Investment Strategy

Landmark Supreme Court Tax Case Could Redefine your Income

Perhaps the longest lasting impact of the previous President Trump administration will be his appointment of three justices to the U.S. Supreme Court. Neil Gorsuch, Brett Kavanaugh and Amy Coney Barrett will join the remainder of the bench to interpret a lower court ruling of Moore v. U.S. Taxes can be complicated, and judging by the fact that the Moore Case has risen to this level, it implies constitutional implications regarding how we the people pay taxes. After all, as you remember, taxation without representation, was a big issue for the founding fathers and a major factor in our decision for independence. 

On December 5, the Supreme Court will hear arguments in the Moore tax case. The petitioners in Moore, a husband and wife, are shareholders in a company located in India that has retained and reinvested its profits rather than distributing those profits to the shareholders. A tax law passed in 2017 and signed into law by President Trump seeks to impose a tax, known as the Mandatory Repatriation Tax (MRT), on some of the company’s domestic shareholders, including the Moore’s, even though, the petitioners argue, income has not been “realized” for them in particular.

As one might imagine, opinion is divided between left and right. The Moore case is backed by several conservative groups, seeing an opportunity here to prevent future congressional action on taxing wealth and capital gains. Legal scholars believe that a decision for Moore could create a hurdle for several popular democratic proposals to tax the ultra-rich. Opponents of the Moore case believe that a favorable ruling will lead to greater income inequality in America. According to Brakeyshia Samms, state policy analyst at ITEP, “Today, the average net worth of white households is 4.1 and 5 times that of Black and Hispanic households, respectively. A broad ruling in Moore could stifle policies for reducing this racial wealth gap.”

One thing that’s for sure, if the Moore’s win, it will open up the flood gates of potential future tax issue litigation. Billions of dollars are tied to the 2017 law, and its unwinding would almost certainly cause concern for the federal government. According to David Rosenbloom, a tax lawyer at Caplin & Drysdale, “It’s hard to see how this is going to turn out well. They really are opening up a can of worms.”

So what would our founding fathers consider to be income today, and what would not violate the constitution. Only head taxes and real estate taxes are direct taxes within the meaning of the Founders’ Constitution, as understood by George Washington, Alexander Hamilton, the overwhelming majority of the 1794 Congress and later early Congresses. Even James Madison and Thomas Jefferson repudiated their earlier Republican allies and came to agree with their Federalist counterparts on this issue. 

If the Supreme Court strikes down the entirety of the deemed repatriation for corporate and non-corporate taxpayers, it is estimated this would reduce revenue by about $346 billion over the next 10 years, including a refund of tax payments made from 2018 to 2023.

As brilliantly prescient as the founders were, they never conceptualized a flat income tax. The Civil War era regarding states’ rights was about taxation as well as slavery. Direct taxes prior to this period were to be apportioned among states by population. This all changed after the Civil War. The Supreme Court ruled in 1895 that an individual income tax was unconstitutional. As such, the 16th Amendment was born, which basically said that income from whatever source can be taxed without apportionment. Unfortunately, this has led us to the burdensome road we are on today. 

Perhaps the easiest way out for the court would be to say that the Constitution doesn’t require income to be realized to be taxed. This is currently the case in other asset classes. Futures contracts and discounted bond issues are two where you don’t have to sell the asset to assume the tax obligation. The prevailing wisdom is that the court will overrule the lower courts in some manner, nonetheless causing changes in the way we pay taxes. 

The Moore v. United States case could have a substantial impact on U.S. tax policy and revenue. It could invalidate some current U.S. tax policies, and a broad ruling could stretch far beyond the provision contested by the plaintiffs. It could also proscribe potential future tax policies Congress may wish to adopt considering changing international tax norms. The size of the impact hinges on the scope of the Court’s ruling.

Investment Strategy