Supreme Court Rules in Case of Federal Taxation of Unrealized Income

On Thursday, the Supreme Court ruled 7-2 to uphold the constitutionality of mandatory repatriation tax (MRT) enacted in 2017, but chose to sidestep and not rule on the issue of whether the Constitution imposes a realization requirement on the taxation of income. (Moore v. United States)

Background & The Decision

  • The petitioners in Moore argued that the MRT exceeds Congress’s authority under the 16th Amendment to lay and collect taxes on income. The Moore’s were shareholders of a foreign corporation. The corporation never distributed its earnings, but the MRT taxed the Moore’s on their deemed share of the corporation’s income. The Moore’s argued that the federal government could not tax them on income they never realized. (Roundtable Weekly, Oct. 13)
  • A decision in favor of the Moore’s could have important consequences for both legislative proposals to tax unrealized gains, but also existing aspects of the tax code and pass-through taxation. 
  • The Ninth Circuit ruled against the Moore’s on the grounds that there is no realization requirement in the Constitution. 
  • The Roundtable has consistently opposed proposals to tax unrealized gains on several grounds, including their constitutionality and the damage they would cause to the economy, entrepreneurship, and productive investment. 
  • The Supreme Court, in a decision authored by Justice Brett Kavanaugh, stepped back from the sweeping holding by Ninth Circuit and concluded that it did not need to rule on the realization question because the foreign company’s operating income was clearly “realized” by the foreign company. In passing the MRT, Congress was simply attributing (or passing through) that income to its U.S. shareholders. 
  • The 7-2 opinion by Justice Kavanagh was accompanied by two concurring opinions, one from Justice Jackson and one from Justice Barrett (joined by Justice Alito). Justices Thomas and Gorsuch dissented. 
  • While the Real Estate Roundtable’s Tax Policy Advisory Committee (TPAC) and its members are still parsing the language of the various opinions to understand the broader implications, at the end of the day, there appear to be at least four justices willing to uphold a realization requirement (Barrett, Alito, Thomas, and Gorsuch), one justice prepared to hold that realization is not required (Jackson), and four justices who have not yet tipped their hand (Kavanaugh, Roberts, Sotomayor, and Kagan).  See analysis of Moore decision by TPAC member Don Susswein (Principal, RSM US LLP)

The Moore ruling is unlikely the last word in the heated debate over the constitutionality of taxing unrealized gains.

Taxation of Unrealized Gains is Focus of Senate Democratic Bill and Supreme Court Case

Senate Finance Committee Chairman Ron Wyden (D-OR), above, and 15 of his Senate colleagues recently introduced the Billionaires Income Tax Act (S.3367), which would tax the appreciation of wealthy individuals’ assets. On Tuesday, the Supreme Court heard oral arguments in Moore v. United States, a case challenging the federal government’s authority to tax unrealized gains under the 16th Amendment.

Billionaires Income Tax Act (BITA)

  • Under BITA, tradable, liquid assets would be marked-to-market and taxed annually on their appreciation, while illiquid assets would be subject to a “deferral recapture” tax when sold—or if certain other currently nontaxable events occur, such as death, a transfer to a trust, or a like-kind exchange. (One-page summary; section-by-section summary). (CQ, Nov. 30)
  • As drafted, the bill would apply to taxpayers with more than $100 million in annual income or more than $1 billion in assets for at least three consecutive years. (Tax Notes, Nov. 30).
  • The legislation is not limited to future appreciation of assets. It would reach back in time and apply the tax to accumulated, unrealized gains at the time of enactment.  The tax on built-in gains could be paid over a five-year period. Mark-to-market losses could be carried back for three years and applied against taxable market-to-market gains.
  • The appreciation of partnership assets (including built-in gains) and gains or losses from partnership transactions would flow through and taken into account at the partner level.
  • Related legislation was introduced in the House by Reps. Steve Cohen (D-TN) and Don Beyer (D-VA). 

