Supreme Court repatriation tax case may have far-reaching ramifications

The U.S. Supreme Court will be hearing a constitutional challenge to a provision in the 2017?Tax Cuts and Jobs Act?(TCJA) imposing a one-time repatriation tax on U.S. taxpayers who owned more than 10% of a foreign corporation. If the challenge is successful, taxpayers who have paid the repatriation tax could seek refunds of taxes they have already paid if the three-year period for claiming a refund has not expired.

The case,?Moore v. United States, No. 22-800 ?(Cert. Granted June 26, 2023), is significant because the taxpayers bringing the suit and their supporters are suggesting that the Supreme Court use it to declare that the repatriation tax is an unconstitutional wealth tax. They contend that the repatriation tax violates the 16th Amendment because it is a tax on unrealized gains, not income.

The case is seen by many as an attempt to stop Democratic plans to enact what amounts to a wealth tax on unrealized capital gains by getting the court to preemptively bar such taxes.

Taxpayers: tax on unrealized gains unconstitutional

The taxpayers, Charles and Kathleen Moore, owned 13% of an Indian farm equipment company (KisanKraft Machine Tools Private Limited) at the time the TCJA went into effect. When they made their initial investment in 2006 it was worth about $40,000. In 2018, the taxpayers discovered that they would be required to pay the?repatriation tax ?based on the earnings they had reinvested in the company. They paid the $14,729 tax due and then sued for a refund because the tax was unconstitutional.

The Moores contended that the repatriation tax was an unapportioned direct tax on unrealized gains and not an income tax allowed under the 16th Amendment. The 16th Amendment gives Congress the power to collect income taxes. The district court and U.S. Court of Appeals for the 9th Circuit disagreed, with the appeals court finding there is no constitutional requirement that income be realized before it can be taxed.

The Department of Justice (DOJ) argued against the Supreme Court hearing the case because there was no question that KisanKraft earned significant income. It also said there is no Constitutional requirement that a taxpayer realize income before it is taxed. The DOJ observed that there are other provisions in the tax code which apply to unrealized amounts that have either been upheld on Constitutional grounds or never been challenged. For example, partners are taxed on their undistributed share of partnership income.

Additionally, the DOJ responded to arguments that the court should use the case to address the constitutionality of a wealth tax by pointing out that Article III of the U.S. Constitution bars federal courts from issuing advisory opinions. Since Congress has not enacted a wealth tax, addressing the issue in the case would constitute an advisory opinion.

Transitional one-time repatriation tax

Prior to the enactment of the TCJA, U.S. companies had an incentive to keep their foreign income offshore due to the high domestic tax rate on repatriated income. In an effort to combat this, the TCJA introduced the global intangible low-tax income (GILTI) regime, which requires U.S. taxpayers to pay a minimum tax on specified foreign earnings, regardless of whether they are repatriated. However, the GILTI regime taxes the foreign earnings at a lower rate than they had been previously.

As a transition to the new GILTI regime and to keep U.S. corporations from benefitting from a windfall when they repatriated income that had formally been held offshore, the TCJA implemented a one-time repatriation tax for the owners of foreign corporations that treated their accumulated earnings abroad as having been repatriated. The repatriation tax was imposed at 15.5% for cash and cash equivalents and 8% for other earnings.

U.S. corporations are allowed to pay the tax on deemed repatriations in installments over eight years. It was estimated that this tax on repatriated earnings would bring in approximately $340 billion from 2018 to 2027, but actual revenue was likely less than expected.

Tax similar to Biden’s proposed ‘wealth tax’

President Joe Biden’s?proposed 2024 budget ?includes a new 25% minimum tax on individuals with net wealth greater than $100 million that would apply to their total income, including unrealized capital gains income. Biden’s plan is often described as a “wealth tax” or “billionaire’s tax” and would tax unrealized capital gains in a manner that is similar to the repatriation tax. Biden’s plan is like other proposals for a wealth tax that have been made by House and Senate Democrats.