The United States Supreme Court on June 20, 2024, upheld the constitutionality of the so-called mandatory repatriation tax (MRT) in a narrow ruling, stating that the MRT taxes realized income – income earned by the offshore corporation – and attributes that corporate income to shareholders and taxes shareholders on their portions of that income.
A team of BakerHostetler attorneys, led by Partners Andrew Grossman and Jeffrey Paravano, represented Charles and Kathleen Moore at the Supreme Court, arguing that realization is required for federal taxation of income pursuant to the 16th Amendment and that the MRT was a tax on property, not income. The Supreme Court majority opinion stated that it “need not resolve” the parties’ disagreement over realization, but also noted that in 1920 the Court stated in Eisner v. Macomber that “income requires realization.”
The MRT, enacted as part of the Tax Cuts and Jobs Act of 2017, raised more than $300 billion of revenue for the federal government. The MRT deems undistributed earnings and profits reinvested abroad by certain businesses going back to 1986 to be “income” in 2017 of certain U.S. shareholders.
BakerHostetler clients, the Moores, in 2017 owned about 13% of the stock of KisanKraft, a controlled foreign corporation operating in India focused on manufacturing low-cost farm equipment. The Ninth Circuit Court of Appeals previously held that an “income tax” does not require that a “taxpayer has realized income under the Sixteenth Amendment.”
The Moores asserted that income must be realized to be taxed without apportionment under the 16th Amendment and that the MRT imposed on them as shareholders is an impermissible unportioned tax on property. How could income earned 30 years ago by a foreign corporation and reinvested by that corporation in property and equipment be “income” to a U.S. shareholder in 2017, asked the Moores.
In a majority opinion, authored by Justice Kavanaugh, the Court held that the 16th Amendment authorizes Congress to attribute income realized by an entity to its owners in certain circumstances: “We emphasize that our holding today is narrow. It is limited to (i) taxation of the shareholders of an entity, (ii) on the undistributed income realized by the entity, (iii) which has been attributed to the shareholders, (iv) when the entity itself has not been taxed on that income. In other words, our holding applies when Congress treats the entity as a pass-through.”
Paravano, counsel to the Moores and firmwide chair of BakerHostetler’s Tax Practice Group and D.C. office managing partner, said, “Although the five-justice majority determined that it need not resolve the issue of realization in Moore, it also specifically noted that the Supreme Court in Macomber ‘stated that income requires realization.’ Further, Justice Barrett’s concurrence in the judgment, joined by Justice Alito, states that ‘[r]ealization may take many forms, but our precedent uniformly holds that it is required before the Government may tax financial gain without apportionment,’ and Justice Thomas’s dissent, joined by Justice Gorsuch, states that ‘Sixteenth Amendment “incomes” include only income realized by the taxpayer.’ Thus, the majority opinion recognizes that prior Supreme Court precedent requires realization, and four justices in Moore recognize that realization is a requirement for federal taxation of income without apportionment. The opinion also notes that nothing in the opinion should be read to suggest that Congress could tax both an entity and its owners on the same income, and that the due process clause ‘proscribes arbitrary attribution’ — which gives tax practitioners food for thought on whether any current taxes might violate that holding.”
Grossman, co-leader of BakerHostetler’s Appellate and Major Motions team who argued the case before the Supreme Court, added, “Divorcing income from realization seems to me to be off the table when you read the opinion in its entirety. The court’s opinion is best read to preserve the status quo and disapprove new kinds of income-taxation, such as taxes on wealth, on appreciation of assets or on ordinary share investments.”
The BakerHostetler team in the Moore case included Grossman, Paravano, Partner David B. Rivkin and Counsel Kristin A. Shapiro.
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