Reuven S. Avi-Yonah (aviyonah@umich.edu) is the Irwin I. Cohn Professor of Law at the University of Michigan Law School. He would like to thank Mark Berg, Ed Fox, David Gamage, Ari Glogower, Andy Grewal, and Henry Ordower for helpful comments.
In this first installment of Reflections With Reuven Avi-Yonah, Avi-Yonah evaluates potential areas of future constitutionality challenges in the aftermath of Moore.
On December 5, 2023, the Supreme Court heard oral arguments in Moore,1 the case challenging the constitutionality of the mandatory repatriation tax enacted in 2017 (section 965). Most of the justices’ questions focused on the potential collateral consequences from requiring realization as a constitutional matter, and the majority seemed inclined to avoid the constitutional issue by focusing on the fact that the income in Moore was realized and that section 965 simply followed a long list of precedents by attributing this corporate income to shareholders in a closely held corporation.2
Assuming the government wins Moore on such narrow grounds, what happens next?
Presumably, the same interests that brought us Moore will try to find another test case. The interesting question is: What’s the most likely target?3
After Moore, it is unlikely that the target would be global intangible low-taxed income or subpart F, because those would be protected by the same narrow attribution theory that is likely to prevail in Moore, namely that Congress can constitutionally attribute realized earnings of a closely held corporation to its shareholders.4
It is also unlikely that a corporate tax case like Altria5 would make it, because the Supreme Court held in 1911 that the corporate tax is an excise tax; therefore, realization is not required even if it is required in an income tax.6 Presumably, lower courts would follow that precedent, meaning the Court would know that it would have to repudiate its 1911 holding, which seems unlikely.7
Subchapters K and S also seem unlikely targets because they can be protected by the same attribution theory. A passive foreign investment company is even less likely because its mark-to-market regime is elective. Original issue discount and accrual accounting can be defended as constitutional because they only involve the timing of realization.
The main target in Moore was not a wealth tax because that is highly unlikely to be enacted at the federal level and even Solicitor General Elizabeth Prelogar would find it hard to defend if it were.8 The main target, as is evident from Justice Clarence Thomas’s and Justice Samuel A. Alito Jr.’s questions, is a mark-to-market tax on billionaires like the one proposed by Sen. Ron Wyden, D-Ore.9 Such a tax on publicly traded assets like the stock of Amazon, Meta, or Tesla would directly raise the question whether realization is a constitutional requirement.
Of course, this mark-to-market tax does not exist yet, and may never exist because, as Justice Brett M. Kavanaugh said in the oral argument, members of Congress want to get reelected and this type of tax on “phantom income” is unpopular among voters even if it is targeted only at the superrich.10 So the opponents would have to find an existing mark-to-market tax.
There are not too many mark-to-market taxes in the code. Some of them, like section 1256, have been challenged on constitutional grounds unsuccessfully because they can be treated as constructive receipt cases, which is how the Moore plaintiffs distinguished them.11 Alternatively, they can be defended as excise taxes on particular types of transactions not subject to a realization requirement, which was the government’s alternative defense in Moore.
Therefore, the best target for a constitutional challenge is section 877A: the expatriation tax. This relatively new tax (from 2008) does not involve attribution, is imposed on individuals, and is not an antiabuse measure because deferral of realization is not abusive.12 It is also not easily defensible as an excise tax because the government would be reluctant to argue that giving up U.S. citizenship is an act subject to tax. Nobody should be forced to remain a U.S. citizen against their will, and an excise tax on expatriation is a high price to pay.
The rationale behind section 877A is that because the rich (it only applies to relatively rich taxpayers) can avoid tax on unrealized appreciation in their assets, in the absence of the exit tax, they can expatriate, then sell the assets outside the United States’ taxing jurisdiction because the source rule for capital gains is the residence of the seller. To put it bluntly, if section 877A did not exist, Elon Musk could expatriate and the next day sell his Tesla shares for billions of dollars in capital gain and pay no tax at all. The old section 877 proved ineffective in this regard because taxpayers were able to argue they had nontax reasons for expatriation.
This is the same rationale underlying the Wyden proposal. As long as the income tax depends on realization, billionaires can avoid tax indefinitely by merely borrowing against the appreciation in their corporate shares, like Musk did when he borrowed against his Tesla shares to buy Twitter. Eventually, the unrealized appreciation can escape tax altogether because of the step-up in basis upon death, although billionaires would also have to deal with the estate tax (another excise tax on the transfer of ownership at death, according to the Court).13 As is well known, the estate tax is relatively easy to avoid in practice.
