Today, the Supreme Court decided to hear a case that could have wide-ranging implications on US taxation of income earned abroad. The case challenges a key international provision in the Tax Cuts and Jobs Act: the Section 965 transition tax. The case has attracted attention (including multiple Wall Street Journal writeups) for its potential impact on Biden’s proposal to impose a wealth tax on high-income Americans. But the case is also of interest to the corporate tax community.
In Moore v. United States, a married couple made a $40,000 investment in a small Indian corporation that proved highly profitable. The corporation reinvested its earnings, and the Moores never received any distribution from the company. As a result of Section 965, though, the Moores had to declare an additional $132,512 as US taxable income in 2017 and pay an additional $14,729 in tax. Suing for a refund, they challenged the transition tax (also called the “Mandatory Repatriation Tax” or “MRT”) in Section 965 as unconstitutional. A federal district court and the Ninth Circuit ruled against the Moores and for the United States. The Supreme Court today granted “certiorari,” meaning that it has decided to hear the case.
The transition tax in Section 965 is at the heart of the dispute. For the 2017 tax year, the provision treats a controlled foreign corporation’s retained earnings back to 1986 as the Subpart F income of certain U.S. shareholders in proportion to their ownership interests in 2017. According to the Moores, these retained earnings are not actually income because they are not yet realized by the US taxpayer.
The case raises the question whether wealth must be realized to constitute income. At first blush, that might seem to be the stuff of law-school symposiums and arcane law review articles. But, if the Court were to side with the Moores, it is possible that a key pillar of the US system of international taxation could fall. Obviously, Section 965 is not the only provision in Subpart F that deems foreign earnings of a controlled foreign corporation as taxable income of the US owners. In their most recent brief, the Moores do try to distinguish Section 965 from the rest of Subpart F, but one could imagine that a broad ruling by the Supreme Court could upset other aspects of CFC taxation and perhaps even extend to the corporate AMT. It might even imperil US implementation of Pillar 2.
It was not clear that the Supreme Court would decide to hear the case. While it has attracted publicity, the Court hears only a small fraction of the cases that are submitted to it each year. Many of these cases involve “circuit splits,” and, here, the Moores did not identify any other circuit court that has addressed the constitutionality of the Section 965 tax. (They did point to allegedly conflicting caselaw authority on the definition of income.) The Court’s decision to hear the case could suggest that some Justices are interested in the scope of the government’s taxing power.
 Specifically, they say, “While this Court has not addressed the constitutionality of Subpart F, its provisions predating the MRT [in Section 965] all turn on events of that Congress identified as manifesting constructive realization of corporate income by shareholders, whereas the MRT simply attributes a foreign corporation’s income going back thirty years to its shareholders, irrespective of realization.”