Moore v. United States launched a frontal, direct attack on the “constitutionality” of federal government’s taxation of “unrealized,” undistributed foreign corporate earnings imposed under TCJA Code § 965, namely, “Mandatory Repatriation Tax” (MRT).

The “Mandatory Repatriation Tax” is a legislative compromise, a one-time revenue raising Code provision to partially fund the transition to “territorial” international tax regime; Code § 245A prospectively waives dividend taxes for US corporations on most distributions from CFCs and foreign subsidiaries. Individual US shareholders, such as the challenging taxpayers, Moores, remain liable for income tax on distributions. Code § 61(a)(7).

Also as a compromise and incentive to repatriate, Code § 965(c) (“Application of Participation Exemption to Included Income”) provides a relatively favorable low rates (15.5% for “aggregate foreign cash position” and 8% rate for non-cash, accumulated earning post 1968).

TCJA § 965 targets US shareholders who own 10% or more (by value or voting power) of foreign corporations primarily owned or controlled by US persons (“CFCs”). Prior to the 2017 TCJA legislative compromise, these shareholders were taxed only when CFCs distributed earnings. The Code § 965 “Mandatory Repatriation Tax,” however, simply deems foreign corporations’ retained earnings going back decades up to 1986 to be 2017 income of US shareholders in proportion to their stock-holding ownership on a prescribed date in 2017.

The US shareholders are taxed on that undistributed, deemed “income”—which, by definition, has not been distributed, at a rate based on how the corporation held the retained earnings in 2017. 26 USC § 965(a) reads:

Treatment of deferred foreign income as subpart F income

In the case of the last taxable year of a deferred foreign income corporation which begins before January 1, 2018, the subpart F income of such foreign corporation (as otherwise determined for such taxable year under section 952) shall be increased by the greater of—
(1) the accumulated post-1986 deferred foreign income of such corporation determined as of November 2, 2017, or
(2) the accumulated post-1986 deferred foreign income of such corporation determined as of December 31, 2017.

As the Taxpayer Petitioners, Moores argue in their brief, because “the MRT simply deems [US shareholders’] accumulated earnings to be the ‘income’ of whoever happened to own the requisite number of shares on an arbitrary date in 2017,” the tax “is a tax on property, not income in any sense of the word.” See: Brief for Petitioners, Moore v. United States.

The Petitioners and their amici in support raise the specter of federal taxation on property or wealth “without [constitutionally required] apportionment;” left unchallenged, it logically leads or opens the door to the dreaded, confiscatory “wealth tax.”

Under the 2017 Trump Tax Reform, TCJA § 965(a), the taxpayers Charles and Kathleen Moore, as US shareholders of their CFC, an Indian farming tools and equipment supplier, had to declare their proportional share of reinvested earnings $132,512 as taxable income and paid an additional MRT $14,729.

In suit seeking a refund, they raise a broad, constitutional argument, characterizing Code § 965 MRT as an unapportioned direct tax in violation of the Constitution’s tax apportionment clauses, U.S. Const., art. I, § 2, cl. 3; id. § 9, cl. 4, because it taxes them on ownership of personal property (their Indian corporation, KisanKraft shares), not on income they realized.

On appeal, the California-based Ninth Circuit panel declared that “realization of income is not a constitutional requirement” for Congress to avail itself of the Sixteenth Amendment’s exemption from apportionment for “taxes on incomes.” It therefore follows that “there is no constitutional prohibition against Congress attributing a corporation’s income pro-rata to its shareholders.” And Code § 965 MRT at issue to be a tax on income authorized by the Sixteenth Amendment.

This bold and constitutional declaration seems directly contradicts the well-known precedent, Eisner v. MaComber, 252 U.S. 189 (1920), and sort of compels US Supreme Court’s granting of certiorari to clarify the “realization of income” constitutionality declaration imposed by MaComber.

Ninth Circuit Judge Bumatay in equally strong-worded dissent, contending essentially that Code § 965 MRT attributable to undistributed corporate earnings and profits would be treated logically same as imposing the dreaded federal wealth or property tax, and the panel’s declaration quoted above “opens the door to new federal taxes on other types of wealth and property being categorized as an ‘income tax’ without the constitutional requirement of apportionment.” Moore v. United States, 36 F.4^th 930 (9^th Cir. 2022).

As the Petitioners, Moores and their amici urge, a conservative, precedent-following approach would be affirming the 100-years Eisner v. MaComber “realization of income” Sixteenth Amendment test, and declare the MRT “transition tax” as unconstitutional. By implication, that would forestall the advent of federal taxation on property and wealth.

The challenging Petitioners’ stare decisis argument and staking the overarching constitutionality claim on Esiner v. MaComber, however, can be risky and unnecessarily broad; the argument invoking and relying on MaComber as the precedential constitutional authority can go easily against the taxpayer Petitioners, Moores. As argued, MaComber is limited to the “stock dividend context:”

As the Court explained, such a “‘stock dividend’ ” is a “book adjustment” that “does not alter the preexisting proportionate interest of any stockholder or increase the intrinsic value of his holding.” [Citations omitted] “The new [stock] certificates simply increase the number of the shares, with consequent dilution of the value of each share.” See: Brief for the United States, Moore v. United States.

In other words, the MaComber ruling explicitly made on the Sixteenth Amendment, does not define or set down the exact elements of taxable “income”, nor imposes a rigid “realization of income” constitutionality test, except declaring that “the essential nature of a stock dividend necessarily prevents its being regarded as income in any true sense” under the Sixteenth Amendment. MaComber, 252 U.S. at 205.

While “realization” provides clarifying conceptual illustration, it is broad and probably unnecessary as a constitutional test—even if the court feels the need to impose conservative, constitutional limitation on Congress’s taxing power. Indeed, the US government now argues that MaComber’s follow-up discussion on “realization of income” and attempts to define income are “misconceived dictum.”

In addition to directly challenging the constitutionality of Code § 965 (and associated MRT revenue of $340 billions), the taxpayers Moores’ line of argument incidentally challenges the constitutionality of a range of taxes and well-established Congressional taxing practices, including most notably Subpart F, under which US shareholders of CFCs for the past 6 decades pay differing types of annual “income” taxes. 26 USC § 951(a).

Taxpayer Petitioners, Moores’ argument force both sides to grapple with the constitutionality of Subpart F (and Code § 965 MRT based on essentially same analytic elements), and both come up not fully persuasive. Moores invoke “a theory of constructive realization of income by those taxed,” which theory would easily and logically cover both Subpart F and MRT at issue. The United States, in its responding brief, argues as follows:

In any event, Subpart F’s constitutionality is best understood to rest not on constructive realization, but on “the history of U.S. income taxation show[ing] that Congress has for decades been drafting income tax statutes which have bypassed the corporate entity” and taxed shareholders on undistributed corporate income. [Citations omitted] That historical pedigree is particularly strong as applied to the undistributed income of foreign corporations—presumably because Congress has generally avoided taxing foreign corporations and instead chosen to tax their U.S. shareholders. [Citations omitted]

See: Brief for United States, Moore v. United States.

It is true Subpart F is a compromise on CFCs taxation made between the Kennedy Administration and Congress in 1962; and it is also true Congress found it more practical and convenient to tax US shareholders rather than CFCs. The question remains, however, how “historical pedigree,” which is not a legal argument or concept, might relieve the court its burden of analyzing and justifying “attribution” under Subpart F and Code § 965, and in trying to uphold the tax how and when to disregard the difference between foreign corporations’ and US shareholders’ taxable income.