Supreme Court Justice James Iredell (1751-1799)
There has been quite a bit of excitement about a case before the Supreme Court – Charles G. Moore, et ux v. United States. The Mandatory Repatriation Tax that is at issue in the case is really not in itself of great practical interest. The excitement centers on what implications the Supreme Court decision in this case might have for a wealth tax or other possible taxes on unrealized income that are being bandied about. There is a good bit of irony in some of the arguments. Organizations that generally favor lower taxes and a more limited role for the federal government will often also be arguing for an originalist interpretation of the Constitution. In this case the anti-tax argument requires them to make light of a Supreme Court decision that came down when the ink was barely dry on the Constitution. Let’s start with the current case, before we dig into the history.
The Issue
Here is the idiot’s guide to the Moore case. It used to be that if you were a US person, natural or otherwise, you were only taxed on the earnings of foreign companies that were actually operating businesses when you received something from them. There are a ton of rules and reporting requirements to somewhat control all the shenanigans that are made possible by that general rule. When it comes to public companies the accounting rule was that they did not have to provide for deferred taxes if they planned to leave the earnings abroad indefinitely.
The Tax Cuts and Jobs Act radically changed the taxation of foreign operating income. Oversimplifying it is not taxed at all whether it is remitted or not. There was a price to be paid for that. The price was a one time tax called a mandatory reparation tax (MRT) on certain taxpayer’s shares of all the accumulated earnings of the foreign companies. The MRT can in some circumstances apply to individual taxpayers. The MRT can be paid over eight years. The Joint Committee on Taxation estimated that it would bring in $338.8 billion in revenue. According to the Institute On Taxation And Economic Policy, roughly 10% of that revenue will come from Apple. Microsoft will chip in 18.4 billion. Pfizer will pay $15 billion and so on.
That MRT is what the case is about. You would think that it would be Apple or Microsoft or one of the other companies that are paying billions that would be suing for refund. Instead it is Charles G. and Kathleen F. Moore. They are shareholders in an Indian company called KissanKraft Machine Tools Private Limited. Its purposes is to import, manufacture, and distribute affordable farming equipment. The Moores don’t mind that they have not gotten any distributions from their 2006 investment of $40,000. They like that the profits are getting plowed back into providing Indian farmers with more affordable equipment. What they didn’t like was that they had to pay an additional $14,279 in tax for 2017 due to a decade’s worth of income amounting to $132,512. That is not so shabby on a $40,000 investment. Just saying.
The Moores paid the tax and asked to have it refunded. The IRS, the district court and the appellate court turned them down. So now they are at the Supreme Court.
What Is Wrong With The MRT?
The main argument is that the MRT does not qualify as an income tax under the 16th Amendment because, in the view championed by the Moore’s advocates, there was no realization. They did not get anything. The precedent that they lean most heavily on is the 1920 decision Eisner v. Macomber. Macomber had received a stock dividend from Standard Oil Company of California. Standard Oil, on its books had made a transfer from its “surplus account” to its “capital stock account” and issued new shares to its shareholders, one new share for each two shares they owned.
If you were going to eat a whole pizza would you have it sliced into eight slices rather than six, if you were extra hungry? That’s what a stock dividend is like. The corporation hasn’t changed and you own the same percentage as before. No realization. No income. Some people argue that Macomber pretty much only applies to stock dividends. There is concern that a much broader constitutional realization requirement could upset large swathes of the tax law.
How Is This About The Constitution?
There is not a lot of language in the Constitution about taxes. One thing does get extra emphasis. In Article One Section Two, which is about the House of Representatives, we get:
“Representatives and direct Taxes shall be apportioned among the several States which may be included within this Union, according to their respective Numbers, which shall be determined by adding to the whole Number of free Persons, including those bound to Service for a Term of Years, and excluding Indians not taxed, three fifths of all other Persons.”
In Article One Section Nine, which is about powers denied to Congress there is:
“No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.”
So no direct taxes without apportionment is a really big deal. The other important thing is uniformity. That is in Article One Section 8, which is about powers of Congress:
“The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States”
There is one more thing about taxes also in Article One Section Nine, the prohibited powers – “No Tax or Duty shall be laid on Articles exported from any State”. I was thinking that maybe that never comes up, but as you can see in Export Clause: Limitation on Congress’s Taxing Power by Erika K. Lunder, it has sometimes.
The rule about having to apportion direct taxes is what is at issue in Moore and also is the rule that generally creates problems in the income tax area.
