Supreme Court May Opt for Narrow Ruling on Foreign Earnings Tax

The US Supreme Court decided to hear a constitutional challenge to a tax on foreign earnings that could upend wide sections of US tax law, but the justices may ultimately coalesce around a more narrow ruling, tax specialists said.

The high court’s interest in Moore v. United States, which it agreed on Monday to hear, may have been driven by broad language from a lower court that implicates the legality of potential wealth taxes, several tax law scholars and practitioners said. However, striking the tax at issue down would not only eliminate a large revenue stream, but also potentially jeopardize other taxes tied to corporate entities and multinational arrangements, they said.

“I would predict a narrow decision in favor of the government, with some of the justices, probably in concurrences, hand waving in various ways,” said David Gamage, an Indiana University tax law professor.

“To do otherwise would be to create an upheaval of over 100 years of jurisprudence on the corporate income tax,” Gamage said.

The case, which the court is likely to hear in the fall, was brought by Charles and Kathleen Moore, who argue that the tax code Section 965‘s charge on unrepatriated foreign earnings from 1987 to 2017 is unconstitutional. The “transition tax” was created using the 2017 Republican tax law, to ensure the earnings didn’t escape US taxation as the country transitioned to a new international tax regime.

While the Moores are seeking a mere $14,729 tax refund, $340 billion in tax revenue over 10 years could be at stake, according to a government estimate. The Moores say they shouldn’t have been taxed on earnings that an Indian company reinvested rather than distributing to them as shareholders.

“The potential is there, depending on who the court rules for and how they frame their ruling, that many of those large multinationals that paid that tax would be able to receive a windfall,” said Chye-Ching Huang, who heads the Tax Law Center at New York University’s law school.

Curbing Appellate Ruling?

The case has galvanized many opponents of a federal wealth tax proposed in various forms by Democratic lawmakers and President Joe Biden, including the Chamber of Commerce and the Wall Street Journal’s editorial board.

Some point to a statement in the US Court of Appeals for the Ninth Circuit’s ruling in the case that income doesn’t need to be “realized"—meaning actually received—in order to be taxable under Congress’ Sixteenth Amendment income tax powers.

Multiple wealth tax proposals are forms of a “mark-to-market” tax that values assets by a recent market price, even if the asset’s appreciation hasn’t been realized by the owner. Sen. Ron Wyden (D-Ore.)'s “billionaire tax” proposal is one example—it targets the unrealized gains of the ultrawealthy, and thus would appear to get a green light under the Ninth Circuit’s ruling.

“The Ninth Circuit went much further than was needed to resolve the facts in dispute, and with strong language said that there is no longer any form of a constitutional realization requirement, and I imagine some justices on the Supreme Court might not agree with that,” Gamage said.

Still, specialists emphasized ways the court could uphold the tax while abstaining from addressing the realization requirement. For example, the court could rule the income was realized by the corporation, and that Congress is permitted to look past the corporate form to tax a shareholder’s income.

Alternatively, the court could comment on the realization requirement in the form of “dicta,” meaning a statement that may be persuasive, but isn’t legally binding on lower courts because it wasn’t necessary to the court’s ruling.

“It’s not at all surprising for a court to take a case, and everyone thinks that they’re gonna go big, and then they go narrow,” said Andy Grewal, a tax law professor at the University of Iowa.

Existing Taxes

If the court struck down the tax, the status of several other government taxes on business profits would be up in the air, including law around partnerships, S Corporations, and the treatment of global intangible low-taxed income, said George Callas, a former House Ways and Means and Republican leadership tax policy staffer.

Owners or partners in an S Corporation, for example, are taxed on their share of the business’s income, whether or not it’s distributed, Callas said. Applying the petitioner’s logic, then, those regimes may also be unconstitutional, he said.

Huang pointed to some of the same provisions Callas noted as well as a section of the tax code known as Subpart F, which deals with taxes on certain US multinational profits.

“Those have been enacted on a longstanding and bipartisan understanding of the scope of Congress’s authority to make tax law, and this case, if the court rules for the Moores, could bring all of that into question.” Huang said.

Throwing out the transition tax itself would also pose challenges, tax experts said.

The court may need to decide what to do with foreign corporate earnings of US shareholders from 1987 to 2017, meaning justices would be “making tax policy on the fly,” Callas said.

For Congress, such a ruling would lead to “wide-scale disarray,” said Steve Rosenthal, a former legislative counsel for the Joint Committee on Taxation, as lawmakers would need to consider new legislation.

“If the Supreme Court starts throwing blockades in front of these simple methods of accreting income on the notion that there’s some technical requirement in the Constitution that there needs to be a sale or distribution first before income is reported, that’s going to be a big problem for our income tax system,” Rosenthal said.

Wealth Taxes

Top Democrats have proposed various forms of wealth taxes for years, including to collect revenue from investments that they argue often go undertaxed, as compared to traditional forms of income from wages.

Wyden, the Chairman of the Senate Finance Committee, said after the court accepted the Moores’ case that he’s “totally confident” his wealth tax plan is constitutional.

“I designed my approach to taxing billionaires, the centerpiece of which is an accounting method already used in our tax code, with the understanding that special interests would come at it with well-funded legal challenges,” Wyden said in a statement.

Still, tax law experts said the high court’s interest in the Moores’ case may spell concern about such proposals. Biden has come out with his own plan for a minimum 20% mark-to-market wealth tax on individuals with more than $100 million in assets.

“I would be very surprised if the Supreme Court said there’s no realization requirement, because if they wanted to endorse that, they could have just left the case alone,” Grewal said.

Gamage said the justices could voice disparate views about the realization requirement—some embracing and some opposing the Ninth Circuit’s broad language—through concurrences, while agreeing to uphold the tax.

Huang questioned whether a case that doesn’t involve such proposals is the right case for ruling on them.

“This case is an extremely poor vehicle for determining this question about a wealth tax or a mark-to-market tax, and the potential for collateral damage here on the logic of the petitioners’ case is very, very broad,” Huang said.