Written by: Nicholas Martelli
On June 20, 2024, the United States Supreme Court decided in favor of the United States in the case Moore v. United States, holding that it is Constitutional to tax, as income, earnings on overseas investments that have been reinvested instead of returned to the investor. The Court’s narrow holding on this issue does not appear to have dramatic implications for issues like the wealth tax proposed by some politicians. However, the Court’s holding is consistent with broader shifts in the extent to which the United States international tax system allows tax deferral.
The case involved the Moores, a Washington couple who had invested in an Indian tool manufacturer, KisanKraft. Their investment did quite well, accumulating more than $500,000 in income between 2006 and 2017. However, instead of distributing dividends to shareholders like the Moores, the Indian company reinvested earnings, a move that previously would have avoided a tax on repatriated payments (i.e. money sent back to the United States). As part of the changes enacted by the Tax Cuts and Jobs Act of 2017 (“TCJA”), § 965 of the Tax Code imposes a one-time taxation of return-on-investment payments like the Moores’ known as the Mandatory Repatriation Tax (“MRT”). Prior to the TCJA, the Moores would not have had to pay taxes on their return-on-investment until that money was repatriated out of India and back to U.S. soil. The Moores had argued that the reinvested earnings were not income, but instead property, and that therefore the MRT was an unconstitutional violation of the Sixteenth Amendment of the United States Constitution.
The rule for what constitutes income subject to taxation, first articulated in the Glenshaw Glass case, is that it must be an undeniable accession to wealth, clearly realized, over which the taxpayer has complete dominion. Accordingly, it is a fundamental principle of U.S. tax law that an accession to wealth is not income until it is clearly realized. Stock that has skyrocketed in value is an accession to wealth, but until the shares are sold, the gain is not yet realized, and so not taxed.
Interestingly, in oral argument, Justice Sotomayor pointed out that the Sixteenth Amendment of the United States Constitution does not explicitly require wealth to be realized for it to be taxed as income. Nevertheless, the Court held that the MRT is a tax on realized income, which in the Moores’ case was realized when it was reinvested, even if it all stayed in India. The Mandatory Repatriation Tax does not tax an increase in the value of shares of stock, which is more clearly a case of unrealized gain. Instead, the Court held that the Moores could not avoid the fact that dividends are realized income just because they were reinvested before repatriation. This leaves open, for now, the question of whether taxing unrealized wealth is Constitutional.
What does Moore mean for a wealth tax on unrealized gain?
Observers have noted that the issue in Moore impinges on the controversial wealth tax proposed by some Democrats. Taxpayers with wealth in assets can delay paying income tax on income generated from those assets by delaying realization. This is advantageous because the longer a taxpayer can delay paying taxes, the more investment capital on hand in the interim, generating higher returns. More money now is more money to invest, a bit like getting an interest-free loan from the IRS. This same principle allows a taxpayer to use a 401(k) to invest income without paying tax on it until years in the future. Through compounding interest, tax deferral allows the investment account to perform better than if the taxes were paid up front. Similarly, a stockholder may use strategies like borrowing against stocks to protect unrealized gain and delay paying taxes. The proposed wealth tax would limit the effect of these strategies by periodically taxing unrealized gain. One of the difficulties with that approach is the fundamental tax principle that gain is not taxable until realized. A holding for the Moores could have been a greater obstacle to the wealth tax by reinforcing the principle that wealth must be realized to be income. But, the actual holding does not necessarily make the wealth tax a stronger possibility. The Court did not hold that unrealized accession to wealth (like increased stock value) could be taxed as income, instead, the Court held that income (in the form of dividends) can be realized before repatriation. The narrow holding in Moore suggests only limited broader implications for the wealth tax.
What does Moore mean for the U.S. international tax system?
Indefinite reinvestment of earnings (like the earnings in Moore) has long been a typical and significant way that multinational corporations use foreign subsidiaries to defer taxes and lower their effective tax rate. More broadly, multinationals have traditionally used a variety of methods to obtain tax advantages from the territorial nature of the U.S. international tax system. In 2015, prominent tax scholars urged Congress to reject a territorial international tax system and adopt a worldwide no-deferral system. Among the arguments for such an approach is that neutralizing the tax advantages of the territorial deferral system could keep business and investment in the U.S. The TCJA that soon followed marked a notable shift away from a territorial deferral system. Additional changes enacted with the 2022 Inflation Reduction Act further point in the direction of a no-deferral worldwide scheme. The current tax regime is still not a no-deferral system because of the alternative minimum tax and limited applicability. However, the decision in Moore is not at odds with a potentially ongoing trend in the worldwide no-deferral direction.
The Organisation for Economic Co-operation and Development (“OECD”), an international policy coalition of 38 countries including the U.S., has advocated for a global minimum tax agreement to implement similar goals on a global scale. Pillar Two of the OECD’s plan seeks to establish a pact of standards for taxation to be adopted by member countries and which are intended to reduce the ability of businesses to shop around for tax rates. Under Pillar Two, U.S. parent companies could be taxed for unrepatriated earnings of their overseas subsidiaries by using an income inclusion rule. Although Congress has not adopted the Pillar Two tax proposals, the decision in Moore appears to leave an income inclusion rule as an open possibility.
Sources:
Moore v. United States, No. 22-800, 2024 U.S. LEXIS 2711 (June 20, 2024).
U.S.C. § 965.
Josh Boak, What’s the so-called ‘wealth tax’ in Biden’s proposed bill, and how would it work?, PBS News (Oct. 27, 2021).
Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955).
Melissa Quinn, Supreme Court appears wary of repercussions of major case that could upend tax code, CBS News (December 5, 2023).
Alan Cole, Why We’re Closely Watching Moore v. U.S., Tax Foundation (May 20, 2024).
Christopher H. Hanna & Cody A. Wilson, U.S. International Tax Policy and Corporate America, 48 Iowa J. Corp. L. 261 (2023).
Andrew Leahey, Mandatory Repatriation Tax Stands—But There’s More To Come, Forbes (June 20, 2024).
Amy Howe, Court upholds Trump-era corporate tax on foreign earnings, SCOTUSblog (June 20, 2024).