Section 877A thus seems to be the most likely candidate for a post-Moore challenge to mark-to-market taxation. Of course, expatriates are less popular taxpayers than Mr. Moore, but they have constitutional rights, and a challenge could involve significant amounts of money. (Eduardo Saverin, Mark Zuckerberg’s Harvard roommate, paid the exit tax on Meta stock worth $4 billion when he expatriated to Singapore in 2011, a year before Meta went public.)
If section 877A is challenged, what should the Court do?
In my opinion, section 877A is constitutional because Macomber does not require realization as an essential element of an income tax.
The issue in Macomber was whether a common-on-common stock dividend was “income” under the 16th Amendment. The Court held as follows:
For the present purpose, we require only a clear definition of the term “income,” as used in common speech, in order to determine its meaning in the Amendment; and, having formed also a correct judgment as to the nature of a stock dividend, we shall find it easy to decide the matter at issue. After examining dictionaries in common use, we find little to add to the succinct definition adopted in two cases arising under the Corporation Tax Act of 1909: “Income may be defined as the gain derived from capital, from labor, or from both combined,” provided it be understood to include profit gained through a sale or conversion of capital assets. . . .
Brief as it is, it indicates the characteristic and distinguishing attribute of income essential for a correct solution of the present controversy. The government, although basing its argument upon the definition as quoted, placed chief emphasis upon the word “gain,” which was extended to include a variety of meanings; while the significance of the next three words was either overlooked or misconceived. “Derived from capital;” ”the gain derived from capital,” etc. Here, we have the essential matter: not a gain accruing to capital; not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value, proceeding from the property, severed from the capital, however invested or employed, and coming in, being “derived” — that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal — that is income derived from property. Nothing else answers the description.
The same fundamental conception is clearly set forth in the Sixteenth Amendment — “incomes, from whatever source derived” — the essential thought being expressed with a conciseness and lucidity entirely in harmony with the form and style of the Constitution.14 [Emphasis in original.]
This part of the opinion is the one cited to support the proposition that Macomber requires realization as part of the constitutional definition of income. But the problem is that the definition of income as “the gain derived from capital, from labor, or from both combined” was explicitly rejected in Glenshaw Glass, and therefore this entire discussion of “derived” cannot be regarded as controlling for future cases.15 The Court there said:
Nor can we accept respondents’ contention that a narrower reading of [section 61] is required by the Court’s characterization of income in Eisner v. Macomber, as “the gain derived from capital, from labor, or from both combined” The Court was there endeavoring to determine whether the distribution of a corporate stock dividend constituted a realized gain to the shareholder, or changed “only the form, not the essence,” of his capital investment. It was held that the taxpayer had “received nothing out of the company’s assets for his separate use and benefit.” The distribution, therefore, was held not a taxable event. In that context — distinguishing gain from capital — the definition served a useful purpose. But it was not meant to provide a touchstone to all future gross income questions.16
The “from whatever source derived” language in the 16th Amendment was designed to overrule Pollock,17 which held that a tax on income derived from property is a direct tax on the property, and it has nothing to do with realization.
But Macomber has another discussion, which is more relevant to the issue of whether income requires realization. The Court said:
Can a stock dividend, considering its essential character, be brought within the definition? To answer this, regard must be had to the nature of a corporation and the stockholder’s relation to it. . . .
The essential and controlling fact is that the stockholder has received nothing out of the company’s assets for his separate use and benefit; on the contrary, every dollar of his original investment, together with whatever accretions and accumulations have resulted from employment of his money and that of the other stockholders in the business of the company, still remains the property of the company, and subject to business risks which may result in wiping out the entire investment. Having regard to the very truth of the matter, to substance and not to form, he has received nothing that answers the definition of income within the meaning of the Sixteenth Amendment.18
This is the part of Macomber that is still valid: A common-on-common stock dividend does not enrich the shareholder because, instead of having one piece of paper worth $100, she now has two pieces worth $50 each. This has nothing to do with realization, but it shows that the key question is enrichment (“the stockholder has received nothing out of the company’s assets for his separate use and benefit”), and that is also the language emphasized in Glenshaw Glass. Of course, a mark-to-market tax requires enrichment.
Another relevant part of the opinion in Macomber rebuts Justice Brandeis’s argument in dissent that, under the enrichment theory adopted by the majority, a cash dividend should not be included in income either because the value of the stock declines when the dividend is distributed. Therefore, Brandeis argued, the shareholder is enriched when the corporation realizes income, because the value of their shares goes up. To this, the majority responds that “enrichment through increase in value of capital investment is not income in any proper meaning of the term.”19
This language can be used to argue that an increase in value of the shareholder’s stock is not income, and therefore a mark-to-market tax is unconstitutional. But this is dicta because Macomber was not about mark-to-market taxation, so it is not controlling.
I therefore argue that nothing in Macomber, as restricted by Glenshaw Glass,20 requires realization as an element of income, making the exit tax in section 877A constitutional.
