Constitutionality of Section 965 Repatriation Tax in Question?

The U.S. Supreme Court on Dec. 5 heard oral arguments in Moore v. United States. The narrow question in this case is whether Congress had the constitutional power—on a one-time basis in 2017 as part of a reform to certain U.S. international tax rules—to require U.S. shareholders in foreign corporations to pay tax on their share of the foreign company’s accumulated and undistributed earnings, without any actual dividend being declared or paid under the provisions of Section 965.

A somewhat similar tax was found by the Supreme Court to be unconstitutional in 1920. A pivotal question in front of the Court is whether and to what degree that 1920 case applies today.

During the oral arguments, many of the justices were concerned about the reaches of their ruling; that a ruling for the Moores could cause major portions of the tax law to be invalidated. But many were also concerned that the absence of any restriction on the government’s ability to tax could lead to abusive or onerous taxation.

Based on the oral arguments, it appears unlikely that the Supreme Court is poised to issue a decision that will bring about significant changes to the current federal tax rules. However, the Court’s decision could affect the viability of future tax legislation governing both domestic and global capital markets, such as legislation relating to a wealth tax or a tax on unrealized capital gains.

A ruling is expected in spring 2024.

Under Article I of the Constitution, Congress can only impose “direct taxes” if they are apportioned among the states in proportion to their populations, a requirement that makes any “direct tax” almost impossible to enact.

The 16th Amendment, passed in 1909, created an exception that permitted Congress to impose an income tax without apportionment. Congress proceeded to enact an income tax in 1913, which is the precursor to our current federal income tax.

However, Eisner v. Macomber and several other Supreme Court cases (dating back to 1920 and 1955) suggest that the 16th Amendment only permits income to be taxed if the income is “realized,” a term whose meaning is less than entirely clear.

In the Macomber case, the Court said there was no “realization” because the corporate earnings there were not distributed to the shareholders. Many believe that the same principle prohibits Congress from taxing unrealized capital gains on a long-term investment in stocks, real estate or other property until the property is sold (or exchanged for materially different property).

Does the modern tax code truly require that income must be realized? After all, many provisions currently in force impose a tax on income that is not received in cash. What exactly does it mean for income to be “realized?” These are the crux of the issue at heart in the Moore case.

The case has attracted a tremendous amount of commentary and attention. Many have argued that, under the Moores’ argument, many longstanding provisions of the tax code could be attacked under the theory that those provisions are no different than the repatriation tax and involve a tax on unrealized gains. Some of the provisions of concern might include:

Did the Supreme Court accept this case simply to opine on the repatriation tax?

Many believe that the Supreme Court’s interest in this case relates to tax proposals that are not currently part of the tax law. In recent years, some commentators and legislators have proposed various new forms of taxes; some have proposed enacting a wealth tax and others have proposed enacting a requirement that “paper” gains on stocks or other assets be taxed, even though nothing has been sold or disposed of. However, during oral arguments, the U.S. government . The attorney appeared to concede that a wealth tax would be unconstitutional under the 16th Amendment.

How would a ruling invalidating Section 965 impact taxpayers who repatriated “previously taxed E&P (PTEP) in subsequent tax years?

If the Court finds that the Section 965 is invalid, then it would also seem that any PTEP generated as a result of the ruling would no longer exist.  Any future distribution of PTEP would likely no longer be PTEP, and would be taxable if received by a non-Corporate taxpayer, resulting in more tax than if Section 965 existed.

It will be interesting to see how all this plays out in the coming months.