A Recap of the Moore Decision

The Supreme Court disposed of the case without tackling the realization issue

Last Thursday, the Supreme Court issued its opinion in Moore v. U.S., which was a highly anticipated case that could have had major implications for what is considered income under the 16th Amendment.

In a previous edition, we delved into the intricate details of the §965 transition tax, a key issue in the Moore case. The Court's consideration of this tax posed a fundamental question:

Whether the Sixteenth Amendment authorizes Congress to tax unrealized sums without apportionment among the states.

The Supreme Court, in a 7-2 majority decision, upheld the constitutionality of the §965 transition tax, as previously ruled by the Ninth Circuit. However, it is essential to note that only five justices agreed with the majority decision, indicating a more nuanced outcome than it may initially seem.

Majority Opinion by Kavanaugh

Justice Kavanaugh, Chief Justice Roberts, Justice Kagan, Justice Sotomayor, and Justice Jackson sidestepped the realization issue, finding that the §965 transition tax was a constitutional income tax under its existing precedent.

The majority noted that close to a century of case law indicates that Congress can tax either the entity or its owners on the undistributed income realized by that entity:

Congress sometimes chooses to tax a business entity itself on the income that the entity earns. Alternatively, Congress sometimes elects to treat an entity as a passthrough—attributing the entity’s undistributed income to the shareholders or partners and then taxing the shareholders or partners on that income. Either way, this Court has held that the tax remains a tax on income—and thus an indirect tax that need not be apportioned…

So by 1938, this Court’s precedents had established a clear rule that directly contradicts the Moores’ argument in this case. That line of precedent remains good law to this day. Indeed, since then, it has gone without serious question in both Congress and the federal courts that Congress can attribute the undistributed income of an entity to the entity’s shareholders or partners, and tax the shareholders or partners on their pro rata share of the entity’s undistributed income…

To sum up: The Court’s longstanding precedents plainly establish that, when dealing with an entity’s undistributed income, Congress may tax either (i) the entity or (ii) its shareholders or partners.

Under current law, for example, Subchapter K (partnership taxation) and Subchapter S (small business corporation taxation) impose a tax on the entity’s income at both the owner and entity levels. Partners are generally taxed on the partnership’s income; however, the centralized partnership audit regime imposes an entity-level tax for any imputed partnership underpayment. Similarly, shareholders of S corporations are generally taxed on the S corporation’s income; however, an S corporation may also be subject to an entity-level tax, such as the §1374 built-in gains tax or the §1375 excess passive income tax.

Since the foreign corporation realized the income taxed by §965, the majority said the realization question did not have to be answered; instead, the majority framed the issue as to whether Congress could impose the tax on that undistributed income on the foreign corporation's owners. The majority said the §965 transition tax was simply an extension of the Subpart F tax regime, which taxes certain U.S. shareholders on certain types of undistributed earnings from foreign corporations. Subpart F has long been held to be a constitutional income tax:

As the Second Circuit concluded in a leading case upholding subpart F: The constitutional challenge to subpart F “borders on the frivolous” in light of Heiner v. Mellon. Garlock, Inc. v. Commissioner, 489 F. 2d 197, 202–203, and n. 5 (1973); see also Estate of Whitlock v. Commissioner, 59 T. C. 490, 507 (1972) (The “Supreme Court’s pronouncements have been to the effect that taxation of undistributed current corporate income at the stockholder level rather than at the corporate level is within the congressional power”)…

The majority explicitly noted the limited scope of its holding:

The Court’s holding is narrow and limited to entities treated as pass-throughs. Nothing in this opinion should be read 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. Nor does this decision attempt to resolve the parties’ disagreement over whether realization is a constitutional requirement for an income tax.

Concurring Opinion by Barrett

Justice Barrett, joined by Justice Alito, agreed only with the outcome of the majority decision but not its reasoning; it held for the government on a procedural issue. The concurring opinion stated that income must be realized under the 16th Amendment to be taxed without apportionment, and the Moores did not realize the undistributed income from the foreign corporation.

Justice Barrett also disagreed with the majority opinion’s expansive view of Congress’s ability to attribute undistributed earnings to entity owners:

Put differently, can Congress disregard KisanKraft’s corporate form, attribute KisanKraft’s income to its shareholders, and tax its shareholders on that income? The Court concludes that it can, describing our case law as “clear and definitive” in the Government’s favor… I read our cases differently. As I understand our precedent, it leaves room for Congress to disregard the corporate form in some circumstances. But that is not because Congress—as the Court suggests—can treat corporations interchangeably with partnerships, whose partners have always been subject to pass-through taxation on the partnership’s income… Rather, our cases allow Congress to disregard the corporate form to determine whether the shareholder received income in substance, if not in form.

