Supreme Court upholds Trump-era tax on foreign earnings, skirting disruptive ruling

Washington — The Supreme Court on Thursday left intact an obscure tax enacted as part of Republicans' sweeping 2017 reform package that targets U.S. taxpayers with shares of certain foreign corporations.

The court ruled 7-2 that the so-called mandatory repatriation tax, or MRT, is constitutional under Article I and the 16th Amendment, rejecting a challenge from a Washington couple, Charles and Kathleen Moore, who claimed the provision was outside the bounds of the Constitution. Justice Brett Kavanaugh wrote the majority opinion. Justices Clarence Thomas and Neil Gorsuch dissented. 

"[T]he precise and narrow question that the Court addresses today is whether Congress may attribute an entity's realized and undistributed income to the entity's shareholders or partners, and then tax the shareholders or partners on their portions of that income," Kavanaugh wrote. "This Court's longstanding precedents, reflected in and reinforced by Congress's longstanding practice, establish that the answer is yes."

The Supreme Court's decision

The court's ruling was a narrow one, but in declining to disturb the tax, the justices avoided closing the door for now on Democrats' proposals to impose taxes on the nation's highest earners. Kavanaugh stressed that the court's analysis doesn't address the issues that would be raised by taxes on holdings, wealth or net worth; or taxes on appreciation.

"Those are potential issues for another day, and we do not address or resolve any of those issues here," he wrote for the court. "As to the Moores' case, Congress has long taxed shareholders of an entity on the entity's undistributed income, and it did the same with the MRT. This Court has long upheld taxes of that kind, and we do the same today with the MRT."

The ruling from the high court is also likely to alleviate concerns about the ramifications that a broad decision invalidating the mandatory repatriation tax would have had on other provisions of the tax code. Kavanaugh acknowledged the consequences of such a ruling, and said that if the court accepted the Moores' argument, it could render "vast swaths" of the Internal Revenue code unconstitutional.

"And those tax provisions, if suddenly eliminated, would deprive the U. S. government and the American people of trillions in lost tax revenue," he wrote for the majority. "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 does not require that fiscal calamity."

Dan Greenberg, general counsel at the Competitive Enterprise Institute, which represented the Moores, said they are disappointed by the ruling, which "lets the government levy income taxes on foreign shareholders who have never received income."

"We think that is unfair, because the Constitution authorizes Congress to tax people on their income, not the income of foreign businesses that they do not control," he said in a statement.

Moore v. U.S.

The tax at the center of the case, known as Moore v. U.S., is imposed one time on U.S. taxpayers who hold shares of certain foreign corporations. The Moores challenged the measure after they were hit with a nearly $15,000 tax bill for 2017 as a result of the law, which required them to pay levies on their share of reinvested lifetime earnings from an India-based company called KisanKraft Tools.

The Moores had invested $40,000 in the company in 2006 in exchange for a 13% stake, and did not receive any distributions, dividends or other payments from it. But the mandatory repatriation tax, enacted through the Tax Cut and Jobs Act that was signed into law by former President Donald Trump, taxed U.S. taxpayers who owned at least 10% of a foreign company on their proportionate share of that company's earnings after 1986. The tax was projected to generate roughly $340 billion in revenue over 10 years.

Though KisanKraft reinvested its earnings in the years after its founding, rather than distributing dividends to shareholders, the tax still applied to the Moores.

The Moores paid, but filed a lawsuit against the federal government to obtain a refund and challenge the constitutionality of the mandatory repatriation tax.

A federal district court ruled for the government and dismissed the case, finding that the mandatory repatriation tax is permitted under the 16th Amendment, which grants Congress the authority to tax "incomes, from whatever source derived."

The U.S. Court of Appeals for the 9th Circuit upheld the lower court's decision, ruling that nothing in the Constitution prohibits Congress from "attributing a corporation's income pro-rata to its shareholders." The 9th Circuit noted that courts have consistently upheld other similar taxes, and warned that finding the measure unconstitutional would call into question many other long-standing tax provisions. 

The Supreme Court affirmed the 9th Circuit's ruling and found that by 1938, its precedents had established a rule that contradicted the Moores' argument in their case. That line of prior decisions, Kavanaugh wrote for the court, "remains good law to this day."

Citing those earlier rulings and the similarities between the mandatory repatriation tax and other tax provisions, the court concluded that the measure "falls squarely within Congress's constitutional authority to tax."

Justice Amy Coney Barrett issued a concurring opinion, joined by Justice Samuel Alito, in which she agreed with the outcome of the case, but split with the majority's reasoning. Addressing the question that was before the court, Barrett said that the 16th Amendment does not authorize Congress to tax unrealized sums without apportionment to the states.

In a dissenting opinion joined by Gorsuch, Thomas said the Moores were correct in challenging the mandatory repatriation tax as unconstitutional. Because the couple never actually received gains from their investment, those unrealized gains couldn't be taxed as income under the 16th Amendment, he wrote. 

"The fact that the MRT has novel features does not mean that it is unconstitutional. But, the MRT is undeniably novel when compared to older income taxes, and many of those differences are constitutionally relevant," he wrote. "Because the MRT is imposed merely based on ownership of shares in a corporation, it does not operate as a tax on income."

Thomas criticized the majority over its concerns about the impact a broad decision would have on other longstanding taxes, writing that "if Congress invites calamity by building the tax base on constitutional quicksand, 'the judicial power' afforded to this court does not include the power to fashion an emergency escape."

He also rebuffed the majority's contention that its ruling does not speak to the constitutionality of other taxes that may be passed by Congress, such as a wealth tax.

"Sensing that upholding the MRT cedes additional ground to Congress, the majority arms itself with dicta to tell Congress 'no' in the future," Thomas wrote. "But, if the court is not willing to uphold limitations on the taxing power in expensive cases, cheap dicta will make no difference."

During oral arguments in December, the justices seemed sympathetic to concerns about how a sweeping ruling would reverberate across the U.S. tax system and threaten existing tax laws.

But some of the justices sought clarity on the limits of Congress' taxing power. Lawyers for the Moores had warned the court that allowing a tax on income that has not yet been realized, or received, would pave the way for lawmakers to levy taxes on all manner of things, such as retirement accounts or gains in the value of real estate.

Justice Samuel Alito had faced pressure from some congressional Democrats to recuse himself from the case because of interviews he participated in with an editor at the Wall Street Journal and David Rivkin, a lawyer who represented the Moores.

The justice declined to step aside from the case, arguing there was "no valid reason" for him to do so.