Finally, I emphasize that a mark-to-market tax is fundamentally different from a wealth tax, which is the paradigmatic direct tax. A tax on unrealized appreciation is different from a tax on property because in the latter case, the same value can be taxed every year. If you have a house that is worth $1 million in 2023 and $1 million in 2024, you must pay the local property tax each year even though there was no accretion in wealth. If that house is subject to a mark-to-market tax, there will be no tax in either year because there has been no enrichment (and as explained above, enrichment is the key issue in both Macomber and Glenshaw Glass). But if the house is worth $1.2 million in 2024, you can constitutionally be required to pay tax on the $200,000 increase in value without a sale, as long as that results in an increase in your basis, so that if you sell it for $1.2 million in 2025, you will have no additional tax liability.21 Thus, the Court can uphold the constitutionality of section 877A without opening the door to a federal wealth tax.
FOOTNOTES
1 Moore v. United States, No. 22-800 (U.S. 2023).
2 See, e.g., foreign personal holding corporations (1937), subpart F (1962), and global intangible low-taxed income (2017), as well as the passthrough regimes (subchapters K and S). The 1864 and 1894 versions of the income tax also attributed corporate income to shareholders at a time when almost all corporations were closely held, and the Supreme Court held that this tax was constitutional (Collector v. Hubbard, 79 U.S. 1 (1871)). By 1913, however, most corporations were publicly traded, so this regime was considered impractical. This change explains why in Eisner v. Macomber, 252 U.S. 189 (1920), the Court emphasizes that a corporation is a separate taxable entity from the shareholders, and regards Hubbard as overruled by Pollock.
3 This discussion does not imply that a taxpayer win in Moore will have only narrow collateral consequences, because if the Court were to require realization as a constitutional matter, there would be a wave of litigation against each of the affected sections, and taxpayers would have substantial authority not to include the affected income on their tax returns for 2024. See Reuven S. Avi-Yonah, “If Moore Is Reversed,” Tax Notes Int’l, June 26, 2023, p. 1725.
4 The taxpayers in Moore tried to distinguish subpart F and GILTI because they apply to current income, not accumulated income, but that is a retroactivity (substantive due process) argument and was not before the Court. In any case, since the United States could have constitutionally taxed all income of all controlled foreign corporations between 1986 and 2017 at 35 percent when it was realized, taxing it in 2017 at 8 to 15.5 percent does not seem to be a violation of due process.
5 Altria Group Inc. v. United States, No. 3:23-cv-00293 (E.D. Va. 2023).
6 See Flint v. Stone Tracy Co., 220 U.S. 107 (1911).
7 See Avi-Yonah, “The Moores’ and Altria’s Realization Requirement Dance,” Tax Notes Int’l, Dec. 4, 2023, p. 1425.
8 But there may be ways to design a constitutional federal wealth tax. See, e.g., Ari Glogower, “A Constitutional Wealth Tax,” 118 Mich. L. Rev. 717 (2020).
9 See The Billionaires Income Tax Act (Nov. 30, 2023), introduced by Wyden and 15 other Democratic senators just before the oral argument in Moore. Under the proposal, traded assets would be marked to market and non-traded assets would be subject to an interest charge upon realization.
10 See Zachary Liscow and Edward Fox, “The Psychology of Taxing Capital Income: Evidence From a Survey Experiment on the Realization Rule,” 213 J. Public Econ. 213 (2022).
11 Murphy v. United States, 992 F.2d 929 (9th Cir. 1993).
12 For an excellent article arguing that section 877A is unconstitutional, see Mark E. Berg, “Bar the Exit (Tax)! Section 877A, the Constitutional Prohibition Against Unapportioned Direct Taxes and the Realization Requirement,” 65 Tax Lawyer 181 (2012). See also Henry Ordower, “Revisiting Realization: Accretion Taxation, the Constitution, Macomber, and Mark to Market,” 13 Va. Tax Rev. 1 (1993).
13 Knowlton v. Moore, 178 U.S. 41 (1900).
14 Macomber, 252 U.S. 189.
15 Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955).
16 Id.
17 Pollock v. Farmers’ Loan & Trust Co., 157 U.S. 429 (1895).
18 Macomber, 252 U.S. 189.
19 Id.
20 The Court in Glenshaw Glass also stated: “Here, we have instances of undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.” This language is sometimes cited to argue that the Court required realization (“clearly realized”) but that is belied by the word “here.” Having discarded the Macomber definition as “not meant to provide a touchstone to all future gross income questions,” the Court was not adopting another definition, merely emphasizing that “here” (in this case) there was both enrichment and realization.
21 See reg. section 1.901-2(b)(2)(C) (defining an income tax to include a mark-to-market tax as long as the basis is increased so there is no second tax upon a later sale).
END FOOTNOTES