Supreme Court OKs TCJA Transition Tax in Moore

The Supreme Court held 7-2 on June 20 that the one-time mandatory repatriation tax (MRT) or “transition tax” under the Tax Cuts and Jobs Act (PL 115-97) is constitutional and Congress did not exceed its authority when it passed the MRT. (Moore, (Sct 6/20/2024) 133 AFTR 2024-682)

Background.

The 2017 tax reform bill established the Code Sec. 965 transition tax imposed on domestic taxpayers with 10% or more shares of a controlled foreign corporation (CFC). The rates are 15.5% for cash and other liquid assets and 8% for nonliquid assets.

Petitioners Charles and Kathleen Moore owned a 13% stake in KisanKraft Tools Private Limited, an American-owned Indian company that manufactures farm equipment. KisanKraft reinvested profits back into the business and the Moores did not receive dividends from their $40,000 investment. However, the transition tax treated untaxed foreign earnings of CFCs the same as if they were repatriated to the US. Thus, the Moores were assessed a transition tax of almost $15,000 based on their pro rata share for tax year 2017.

The Moores paid the tax and sued the government for a refund, arguing the transition tax violates the Sixteenth Amendment because it is a tax on unrealized income, which runs afoul of the apportionment clause. Both the US District Court for the Western District of Washington and the Ninth Circuit disagreed, holding Congress did not overstep in creating the tax.

Last June, the Supreme Court granted the Moores’ cert petition but during oral arguments in December, justices indicated their decision would be narrowly tailored to the facts of the case so as not to invite an existential crisis over what constitutes income and if the Constitution requires realization to be taxed.

Tax and legal analysts cautioned that a win for the Moores could have ripple effects throughout the Tax Code, theoretically resulting in other taxes becoming invalid, such as those on interest income or capital gains.

Loss for the Moores.

Thursday’s opinion was delivered by Justice Brett Kavanaugh, who was joined by Chief Justice John Roberts and Justices Sonia Sotomayor, Elena Kagan, and Ketanji Brown Jackson, who filed her own concurring opinion. Justice Amy Coney Barrett also had a separate opinion concurring in judgment, joined by Justice Samuel Alito. Justice Clarence Thomas filed a dissent in which Justice Neil Gorsuch joined.

As promised, the Court’s majority opinion “is narrow and limited to entities treated as pass-throughs.” It stressed that the opinion should not be interpreted “to authorize any hypothetical congressional effort to tax both an entity and its shareholders or partners on the same undistributed income realized by the entity.” Further, the decision does not “attempt to resolve the parties’ disagreement over whether realization is a constitutional requirement for an income tax.”

The Court affirmed the Ninth Circuit’s opinion, maintaining that the MRT is in line with Congress’ history of taxes imposed on shareholders based on an entity’s undistributed income.

“In short, the Moores cannot meaningfully distinguish the MRT from similar taxes such as taxes on partnerships, on S corporations, and on subpart F income,” the opinion read. “The upshot is that the Moores’ argument, taken to its logical conclusion, could render vast swaths of the Internal Revenue Code unconstitutional.”

The Court noted that if other taxes were rendered unconstitutional per the Moores’ theory, the federal government would suffer “trillions in lost tax revenue.” Consequently, Congress would then need to “either drastically cut critical national programs or significantly increase taxes on the remaining sources available to it — including, of course, on ordinary Americans.”

Justice Thomas in his dissent wrote that the “Moores are correct” because “incomes” under the Sixteenth Amendment “includes only income realized by the taxpayer” and distinguishes between “‘income’ and the ‘source’ from which that income is ‘derived.'” He argued that the Moores did not receive investment gains which could be counted as taxable income.

Justice Barrett in her opinion said both the Moores and the government “barely addressed” the extent in which Congress can attribute the income of closely held corporations to their shareholders,” which she believes “is a difficult question.” In lieu of a “focused briefing on the attribution question,” and because the Moores conceded that Subpart F is constitutional, she determined the couple did not meet the burden in proving their entitlement to a refund.

She concurred despite finding the majority opinion was “too quick to bless the attribution of corporate income to shareholders.”

For more information about the transition tax, see Checkpoint’s Federal Tax Coordinator ¶ O-2701.