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Supreme Court Takes Up Constitutional Challenge to TCJA Transition Tax

Tim Shaw  

· 5 minute read

Tim Shaw  

· 5 minute read

The Supreme Court will hear a couple’s case where the taxpayers, who both owned shares in a controlled foreign corporation (CFC), sued the government for a tax refund on the grounds that a controversial Trump-era tax is unconstitutional under the Sixteenth Amendment.

Dubbed the mandatory repatriation tax (MRT), also known as the “transition tax,” Code Sec. 965 was established by the Tax Cuts and Jobs Act of 2017 (PL 115-97) and applies to U.S. taxpayers with 10% or more shares of a CFC as of December 31, 2017. The one-time tax was designed to make such taxpayers pay their pro rata share of the CFC’s earnings—15.5% on cash and other liquid assets and 8% on nonliquid assets.

Charles and Kathleen Moore were subject to the transition tax, as the couple owned a 13% stake in a foreign company, KisanKraft Machine Tools Private Limited, which provides equipment to rural Indian farmers. The Moores made their initial investment in 2006, and KisanKraft reinvested profits into its business operations rather than distributing dividends to shareholders like the Moores. But because the MRT targets “the untaxed foreign earnings of certain specified foreign corporations as if those earnings had been repatriated to the United States” (as described by the IRS), the Moores paid an additional $15,000 on top of their 2017 tax liability (based on their pro rata’s share of KisanKraft’s retained earnings of $508,000), then sued for a refund.

The question before the Supreme Court now that it granted the Moores’ cert petition on June 26 is if the MRT violates the Sixteenth Amendment as a tax on unrealized income. The Moores suffered losses in the U.S. District Court for the Western District of Washington and the Ninth Circuit. The circuit court held that the MRT does not violate the Apportionment Clause of the U.S. Constitution, nor the Fifth Amendment’s Due Process Clause.

“Whether the taxpayer has realized income does not determine whether a tax is constitutional,” read the Ninth Circuit’s June 7, 2022, majority opinion authored by Judge Ronald Gould. “Further, there is no blanket constitutional ban on Congress disregarding the corporate form to facilitate taxation of shareholders’ income. In other words, there is no constitutional prohibition against Congress attributing a corporation’s income pro-rata to its shareholders.”

Ninth Circuit Judge Patrick Bumatay dissented from the court’s denial of the Moores’ request for rehearing, writing: “Without the guardrails of a realization component, the federal government has unfettered latitude to redefine ‘income’ and redraw the boundaries of its power to tax without apportionment.”

The taxpayers sought review before the Supreme Court in their petition filed February 21. There, they argued neither lower court explained how KisanKraft’s retained earnings were the couple’s income, calling the decisions “broadly declared.” The petition, penned by the taxpayers’ representation at Baker & Hostetler LLP, went on to say that the Ninth Circuit’s opinion creates a rift with past decisions of other circuits, “eviscerates” the Sixteenth Amendment’s apportionment requirement, and raises an “exceptionally important” question about Congress’ “power to tax unrealized ‘income’ without apportionment.”

In the government’s response filed May 16, Solicitor General Elizabeth Prelogar, Deputy Assistant Attorney General David Hubbert, and three U.S. attorneys countered that “no other court of appeals has even considered the MRT’s constitutionality. And because the MRT is a one-time tax applicable only to pre-2018 income, the case lacks pressing prospective importance.” The government added that the MRT “shares common features” with “several other income taxes” like those relating to Code Sec. 877ACode Sec. 1256Code Sec. 475, and other areas of the Tax Code.

Eight amicus briefs were filed March 27 by various policy and trade organizations, all in support of the petitioners. One filing by the Chamber of Commerce put forth that the Ninth Circuit’s holding harms businesses and economy by introducing uncertainty in tax planning.

“First, uncertainty simply costs businesses money, as they are forced to hire lawyers and accountants to navigate the uncertainty, a deadweight loss to the nation’s economy,” read the Chamber’s amicus brief. “Businesses’ necessary and predictable responses to tax uncertainty benefit no one in the long run. Consumers are affirmatively harmed, as they have to pay twice-suffering the generalized depressive effect of deadweight loss on the economy while also paying more for goods and services.”

The case is Moore v. United States, No. 22-800.

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


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