A little-discussed legal case heading for a hearing at the US Supreme Court’s October session has the ability to not only blow up a lot of current tax law but torpedo Joe Biden’s proposed “billionaires tax” before the House of Representatives gets the chance to euthanize it.
In 2005, Charles and Kathleen Moore invested $40,000 in an Indian business named KisanKraft, which marketed power tools to Indian farmers in exchange for 13% of the company’s equity. It was a good investment, and the company made a profit every year. The profit was reinvested in the company and made no distribution to equity owners. The 13% equity share the Moores owned increased in notional value, but they didn’t receive a single cent in income.
Ordinarily, the Moores would have had a tax bill due when they sold their share of the business or started receiving a share of the profits. This changed in 2017 with the passage of the Tax Cuts and Jobs Act; investors in foreign corporations, like the Moores, were hit with a one-time “repatriation” tax on profits held overseas. The profits were based on the increased investment value even though the asset was not sold. I won’t tell you who controlled the Executive and both houses of the Legislative Branch when this was passed.
As a result of the change in the law, the Moores were hit with a $14,729 tax bill. They paid the bill and sued the federal government claiming a violation of the 16th Amendment.
The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.
The Moores’ theory is pretty basic. Article 1, Section 9, Clause 4 of the Constitution reads:
No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or enumeration herein before directed to be taken.
While the 16th Amendment permits an income tax, income has always meant, well, income. As the 2017 bill introduced by Texas Republican Kevin Brady taxes unrealized profits as a direct tax and not apportioned among the states, the tax is illegal. Supreme Court precedent seems to agree. In Eisner v. Macomber (1920), the Supreme Court ruled:
There, the Court addressed whether a corporation’s issuance of additional shares to a stockholder as stock dividends wasincomeunder the Sixteenth Amendment and, if not, whether a tax on those unrealized gains was a direct tax. After concluding that the stock dividends were notincome,the Court relied on Pollock [v. Farmers’ Loan & Trust Co.] to conclude that the tax was a direct tax.
The Moores lost in district court and again in the Ninth Circuit.
The problem is that US tax law has moved on from that dusty old Constitution thing.
The court faces a difficult question: Is this mandatory tax on foreign profits that shareholders never actually received constitutional under the 16th Amendment? The Supreme Court has maintained since 1920 that income must be “clearly realized” for it to be taxable. Yet the U.S. tax code is riddled with taxes on unrealized income.
For example, the main tenet of partnership tax law is that partners are taxed on income allocated to them for tax purposes, whether or not they actually receive the income. The Supreme Court upheld this principle in 1938, less than three decades after the 16th Amendment was ratified. Since 1962, the United States has also taxed the passive and highly mobile income of overseas corporations controlled by U.S. shareholders, whether or not the income is distributed to them, to prevent aggressive tax avoidance strategies. The TCJA’s mandatory repatriation tax fits within this existing international tax regime.
Small case, massive impact.
Like so many things in life, the “gray area” is only our attempt to justify some fu**ed up action we really want to take. Nearly everything in life is black and white. Sure, obeying the Constitution is difficult when you want to do unconstitutional stuff. And you can twist and turn all kinds of ways to rationalize locking down communities. But just because that has been done in the past is no reason to continue doing it.
Where the real impact of this decision will come is Joe Biden’s attempt to scapegoat any American wealth. Biden’s tax proposal for FY 2024 includes a 20% tax on unrealized capital gains. That’s what the Moores had. This tax would hit households with over $100 million net worth. So if you started a trucking company with a single rented truck and built it up until you break the net worth threshold, you could owe the government a quarter of your company’s value no matter how much cash you have on hand.
Words should have meaning; at least they did until Harry Blackmun decided abortion was health care, Anthony Kennedy found homosexuality to be in a “realm of personal liberty,” and John Roberts declared Obamacare was not a tax.
The Supreme Court should take this as an opportunity to reiterate two precedents that backstop the black-letter words of the Constitution and the English language. Taxing people on money they haven’t made is obscene. Opening the door to the government confiscating wealth is a betrayal of the country because that is where this concept leads.