A common view that while mistaken is understandable is that the Constitution did not allow an income tax until the Sixteenth Amendment was ratified. The text of the Amendment gives a clue to the source of the error:
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.
If Congress had been unable to tax incomes the first clause would have solved the problem. The important part is “from whatever source derived without apportionment”. That language was in response to Pollock v. Farmers’ Loan and Trust Company which the Supreme Court decided on April 8, 1895. It was about the Income Tax Act of 1894. Oyez.org provides this summary.
“The Court held that the Act violated the Constitution since it imposed taxes on personal income derived from real estate investments and personal property such as stocks and bonds; this was a direct taxation scheme, not apportioned properly among the states. “
Four justices dissented among them Henry Billings Brown who wrote “The decision involves nothing less than the surrender of the taxing power to the moneyed class”.
What Is A Direct Tax?
If the MRT qualifies as an income tax under the 16th Amendment the government wins. If it does not, that does not necessarily mean the taxpayer wins. There was some discussion in the oral arguments about whether the issue is properly in play, but the follow on question is whether MRT, assumed to be not an income tax, is a direct tax.
There are quite a few Amicus Briefs from organizations that support the Moores. I am going to pick out as exemplary the brief filed by the Landmark Legal Foundation. Landmark is a national public-interest law firm committed to preserving the “principles of limited government, separation of powers, federalism, originalist construction of the Constitution and individual rights” (Emphasis added). Landmark is not just worried about the MRT. Their big concern is a potential wealth tax.
“The Court should make the boundaries of income tax realization clear and demonstrate that the Apportionment Clause and Direct Tax Clause survive as restrictions on taxation before Congress passes wealth taxes.”
What is fascinating about this being an originalist project is that there is a Supreme Court decision prior to Pollock. Hylton v United States was decided on March 8, 1796. That’s right 1796. These justices were quite familiar with what the framers of the Constitution had in mind. Justice James Iredell wrote:
“As all direct taxes must be apportioned, it is evident that the Constitution contemplated none as direct but such as could be apportioned. If this cannot be apportioned, it is therefore not a direct tax in the sense of the Constitution.”
In the North Carolina convention for ratification of the Constitution in 1790 Justice Iredell became the acknowledged leader for ratification. In the brief of the Southeastern Legal Foundation there is discussion about why scholars have issues with the Hylton decision, but if we if you want to be originalist, it seems that an opinion from the founding era deserves a lot of respect relative to something form the Gilded Age.
Professor Akhl Reed Amar of the the University of California takes this up in his amicus brief. He points out that the lawyer for the government in the case was Alexander Hamilton, who should have known what a direct tax was. Professor Amar asks the Court to follow Hamilton and Hylton and in the process inter Pollock and Macomber.
The amicus brief of Professor Calvin Johnson of the University of Texas also calls the Court to overrule Pollock.
“This Court should overrule Pollock v. Farmers’ Loan & Trust Co., in which the Court imposed fatal apportionment on a tax it did not like, and return to the Founders’ meaning, under which a tax base that is equal per capita in every state is the critical defining characteristic of direct tax. With the fall of Pollock, Macomber should also be explicitly overruled because whether a tax is income only matters if Pollock were good law.”
If you would like to hear what Professor Johnson has to say you might want to check out this video from the Federalist Society
I reached out to Professor Johnson and had a bit back and forth with him. HIs conclusion was:
“A tax that does not have a reasonable apportionment because it does not have an equal tax base per capita in every state is not a direct tax.”
Back To The Present
Amy Howe of SCOTUSblog in Oral argument suggests narrow ruling to uphold disputed tax indicates a general feeling among those who listened to the oral arguments that the justices are unlikely to make a really earth shaking decision one way or the other. I spoke with Sandy Christopher, a partner in the private client and tax team of Withers, who agreed that the oral arguments seemed to be leaning toward a narrow ruling.
The Wall Street Journal Editorial Board calls for the Court to use this decision to shut the door on a wealth tax as did many if not most of the amici. Taking Professor Johnson’s view there is almost no limit on Congress’s ability to tax as long as the tax is uniform. Ms. Howe seems to indicate that the Court will likely satisfy neither.
“If some of the court’s conservative members were worried about the possible implications of a rule for the government, other members of the court expressed concerns that a ruling for the Moores would put – as Kagan said – other “very established taxation schemes” at risk. These concerns, particularly when combined with the comments by Kavanaugh and Barrett, seemed to suggest a narrow ruling for the government, leaving broader questions for another day.”
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Originally published on Forbes.com.
For articles oriented toward tax professionals check out Think Outside The Tax Box.
