholar Walter Hellerstein observes in State Taxation that as of late 2021, 15 states had adopted the tax “to some extent and with very little uniformity, with the precise tax treatment depending on whether and the manner by which the state includes subpart F income in its tax base and provides a deduction for foreign dividends received.” He points to four states, including Nebraska, that adopted the tax but disallowed a deduction for foreign dividends received as applied to the tax. In a 2023 dispute, a Nebraska court upheld guidance of the Nebraska Department of Revenue that deemed repatriation income recognized under IRC § 965(a) did not constitute divided income for purposes of Nebraska law and thus did not qualify for the dividends received deduction.² The Nebraska Supreme Court has taken up the taxpayer’s appeal.³

The takeaway.

Uncertainty persists across the states, but the Moore decision provides continuity in an area of international tax law that has generated a great deal of state tax confusion in recent years.

Checkpoint resources.

Checkpoint Catalyst Topic # 2111 provides a detailed primer on the tax at the federal level, as well as state-by-state analysis and advisory perspective.

State Taxation (Hellerstein, Hellerstein, and Appleby, last revised 2023) offers an invaluable overview of the complex state tax issues posed by the tax.

Checkpoint’s popular State Charts capture current state approaches to the following issues: Conformity to Post-TCJA IRC § 965 Deemed Repatriation Rules, and Conformity to Pre-TCJA IRC § 965 Deduction.