Implications of the Supreme Court’s Moore decision

Editor: Mark G. Cook, CPA, CGMA

On June 20, 2024, the U.S. Supreme Court delivered its decision in Moore, No. 22-800 (U.S. 6/20/24), upholding the constitutionality of the transition tax under Sec. 965. This decision has significant implications for tax professionals, particularly in the context of international taxation, and for potential future wealth taxes.

Background

The case involved Charles and Kathleen Moore, who invested in KisanKraft, an American-controlled foreign corporation (CFC). From 2006 to 2017, KisanKraft accumulated substantial income but did not distribute it to its American shareholders. The 2017 Tax Cuts and Jobs Act (TCJA), P. L. 115-97, introduced the transition tax, a one-time tax on the post-1986 accumulated earnings of foreign corporations controlled by U.S. taxpayers. The Moores paid a transition tax of $14,729 on their pro rata share of KisanKraft’s accumulated income, despite not receiving any distributions.

The Moores challenged the transition tax, arguing that it violated the Constitution’s Direct Tax Clause in Article 1 and the Fifth Amendment’s Due Process Clause. The couple sued for a refund in district court. The district court dismissed the case (Moore, No. C19-1539-JCC (W.D. Wash. 11/19/20)), and the Ninth Circuit affirmed the decision (Moore, 36 F.4th 930 (9th Cir. 2022)). The Moores appealed to the Supreme Court, which granted certiorari (Moore, No. 22-800 (U.S. 6/26/23, cert. Granted)).

The decision

The Supreme Court held in favor of the government, upholding the transition tax (which the opinion referred to as the “mandatory repatriation tax”). The Court, affirming the Ninth Circuit’s decision, stated: “As to the Moores’ case, Congress has long taxed shareholders of an entity on the entity’s undistributed income, and it did the same with the [transition tax]. This Court has long upheld taxes of that kind, and we do the same today with the [transition tax]” (Moore, slip op. At 24).

Key points of the Supreme Court decision

Constitutionality of the transition tax: The Moores argued that the transition tax was unconstitutional because it taxed income that they had not yet realized. They contended that the transition tax taxed their shares of KisanKraft’s accumulated income even though KisanKraft had not distributed any earnings to its shareholders.

However, the Supreme Court held that the transition tax did not tax unrealized income because income was realized by KisanKraft. The Court found “longstanding precedents” that Congress has the authority to tax an entity’s shareholders or partners on the undistributed, realized income of that entity.

A dissent in the case argued that the transition tax was unconstitutional because it was levied on income that the Moores had not yet realized. According to the dissent, the Sixteenth Amendment allows taxation only of income realized by taxpayers. This majority’s opinion has significant implications for the definition of “income” and the constitutionality of taxing unrealized gains — questions that the Court determined it did not need to answer to decide the case.

Direct vs. indirect tax: The Moores argued that the transition tax was an unapportioned direct tax on their shares of KisanKraft stock, which they claimed violated the Direct Tax Clause of the Constitution.

The Supreme Court, however, held that the transition tax was not a direct tax but an indirect tax on income, and under the Sixteenth Amendment, taxes on income need not be apportioned. This part of the decision also has significant implications for the definition of “income” and the constitutionality of taxing unrealized gains. The decision does not directly address the constitutionality of taxing unrealized appreciation of assets and specifically mentions that whether realization is a constitutional requirement is an issue for “another day” (Moore, slip op. At 24).

Due Process Clause: Earlier in the litigation, the Moores contended that the transition tax violated the Due Process Clause of the Fifth Amendment because it applied retroactively to past earnings. However, the Ninth Circuit rejected this argument in the Moores’ case based on the Supreme Court’s decision in Carlton, 512 U.S. 26 (1994). In Carlton, the Court held that a law retroactively imposing a tax did not violate the Due Process Clause if the retroactive application of the law was supported by a legitimate legislative purpose furthered by rational means. Although the Court’s Moore decision affirms the Ninth Circuit’s judgment, the Court did not rule on retroactive taxation and due process, noting that “the Moores did not seek certiorari on that issue” (Moore, slip op. at 21).

Implications for tax professionals and taxpayers

The Supreme Court’s decision in Moore has several important implications. The decision:

• Reinforces the need for tax professionals to ensure compliance with tax provisions regarding foreign income, particularly those related to CFCs. The transition tax’s constitutionality means that similar taxes on undistributed foreign earnings are likely to withstand legal challenges.
• Highlights that companies should reassess their global tax strategies to consider the tax implications of foreign earnings.
• May influence future tax legislation, particularly in the context of wealth taxes. The Court’s broad interpretation of Congress’s taxing power could pave the way for new taxes on unrealized gains or other forms of wealth. 

Editor Notes

Mark G. Cook, CPA, CGMA, MBA, is the lead tax partner with SingerLewak LLP in Irvine, Calif.

For additional information about these items, contact Cook at mcook@singerlewak.com.

Contributors are members of or associated with SingerLewak LLP.