Roundtable Position and Outlook

  • Real Estate Roundtable President and CEO Jeffrey DeBoer said, “Taxes rarely remain targeted, and like the income tax, this targeted proposal could be revised and expanded over time to apply to everyone. Moreover, taxing unrealized gains would upend over 100 years of federal taxation, require an unprecedented IRS intrusion into household finances, and create unknown and potentially unintended consequences at a time of economic uncertainty. Deferring the taxation of gains until an asset is sold supports entrepreneurs while encouraging the type of patient, long-term investing and productive risk-taking that drives our economy forward.”
  • In the last Congress, efforts to enact a mark-to-market regime were unsuccessful when they ran into resistance from moderate Democrats. Sen. Wyden (D-OR) acknowledged that his bill, which lacks bipartisan support, would not be part of any year-end tax legislation. (CQ, Nov. 30)

Moore v. United States

  • On Tuesday, the Supreme Court heard oral arguments in Moore v. United States, which challenges the federal government’s constitutional authority to tax unrealized income.
  • The petitioners in Moore argue that the mandatory repatriation tax in the Tax Cuts and Jobs Act exceeds Congress’s authority under the 16th Amendment to lay and collect taxes on incomes. They argue that because the tax is based on the accumulated, undistributed earnings of a foreign corporation, there is no income realization event for the Moores, who are a non-controlling minority shareholder of the corporation. (Roundtable Weekly, Oct.13)
  • Depending on the outcome and the scope of the decision, the Moore case could have implications for other forms of taxing unrealized gains, such as the appreciated value of real estate and other assets directly owned by a taxpayer.

A majority of the justices signaled they are hesitant to weigh into the broader debate of how to define income for tax purposes. A decision in Moore is not expected until June 2024. (USA Today and PoliticoPro, Dec. 5 | Tax Foundation, Aug. 30)

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Supreme Court Case Challenges Federal Taxation of Unrealized Income

The Supreme Court

This week, the Supreme Court announced it will hear oral arguments on Dec. 5 in a case—Moore v. United States—challenging the federal government’s right to tax unrealized gains. (PoliticoPro, Oct. 12)

Moore Consequences

  • The question raised by the petitioners in Moore, and granted certiorari by the Supreme Court in June, is whether the 16th Amendment authorizes Congress to tax unrealized sums without apportionment among the states.

  • Specifically, the case involves a Washington state couple with an interest in an India-based corporation who are challenging a 2017 mandatory repatriation tax on foreign earnings as an unconstitutional levy on unrealized gains.

  • Outside legal and tax commentary and analysis have suggested the case could have far-reaching consequences for both the existing tax code and pending legislative proposals, depending on how the decision is drafted. 

  • A recent report from the Urban-Brookings Tax Policy Center report estimates that a ruling in favor of the petitioners could result in tax revenue losses exceeding $100 billion annually. Estimates of revenue losses from the Tax Foundation range as low as $3.5 billion and as high as $5.7 trillion in the unlikely event the Supreme Court were to strike down taxes on all undistributed business earnings, whether earned domestically or from foreign sources.

Policy Ramifications

  • A Supreme Court decision in favor of the petitioners could also undercut President Biden’s proposal to tax the unrealized real estate and other gains of wealthy taxpayers. The President and influential lawmakers such as Senate Finance Chairman Ron Wyden (D-OR) have proposed new mark-to-market taxes on assets based on annual changes in asset values rather than specific realization events. (Roundtable Weekly, Sept. 19, 2019)

  • The Real Estate Roundtable has consistently opposed the proposals to tax unrealized gains since they first emerged in 2019 (Sen. Wyden, Treat Wealth Like Wages, 2019).

JCT Memo

Joint Committee on Taxation logo
  • On Oct. 3, in a letter to House Ways and Means Ranking Democrat Richie Neal (D-MA), the Joint Committee on Taxation (JCT) provided an analysis of how a ruling for the petitioners in Moore could impact the tax code.

  • JCT informed Rep. Neal that partnership taxes, taxation of shareholders of S corporations, and taxes on mark-to-market valuations also could be implicated in the outcome. The income of real estate mortgage investment conduits, or REMICs, also may be affected, according to JCT’s memo.

Alternatively, notes JCT, the Court could rule that the mandatory repatriation tax is a tax on realized income, in which case it could “leave unanswered the question of whether the Constitution imposes a realization requirement.” (JCT memo, p. 2)