Taxpayers are improperly using dictum from a century-old case to challenge the constitutional validity of the transition tax, which is in line with numerous other legal tax policies, the government has told the Supreme Court.
The government filed its brief with the Court on October 16 in Moore v. United States. In it, the government argues that the transition tax is an income tax under the 16th Amendment and that that amendment does not have a realization requirement or, alternatively, that it is a constitutional excise tax.
“Realization was a well-established concept when the Sixteenth Amendment was adopted — yet the Amendment never references it. Petitioners cannot read that requirement into the term ‘income,’ which encompasses all economic gains. Nor can petitioners read that requirement into the phrase ‘from whatever source derived,’” the brief argues. “Petitioners advocate for a strict realization requirement. But petitioners concede the constitutionality of various taxes that appear to violate that requirement — without offering any principled basis for distinguishing them.”
The Moores are seeking a refund of $15,000 in taxes they paid on undistributed earnings from an Indian controlled foreign corporation of which they were minority owners. They have challenged the section 965 transition tax imposed on a taxpayer’s post-1986 accumulated foreign earnings, arguing that it is a direct tax and therefore unconstitutional because it is not subject to apportionment. In June 2022 the Ninth Circuit affirmed a district court’s decision to reject the challenge. In its decision, the Ninth Circuit said courts have consistently held that taxes like the transition tax are constitutional and that whether income is realized is not determinative.
The Moores have argued in their briefing to the Court that the transition tax is unlike other income attribution provisions because it doesn't rely on constructive realization of income by those being taxed and instead relates back to the ownership of a specified asset at a specified time. The Moores have also looked to Eisner v. Macomber, 252 U.S. 189 (1920), in which the Court held that a stock dividend was not subject to tax under the 16th Amendment, to assert that income requires realization. The Court there stated that income is “a gain, a profit, something of exchangeable value” that is “received or drawn by the recipient (the taxpayer) for his separate use, benefit, and disposal.” The government argues that the Moores are improperly relying on “poorly reasoned” dictum from that case that has been limited to the stock-dividend context. It argues that the Supreme Court has since abrogated that dictum in multiple decisions since Macomber.
Once again citing Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955), the government argues that the phrase defining gross income as applying to “all income from whatever source derived” sweeps broadly. It also cites dictionary and treatise definitions at the time of 16th Amendment adoption to support the contention that the definition of income applies to all economic gains.
In Glenshaw Glass, the Supreme Court found that punitive damages were taxable as income. The government argues that Glenshaw Glass rejected Macomber’s characterization of income as “gain derived from capital, from labor, or from both combined” and that Macomber related to a dividend where only the form and not the essence of capital investment changed. The Moores are thus wrong to argue that stare decisis instructs the case, the government asserts, as Macomber’s “broader relevance as a constitutional precedent” no longer applies.
Donald B. Susswein of RSM US LLP told Tax Notes that the government appeared to recognize in its brief that Macomber will control and win the day for the Moores on the income tax issue if it hasn't been abrogated.
“Note carefully that the government only says that the ‘broader relevance’ of the case has been abrogated. That may be true. The word ‘realization’ may not mean anything. That may have just been a throwaway line or a poor choice of words. But the issue, with stare decisis, is not the ‘broader relevance’ of a case or its holding. The issue is the very narrow holding. If the facts are the same today, and the case is not overruled, then stare decisis applies. If Macomber cannot be distinguished, which the government does not try to do, the government would lose on the income tax issue. The government seems to sense that,” Susswein said. “How does the government deal with the narrow issue of the actual holding in Macomber? It seems to avoid that holding entirely, or perhaps mischaracterize it as ‘dictum’ — as mere extraneous words, not really binding.”
The government also asserts that the same Congress that passed the 16th Amendment a few years earlier enacted a corporate excise tax on net income of covered corporations with Treasury interpreting income there to include a valuation increase in capital assets.
Monte Jackel of Jackel Tax Law noted that in arguing that realization is not a constitutional requirement, the government didn't discuss regs issued in 1957 (T.D. 6272), which state that for property dealings under section 61(a)(3), there must be gain realized and recognized and that gross income includes income realized in any form.
“Why are not these regulations dispositive of the question?” Jackel asked.
