Millions of people pay income taxes every year. But what would happen if instead of only being taxed on realized income, corporations and individual taxpayers also were taxed on unrealized income?[1] The implication of this question is one of the main issues being presented in the pending Supreme Court case, Moore v. United States.[2]
In Moore v. United States, Mr. and Mrs. Moore, an American couple, invested in a foreign corporation in India and received stock which amounted to about 11% of the corporation.[3] However, they never received any dividends or earnings from their investment, meaning that they never received any income from their foreign investment.[4] However, all of this changed with the introduction of the Tax Cuts and Jobs Act (TCJA), that Congress passed in 2017, which made changes to the taxation of foreign earnings.[5] This included an end to the deferral of foreign earnings under the Repatriation of Foreign Earnings under §965 of the tax code[6] and introduced a new one time tax, known as the Mandatory Repatriation Tax (“MRT”).[7] The Repatriation Act states that foreign earnings have a one-time inclusion under §965, which then also provided a deduction on the earnings.[8] However, under the MRT, this earnings tax can now be imposed regardless of whether there were dividends or any sort of earnings distributed to the individuals who own more than 10% of the shares of a foreign corporation.[9]
In 2018, the Moores learned about this new tax provision and found that their tax liability had increased by about $15,000, which subjected them to a significant increase in their income tax for the year.[10] The present issue is whether it is constitutional to tax these earnings.[11] The Moores argue that the policy is unconstitutional because it taxes unrealized income.[12] This goes against a provision in the 16th Amendment and subsequent cases which require that income be “clearly realized” before it can be taxed.[13]
The present issues that arise from the case deal with the constitutionality of taxing unrealized income and the potential implications of allowing unrealized income to be taxed.[14] The court in Moore stated that it was constitutional to tax this unrealized income[15], but others are concerned with what that means for taxpayers around the country. If the Supreme Court agrees with the previous rulings in Moore, it could have hundreds of different consequences for taxpayers.[16] Some of these could include a taxation on appreciation and on wealth.[17] This could have an expansive reach in the United States, as it could mean that any sort of appreciation of assets, including stocks, real estate, and property of any kind could mean an increase in tax for any given year.[18] Additionally, this sort of tax could result in individuals and corporations not having the liquidated assets needed to be able to pay this unexpected increase in their taxes.[19] Lastly, not only would a Supreme Court ruling striking down §965 have tax implications for foreign investment income tax, it could also have potential impacts on a variety of other U.S. income tax provisions.[20]
So where do we go from here? As of right now, we will have to wait until the Supreme Court rules on the case, but there are certain protections that taxpayers can set up in case of an unfavorable ruling. This would include a protective refund claim.[21] “Protective claims are filed as placeholders to protect the statute of limitations when the refund is contingent on outcome of a pending case, which is not likely to be resolved until after the statute expires.”[22] This is just one measure that taxpayers can take to try and protect their interests, but until the Supreme Court makes a ruling, we just have to hope that more money does not equal more income tax problems.
[1] Will Kenton, Realized Gain: Definition, and How It Works Vs. Unrealized Gain, Investopedia (April 26, 2022), https://www.investopedia.com/terms/r/realizedprofit.asp#:~:text=Realized%20income%20refers%20to%20income,from%20interest%20or%20dividend%20payments. (Realized income refers to the income earned through salary or wages as well as any income received from income or dividends. Unrealized income refers to the potential profit that comes from an investment. In other words, it is the increase in an asset, such as stock or property, that has yet to be sold.)
[2] Moore v. United States, 36 F.4th 930 (9th Cir. 2022).
[3] Id. at 933.
[4] Id. at 932-33.
[5] Daniel Bunn et al., How the Moore Supreme Court Case Could Reshape Taxation of Unrealized Income, Tax Found. (Aug. 30, 2023), https://taxfoundation.org/research/all/federal/moore-v-united-states-tax-unrealized-income/#:~:text=These%20changes%20included%20an%20end,dividends%2Dreceived%20deduction%20for%20corporations.
[6] Id.
[7] Moore, 36 F.4th at 933.
[8] Bunn et al., supra note 5.
[9] Moore, 36 F.4th at 933.
[10] Id.
[11] Id.
[12] Id.
[13] Bunn et al, supra note 5; see also Commissioner v. Glenshaw Glass, 348 U.S. 426 (1955); see also Eisner v. Macomber, 252 U.S. 189 (1920).
[14] Moore, 36 F.4th at 934.
[15] Id. at 935.
[16] Moore Money, More Tax Problems? Analyzing Moore v. United States, Forbes (July 25, 2023), https://www.forbes.com/sites/taxnotes/2023/07/25/moore-money-more-tax-problems-analyzing-moore-v-united-states/?sh=fbbdbfa781d2.
[17] Id.
[18] Id.
[19] Id.
[20] Jenny A. Austin & Gary B. Wilcox, US Supreme Court to Determine Whether Section 965 is Constitutional: What You Need to Know, Mayer Brown (July 24, 2023), https://www.mayerbrown.com/en/perspectives-events/publications/2023/07/us-supreme-court-to-determine-whether-section-965-is-constitutional-what-you-need-to-know.
[21] Id.
[22] Id.
