The Supreme Court on Thursday upheld a provision of a 2017 corporate tax reform law, known as the mandatory repatriation tax, that taxes the undistributed profits from U.S. shares of foreign corporations in which Americans own a majority. An American couple had challenged the constitutionality of the one-time tax, which was imposed on earnings after 1986 and would increase the couple’s tax bill by approximately $15,000. But by a vote of 7-2, the court ruled that the tax does not violate the Constitution.
Justice Brett Kavanaugh wrote for the majority. Stressing that the court’s ruling was a narrow one, Kavanaugh noted that a contrary decision “could render vast swaths of the Internal Revenue Code unconstitutional.”
Congress enacted the tax in 2017 as part of then-President Donald Trump’s plan to overhaul the tax code. The tax, which was expected to raise approximately $300 billion over 10 years, applied to all earnings by a controlled foreign corporation after 1986, regardless of whether they were distributed to shareholders or whether the shareholders owned the shares when the corporation made the earnings on which they are being taxed.
Lease and Its Implications
In 2005, the U.S. couple at the center of the case, Charles and Kathleeen Moore, invested $40,000 in an Indian corporation, KisanKraft, that supplies small farmers in India with modern tools. In return, they received 13% of the company’s shares, but over the next 12 years they did not receive any distributions or dividends from KisanKraft, which instead reinvested its profits in the business.
The Moores went to federal court, seeking a refund of the additional $15,000 in taxes that they paid as a result of the mandatory repatriation tax. They argued that the tax violates the Constitution’s apportionment clause, which requires taxes to be imposed so that its state’s share is proportional to its population, because it taxed their personal property, rather than any income from the corporation. And although the Constitution’s 16th Amendment carves out an exemption to the apportionment clause for income taxes, they alleged, KisanKraft’s profits did not qualify as their income because they never received it.
In its 24-page ruling, the majority did not resolve the question whether – as the Moores contended and the government disputed – the Constitution requires income to be realized before it can be taxed. Instead, Kavanaugh explained, the real “precise and narrow question” before the justices was whether Congress can attribute income that an entity has realized but not distributed to its shareholders or partners and then tax that income. For Kavanaugh and the four justices who joined his opinion – Chief Justice John Roberts and Justices Sonia Sotomayor, Elena Kagan, and Ketanji Brown Jackson – the answer was clear from the Supreme Court’s “longstanding precedents”: yes, although they stressed that their ruling was a narrow one that “applies when Congress treats the entity as a pass-through.”
Moreover, Kavanaugh continued, “in an effort to contain the blast radius of their legal theory,” the Moores have conceded that other taxes – such as partnership taxes, taxes on S-corporations, and taxes under subpart F of the Internal Revenue Code, which applies to American-controlled foreign corporations – are constitutional. Because the Moores “cannot meaningfully distinguish” the mandatory repatriation tax from those other taxes, Kavanaugh reasoned, their argument, “taken to its logical conclusion,” would mean that other parts of the code are also unconstitutional – which could in turn cost the federal government “trillions in lost tax revenue.”
“The logical implications of the Moores’ theory would therefore require Congress to either drastically cut critical national programs or significantly increase taxes on the remaining sources available to it — including, of course, on ordinary Americans.” “The Constitution,” Kavanaugh concluded, “does not require that fiscal calamity.”
Jackson joined the Kavanaugh opinion but also penned a brief concurring opinion in which she contended that the court’s role in tax disputes should be a limited one. “I have no doubt,” she wrote, “that future Congresses will pass, and future Presidents will sign, taxes that outrage one group or another.” But the court’s tax cases demonstrate that “the remedy for such abuses is to be found at the ballot-box,” she concluded.
Justice Amy Coney Barrett, in an opinion joined by Justice Samuel Alito, agreed with the court’s decision to uphold the lower court’s ruling in favor of the government but not with her colleagues’ reasoning. In her view, “Congress’s power to attribute the income of closely held corporations to their shareholders is a difficult question — and unfortunately, the parties barely addressed it.” Because the Moores have conceded that subpart F is constitutional, and that section of the Internal Revenue Code “is not meaningfully different from the MRT in how it attributes corporate income to shareholders,” she concluded, the Moores have not met their burden to show that they are entitled to a refund.
Justice Clarence Thomas dissented from the court’s decision, in an opinion joined by Justice Neil Gorsuch. He argued that for purposes of the 16th Amendment, “income” is only income that a taxpayer receives. And because the Moores “never actually received any of their investment gains,” he contended, “those unrealized gains could not be taxed as ‘income.’”
Thomas was sharply critical of what he characterized as the “consequentialist heart” of the majority’s opinion. Thomas agreed with Kavanaugh that the Constitution does not mandate the “fiscal calamity” of requiring Congress to cut programs or increase taxes. “But, if Congress invites calamity by building the tax base on constitutional quicksand,” Thomas warned, “the judicial Power afforded to this Court does not include the power to fashion an emergency escape.”
Thomas also suggested that the majority “apparently believes that a generous application of dicta” – that is, language that is not necessary to the court’s ruling and is not binding in future cases – “will guard against unconstitutional taxes,” such as a wealth tax, going forward. “But,” Thomas cautioned, “if the Court is not willing to uphold limitations on the taxing power in expensive cases, cheap dicta will make no difference.”