Long-Standing Practices
The government’s brief acknowledges the concern raised by several amicus briefs over the specter of future property or wealth taxes that could be enacted without a realization requirement for income. But it notes that Congress hasn't enacted any such tax yet and that its constitutionality can't yet be decided. Further, a property or wealth tax is “fundamentally distinct” since it targets an amount on a fixed date whereas an income tax targets gain over a period of time, the brief says.
Jackel argued that the distinction made by the government between wealth taxes and its concept of income taxes related to a measurement in time seemed disjointed.
“This statement may come back to haunt the government if a wealth-type tax is ever enacted and then challenged,” Jackel said.
Rather than a hypothetical wealth tax, the government looks to long-standing taxes and taxes imposed after the ratification of the 16th Amendment to show that Congress can tax individuals on undistributed business earnings. It notes that Congress passed an income tax within months of the 16th Amendment that taxed individuals on gain and profits from a corporation — whether distributed or not — if formed for the avoidance of tax.
“Congress’s taxation of shareholders on undistributed corporate earnings at all — even in a targeted manner to combat tax avoidance — belies petitioners’ categorical realization requirement,” the government argues.
The brief also points to partnership taxation, held valid by the Supreme Court in Heiner v. Mellon, 304 U.S. 271 (1938), to support the contention that individuals can be taxed on their share of profits from a business, even if not distributed.
“Because Congress may tax partners on undistributed partnership income — as petitioners concede — there is no principled reason why Congress would lack authority to tax shareholders on undistributed corporate income,” the government argues (citation omitted).
The Moores have argued that reliance on Mellon, also cited by the Ninth Circuit, is misplaced since that case was not a constitutional case but a statutory one related to the Revenue Act of 1918.
According to Jackel, the brief “directly calls into play” Macomber’s holding, which hasn't been explicitly overruled.
“Macomber clearly holds that taxing a shareholder on corporate income must be distinguished from taxing a partner on partnership income without the income being distributed,” Jackel said, pointing to an argument previously made by Susswein and Ramon Camacho of RSM.
In addition to Mellon, Jackel also cited United States v. Basye, 410 U.S. 441 (1973), which upheld the taxation of partners, with receipt of income not relevant in determining an individual’s taxation. He argued that although it wasn't raised in the government’s brief, those cases didn't raise a constitutional question, so it should be assumed the Court would not have ruled on them the way it did if there had been one.
“This leaves the question as to whether the Macomber principle of separating income of a domestic C corporation from income of a partnership also applies to foreign-source income of a foreign corporation,” Jackel said, adding that was also not raised in the brief.
An October 11 amicus brief in support of the government argued that the income subject to the transition tax is only taxed at the owner level — an important difference between Moore and Macomber.
Beyond partnership taxation, the government argues that Congress for decades has taxed U.S. shareholders of foreign corporations on undistributed income, including through enactment of subpart F in 1962. It notes that petitioners have conceded subpart F’s constitutionality, which shows that “they do not genuinely believe the Constitution mandates a bright-line realization requirement.” Subpart F does not fit the Moores’ definition of constructive realization, it argues, and the transition tax shares the “same essential features” as subpart F.
“Petitioners do not explain how any income taxed under Subpart F — let alone all forms of it — is subject to the ‘unqualified[]’ control of a CFC’s 10 percent shareholders,” the government argues.
In making its alternative argument that the transition tax should be considered an excise tax, the government argues that, at a minimum, the case should be remanded to the Ninth Circuit to consider that question. It asserts a remand would be “particularly prudent here because of the disruptive consequences” that could arise if the transition tax were held unconstitutional. That could lead to a loss of $340 billion to the government from just the invalidation of the transition tax as well as far more if subpart F, partnership, and S corporation taxation were called into question.
Susswein said the government’s brief could have been stronger and that its request for remand may reflect anxiety.
“The government sounds quite nervous,” Susswein said. “They may realize their brief on the income tax issue is quite weak.”
Jackel was surprised the government did not dispute the facts of the case in its brief.
In examining Indian financial, annual, and shareholder allottee statements, Tax Notes has previously reported that Charles Moore, in holding himself out as a minority shareholder in court, did not fully disclose his interest in the company at the center of the dispute, including a directorship position he held, travel reimbursements he received, and additional stock purchases and advances he made.
On October 17 the record was requested and received from the Ninth Circuit, according to the Supreme Court docket.
In Moore v. United States, No. 22-800, the government is represented by the solicitor general, and the petitioners are represented by Baker & Hostetler LLP and the Competitive Enterprise Institute.