By Jesse Hooker, JD, Kevin Wilkes, JD, LLM, and Tiffany Ippolito, JD, LLM

On Dec. 5, 2023, the U.S. Supreme Court heard oral arguments in Moore v. United States, a case that represents one of the few times in Supreme Court history where the Court will opine on Congress’s constitutional ability to tax income under the 16th Amendment to the U.S. Constitution.

At the heart of the case is Internal Revenue Code Section 965, a repatriation tax enacted in 2017 as part of the Tax Cuts and Jobs Act. The tax is a one-time mandatory tax on U.S. shareholders’ pro rata share of accumulated untaxed earnings of certain foreign corporations by U.S. persons who own at least 10% of the foreign corporation.

Tax scholars have been writing extensively on the far-reaching federal tax implications a decision in favor of the taxpayers could have. In one possible outcome, a narrow ruling in Moore could maintain the status quo until larger issues of income taxation (such as the constitutionality of a wealth tax) potentially arise in the future. Conversely, a strong ruling in favor of the plaintiffs (the Moores) could significantly limit the taxing power granted to Congress under the Constitution and upend the current U.S. tax regime.

Both the U.S. District Court for the Western District of Washington and the U.S. Court of Appeals for the Ninth Circuit found that the Section 965 repatriation tax was constitutional, falling within Congress’s power under the 16th Amendment. Specifically, the Court of Appeals rejected the Moores’ argument that income must be realized by the taxpayer, holding instead that the concept of realization was founded on administrative convenience and is not a constitutional requirement that limits congressional power.¹ On appeal, the petitioners renewed their argument that the tax represents an overreach of congressional ability to tax because the tax is on unrealized income.

Petitioner’s Argument

The Moores rely primarily on Eisner v. Macomber² – a case decided shortly after the passage of the 16th Amendment and the last time the Supreme Court struck down an element of the income tax code – to argue that the tax imposed by Section 965 is unconstitutional because it is a tax on property, not income.³

In Macomber, the Standard Oil Company of California issued a stock dividend to its shareholders. The IRS imposed a tax on the portion of the stock dividend that was paid out of the surplus and undivided profits of the corporation. Ruling that the stock dividend was not income for purposes of the 16th Amendment, the Supreme Court crafted a definition of income that included “a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital however invested or employed, and coming in, being derived, that is received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal.”⁴ The court in Macomber found that the IRS was taxing a stockholder’s share in corporate earnings, which was not income.

The petitioners also point to Commissioner v. Glenshaw Glass,⁵ where the court held that punitive damage awards were taxable income, as additional support that the 16th Amendment requires a realization event. In Glenshaw Glass, the court held that punitive damages were taxable income because they are “undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.”⁶ The petitioners also argue that a realization requirement is evident from the text of the 16th Amendment. As the 16th Amendment allows Congress to impose “taxes on incomes, from whatever source derived,” the Moores argue that the text imposes a realization requirement because income must be “derived from a source”.

Government’s Response

The government argues that the petitioners “err in contending that the 16th Amendment created a realization requirement.”⁷ Instead, the government contends that income encompasses “all economic gains.”⁸ Nor does the government believe a realization requirement can be read into the phrase “from whatever source derived.” The government contends that the phrase was designed to overturn a source-based analysis of income taxes adopted in Pollock v. Farmers’ Loan & Trust Co.⁹ Contrary to the Moores’ contention, the government argues that there is no textual basis to read in a realization requirement to the 16th Amendment.

The government points to early income tax codes to argue that it was the drafters’ intent that the undistributed earnings of a corporation be included in the definition of income. The government points to tax acts of 1864, 1865, 1867, and 1870, which taxed “gains, profits, or income of any person entitled to the same, whether divided or otherwise.” Collector v. Hubbard¹⁰ upheld Congress’s ability to enact these decisions. In response to Pollock undermining Hubbard, the 16th Amendment was passed to restore Congress’s pre-Pollock taxing ability, thus income must therefore include the ability to tax undistributed corporate earnings and profits.

The government also points to other established areas of the Income Tax Code, such as Subpart F, to support the constitutionality of Section 965. Subpart F requires a U.S. person who owns at least 10% of a controlled foreign corporation to include in their gross income the pro rata share of the Subpart F income attributable to that person, including income from passive investment activities, dividends, interest, and rents that are foreign personal holding company income under Section 954. The petitioners conceded that Subpart F is constitutional because there is a “constructive realization” of income by the U.S. person. The government goes further and argues that the constitutionality of Subpart F lies not in a constructive realization, but in Congress’s long-standing ability to tax economic gains as income.

Potential Consequences

If the Moores prevail, Section 965 will be declared unconstitutional, at least with respect to individuals. There is some concern that a favorable ruling could implicate mark-to-market taxes, Subchapter K and S corporation rules, and Subpart F. Numerous taxpayers who paid the tax may seek refunds, provided the statute of limitations does not preclude such claims. Some taxpayers have filed protective refund claims, which the IRS will need to process. Furthermore, questions surrounding the constitutionality of the United States adopting global minimum tax rules proposed by the Organisation for Economic Co-operation and Development could be brought to the forefront. Corporations that receive a refund should also revisit stock basis calculations for the controlled foreign corporations.

If the government prevails, what will the court’s reasoning be? The Supreme Court could rule that there is no realization requirement under the 16th Amendment. If so, then any economic gain of the corporation could be taxed, even without some event giving rise to the gain. This could clarify congressional powers surrounding wealth taxes and mark-to-market taxes and support the constitutionality of such taxes. Alternatively, the Supreme Court could find that realization is a requirement under the 16th Amendment, and that realization did occur in the Moore case (the foreign corporation’s recognition of gain is sufficient to give Congress the power to tax individual shareholders).

Whatever the Supreme Court’s decision turns out to be, granting certiorari indicates a willingness to decide constitutional issues in an area where the executive and legislative branches have been afforded significant deference for the last 100 years. This could presage future constitutional challenges to proposed taxes.

¹ Moore v. U.S., 36 F.4th 930 (9th Cir. 2022).
² Eisner v. Macomber, 252 U.S. 189 (1920).
³ Charles G. Moore v. United States of America, petition for writ of certiorari, (Feb. 21, 2023).
⁴ Eisner, 252 U.S. at 209.
⁵ Comm’r v. Glenshaw Glass Co., 348 U.S. 426 (1955).
⁶ Id.
⁷ Charles G. Moore v. United States of America, response by the government, page 9.
⁸ Id.
⁹ Pollock v. Farmers’ Loan & Trust Co., 158 U.S. 601 (1895).
¹⁰ Collector v. Hubbard, 79 U.S. 1 (1871).

Jesse Hooker, JD, is a senior in the transaction advisory services group of BDO in Grand Rapids, Mich. He can be reached at jshooker@bdo.com.

Kevin Wilkes, JD, LLM, is tax principal with the transaction advisory services group with BDO in Grand Rapids. He can be reached at kwilkes@bdo.com.

Tiffany Ippolito, JD, LLM, is a managing director in the national tax office at BDO in Tampa, Fla. She can be reached at tippolito@bdo.com.

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^{Statements of fact and opinion are the authors’ responsibility alone and do not imply an opinion on the part of the PICPA's officers or members. The information contained herein does not constitute accounting, legal, or professional advice. For actionable advice, you must engage or consult with a qualified professional.}