She also stated the attribution issue was a difficult question that required additional briefing by the parties and that the majority reached its conclusions too quickly.

In an attempt to make their case more palatable to the justices, the Moores conceded that Subchapter K, Subchapter S, and Subpart F were constitutional; to Justice Barrett, their concession on Subpart F essentially ended their case:

In this litigation, however, the Moores have conceded that subpart F is constitutional… And I agree with the Court that subpart F is not meaningfully different from the MRT in how it attributes corporate income to shareholders… Taxpayers generally bear the burden to show they are entitled to a refund… Given the Moores’ concession, they have not met that burden here. For that reason, I concur in the Court’s judgment affirming the judgment below.

Dissenting Opinion by Thomas

Justice Thomas, joined by Justice Gorsuch, would have held the §965 tax as unconstitutional:

The Moores are correct. Sixteenth Amendment “incomes” include only income realized by the taxpayer. The text and history of the Amendment make clear that it requires a distinction between “income” and the “source” from which that income is “derived.” And, the only way to draw such a distinction is with a realization requirement. Our precedent says as much. In Eisner v. Macomber, 252 U. S. 189 (1920), the Court explained that “the characteristic and distinguishing attribute of income,” as the term is used in the Sixteenth Amendment, is that it is “received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal.” Id., at 207. Because the Moores never actually received any of their investment gains, those unrealized gains could not be taxed as “income” under the Sixteenth Amendment.

The Ninth Circuit wrongly rejected the Moores’ challenge on the ground that “realization of income is not a constitutional requirement.” 36 F. 4th 930, 936 (2022). That conclusion cannot be reconciled with the Sixteenth Amendment as the Court correctly interpreted it in Macomber. We therefore granted certiorari to answer the question “[w]hether the Sixteenth Amendment authorizes Congress to tax unrealized sums without apportionment among the states,” i.e., as “incomes.” Pet. for Cert. i.

Today, the Court upholds the MRT only by ignoring the question presented. It does “not address the Government’s argument that a gain need not be realized to constitute income under the Constitution.” Ante, at 12–13, n. 3. Instead, the Court answers the question “whether Congress may attribute an entity’s realized and undistributed income to the entity’s shareholders or partners, and then tax the shareholders or partners on their portions of that income.” Ante, at 8. After changing the subject, the majority upholds the MRT by relying on unrelated precedent to derive a “clear rule” that “Congress can attribute the undistributed income of an entity to the entity’s shareholders or partners.” Ante, at 10–11.

I respectfully dissent. The Ninth Circuit erred by concluding that realization is not a constitutional requirement for income taxes. And, the majority’s “attribution” doctrine is an unsupported invention.

Justice Thomas did not take the position that Subchapter S, Subchapter K, and Subpart F are unconstitutional; however, he believes that the §965 transition tax is different enough from Subpart F that it is not an income tax:

Finally, the MRT is unlike other taxes on shareholders of closely held foreign corporations. The MRT “differs from other provisions of Subpart F”—the portion of the Internal Revenue Code dealing with controlled foreign corporations—because the MRT does not focus on “the corporation’s receipt of investment earnings while subject to the shareholders’ control.” Brief for Petitioners 44–45.

Subpart F “aligns the corporation’s earning of the money being taxed with the shareholder’s control in the same year.” Reply Brief 23. But, “[t]he MRT by its terms takes no account of whether a shareholder had any interest or control when the corporation made the earnings that it attributes to her.” Ibid. In fact, the MRT “tags a shareholder with taxable ‘income’ even if ” he purchased shares “long after the corporation earned the sums being taxed,” and it imposes no liability on taxpayers who owned shares for years of retained earnings but sold them before the MRT’s trigger date. Brief for Petitioners 45. Subpart F includes some minimal requirements to ensure that taxable “income” belongs to the shareholder in some way; the MRT abandons that effort entirely…

The fact that the MRT has novel features does not mean that it is unconstitutional. But, the MRT is undeniably novel when compared to older income taxes, and many of those differences are constitutionally relevant. Because the MRT is imposed merely based on ownership of shares in a corporation, it does not operate as a tax on income.

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