The U.S. Supreme Court upholds the contentious Mandatory Repatriation Tax (MRT), affirming the government’s stance on the constitutionality of one of the most debated elements of the 2017 Tax Cuts and Jobs Act. The financial and legal communities have closely followed this case since December of 2023, when the Supreme Court heard oral arguments from Charles G. Moore (the petitioner) and the United States of America (the respondent) regarding the constitutionality of the MRT. On June 20, 2024, the Supreme Court ruled the MRT constitutional.
But what’s at the heart of this ruling, and why are the repercussions of this ruling so critical for American taxpayers and the future of the U.S. tax code? Let’s dive in.
What is the Mandatory Repatriation Tax?
The Tax Cut and Jobs Act of 2017, through Section 965 of the Internal Revenue Code, introduced the one-time mandatory repatriation tax for U.S. owners of certain foreign corporations. Such corporations include foreign corporations held 10% or more by U.S. C corporations and all Controlled Foreign Corporations (CFCs). CFCs are foreign corporations in which more than 50% of the corporation’s shareholders are U.S. owners who each hold a 10% or greater interest in such foreign corporation.
The purpose of the MRT (also known as the 965 tax or transition tax) was to treat untaxed foreign accumulated earnings as repatriated to the United States for U.S. federal income tax purposes. The income was to be included in the U.S. taxpayer’s Subpart F income for the 2017 tax year, and the assessed tax rate was 15.5% for foreign earnings held in liquid assets (e.g., cash or cash equivalents) and 8% on illiquid assets. This MRT was projected to generate $340 billion in revenue for the United States.
Who are the Moores?
Charles and Kathleen Moore are Washington-based U.S. taxpayers. As of December 31, 2017, the Moores owned 11% of a controlled foreign corporation, so they were among the countless U.S. taxpayers subject to this repatriation tax. The couple paid a total of $14,729 for their one-time MRT. After paying their 2017 tax bill, the couple sued the government to recover the amount paid.
What were the arguments?
The Moores and their legal counsel argued that the tax was unconstitutional under the Sixteenth Amendment because it was not a permissible income tax due to a lack of realization of income. In other words, they argued that the Moores should not be taxed on accumulated earnings they never received from the foreign corporation.
The couple focused on the Macomber court case, which took place in 1920. The case determined whether a stock dividend that solely diluted the value of the taxpayer’s stock was considered realized income. While the courts concluded that this type of dividend was not taxable income, the case did not provide a legal definition that required a realization event for the term “income.”
The U.S. argued that “incomes, from whatever source derived, without apportionment among the several States and regard to any census or enumeration” (as stated in the Sixteenth Amendment) is a broad and all-encompassing statement. The U.S. provided the similarly worded Internal Revenue Code’s income definition and referred to the Glenshaw case, which states income is any accession to wealth. The U.S. remains steadfast that there was realization of income within the entity, but even so, realization is not a requirement for taxable income. The case went through the district court and the court of appeals, both holding the position that the tax was constitutional. The case was then brought to the U.S. Supreme Court.
What was the decision?
The Supreme Court’s opinion is that the MRT is constitutional. The opinion states that the MRT is a tax on the foreign corporation’s realized earnings, so the topic of whether realization is required for the taxation of income was not discussed. The Supreme Court focused on whether Congress may attribute the foreign corporation’s realized (but undistributed) earnings to its shareholders. The Supreme Court introduced a few important code sections and cases to support its claim that Congress may attribute the earnings.
The first topic was whether Congress may tax flow-through entities at the entity or owners’ levels. The Supreme Court referenced Burnet v. Leininger, which stated that net income tax may occur at the partnership or partner level. Heiner v. Mellon supports that partnership income is taxable at the partner level, even if no distributions are made. The Supreme Court stated this treatment may also apply to corporations, as shown in other court cases.
The Subpart F regime was an important topic in this ruling. Subpart F is Section 951(a) of the Internal Revenue Code and allows for the taxation of certain income generated in a CFC (even if not yet distributed). The opinion stated that this regime is an example of the Internal Revenue Code, which treats CFCs as flow-through entities for U.S. federal income tax purposes. The Supreme Court views income passed out to owners through S Corporations, Partnerships, and Subpart F as similar to the MRT.
How does this decision affect the rest of the Internal Revenue Code?
The U.S. is familiar with the concept of taxing income before realization. Tax regimes such as Subpart F (as discussed above) and the exit tax, introduced to the Internal Revenue Code in 1962 and 1966, respectively, have existed without the same amount of contention. The exit tax will tax expatriates as if they sold their assets on the last day they are considered a U.S. person (even though they have not sold their assets in any legal transaction). In addition, the Tax Cut and Jobs Act also introduced an ongoing repatriation regime called Global Intangible Low-Taxed Income (“GILTI”), which taxes a portion of a foreign corporation’s foreign earnings (even if not distributed) to ensure a global minimum tax is met.
If the decision favored the Moores, it would have called into question the constitutionality of these other tax regimes, some of which have been in the U.S. tax code for decades. As the decision went in favor of the United States, the MRT will remain in place, and this case will be used to support the constitutionality of similar tax regimes. It is important to note that since the Supreme Court did not confirm the realization requirement for income tax, this opinion has left the door open for other possible tax regimes (e.g., a wealth tax).