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The long-standing goal of the Republican right, in the famous words of anti-tax activist Grover Norquist, is to starve the beast of the deep state by denying it revenue. The right may get at least some of its wish if the Supreme Court sides with the plaintiffs in the case of Moore v. United States.
The technical question before the high court is what exactly it means for an investment to be “realized,” which in simple English seems to mean cashed in. Thus, a shareholder doesn’t pay capital gains tax on the increased value of a stock or a house until the asset is sold and converted to cash.
That seems very straightforward. But in practice, there are lots of gray areas, of which more in a moment.
In 2017, as part of the Tax Cuts and Jobs Act, a bipartisan deal allowed the government to recoup some of the revenue given away in Trump’s tax cut by going after profits hidden by Americans overseas. The new provision, called a mandatory repatriation tax, ended the unlimited deferral from taxation by the U.S. of foreign income kept offshore. The closing of this loophole was estimated to bring in about $338 billion over ten years.
In the Moore case, the plaintiffs, Charles and Kathleen Moore, had invested in a friend’s company in India. Their earnings were left in India. But under the new 2017 law, the IRS taxed them $14,729 on their share of the profits.
The Moores cited a 1920 Supreme Court case, Eisner v. Macomber, decided just seven years after the 16th Amendment authorized income taxes, in which the Court held that a gain in asset value qualifies as taxable income only if it is “received or drawn” by the investor. However, that earlier ruling was sufficiently ambiguous that the IRS has been able to tax several forms of income, even though they are not literally turned into cash.
For instance, partnerships typically leave a portion of income earned by the partners in the firm, but the IRS has long treated it as taxable income and that view has never been successfully challenged in court. Similarly, corporate retained earnings that are not paid out to investors are still subject to taxation. And under Subpart F, which dates to 1962, American investors in foreign corporations must pay taxes on their share of income.
In oral arguments Tuesday, several justices including conservative Amy Coney Barrett pounced on the inconsistency and asked the counsel for the Moores, Andrew Grossman, whether they were contending that it was unconstitutional to tax partnership income or retained corporate income. Grossman prudently narrowed the argument to just the issue of the 2017 mandatory repatriation tax.
This narrowing could spare government the worst-case scenario, in which taxation of all such ambiguous categories of income would be found to be unconstitutional. That would cost an estimated $7 trillion over ten years. It would also prevent a tax on a billionaire’s wealth from ever being enacted, because taxing net wealth would involve unrealized income from investments.
Even so, the $338 billion at risk in this case is not pocket change. Justices Neil Gorsuch and Brett Kavanaugh seemed sympathetic to the Moores’ reading of the 16th Amendment. If it runs true to form, the Roberts Court could well find for the Moores as a spurious middle ground.
