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Supreme Court to weigh 2017 tax on overseas earnings

Case could affect decades of tax law and Democratic proposals to tax the wealthy

Zackary Dunn stacks copies of the Internal Revenue Code on the dais in November 2017, before a Senate markup of what would become that year's tax law.
Zackary Dunn stacks copies of the Internal Revenue Code on the dais in November 2017, before a Senate markup of what would become that year's tax law. (Bill Clark/CQ Roll Call file photo)

A dispute over a roughly $15,000 tax bill could shape the future of the U.S. tax system in a case set for Supreme Court oral argument Tuesday.

A couple, Charles and Kathleen Moore, have challenged the constitutionality of their tax bill for their shares of a company in India under a provision of a 2017 tax law meant to initiate a one-time tax on earnings held in overseas corporations.

The mandatory “repatriation” tax provision itself represents hundreds of billions of dollars in government revenue. But many tax experts have said the case could determine the fate of decades of U.S. tax law and Democratic proposals to tax the wealthy.

Even Republican former Speaker Paul D. Ryan of Wisconsin said the case may have huge stakes. At a Brookings Institution event in September, he called the dispute a “misguided challenge” to tax law that could “basically get rid of, I don’t know, a third of the tax code.”

Both sides have bet heavily on how the justices will parse the meaning of “incomes” in the 16th Amendment, which gives Congress the power to “lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”

1890s decision

That amendment was passed in response to a Supreme Court decision in the 1890s that invalidated the first income taxes.

The Moores argue the repatriation tax provision of the 2017 law taxed the value of their holdings in the Indian company KisanKraft, not any income they actually received.

They are minority shareholders in a business to supply farmers in India’s most impoverished regions with basic tools and equipment, and they have not distributed earnings to themselves but reinvested them to grow the business, their brief states.

A district court judge in Washington state and the U.S. Court of Appeals for the 9th Circuit did not agree, and the couple has now asked the Supreme Court to throw out that part of the tax law.

When the 16th Amendment was passed, “as now, income was understood to refer to gains realized by a taxpayer through payment, exchange, or the like, not mere increase in the value of property,” the Moores’ brief said.

The 2017 law “is a tax on property, not income in any sense of the word,” their brief states.

On the other side, the Biden administration argues that Congress has passed laws for decades with a looser definition of what qualifies as income — and anything tighter could endanger decades of tax law or incentivize tax cheats.

The Biden administration said that provisions taxing assets of expatriated Americans, life insurance companies, debt instruments and foreign pass-through entities would be at risk if the courts sided with the Moores.

“Adopting petitioners’ realization requirement therefore could put at risk billions of dollars in revenue and reinvigorate the abusive tax-avoidance schemes that Congress has addressed,” the administration argued in a brief in the case.

A letter sent by Joint Committee on Taxation staff to House Ways and Means ranking member Richard E. Neal, D-Mass., last month said that siding with the Moores could put whole subchapters of the U.S. tax code at risk, representing billions of dollars in revenue each year.

The positions Moore advocated could endanger provisions ranging from taxes on below-market-rate loans to those taxing S corporations and real estate mortgage investment conduits, the letter states.

An analysis published by the Tax Foundation found that throwing out those provisions of the tax code could reduce government revenue by hundreds of billions of dollars over the next decade, depending on how the Supreme Court rules.

Alan Cole, a senior economist at the Tax Foundation, said a strict interpretation of the amendment could incentivize all kinds of tax schemes.

“If you have too strict of a realization principle and you can’t be really flexible with it then taxpayers will start to find a way around it,” Cole said. “It is possible often in the modern financial world to derive value from an asset without actually taking the money out.”

Cole said the court could create an incentive for taxpayers to structure assets in a way that prevents them from paying taxes on them, such as taking a loan against a locked-away asset they never cash out. The loan, not counting as income, could still be cash in the pocket of the would-be tax dodger.

Global minimum tax

Cole also pointed out that the Moores’ position could end up endangering the U.S. participation in an international effort to negotiate a 15 percent minimum tax on large corporations’ global earnings, which is meant to root out dodging by seeking lower-tax jurisdictions and parking profits there.

More than 130 countries have signed on to the deal, but it’s faced skepticism in Congress, particularly from Republicans who oppose the Biden administration’s actions in the talks.

Cole said the plan, Pillar Two, contains provisions that incentivize countries to adopt the minimum-tax regime — and effectively punish countries that remain outside of it.

“Our Treasury negotiators have said this deal is good, Congress hasn’t ratified it, and if the Supreme Court has said it is unconstitutional, then that could be a very messy situation,” Cole said.

Cole, as well as court papers filed by the Biden administration and outside experts, noted that the U.S. could become an outlier on international tax policy if the Supreme Court sides with the Moores.

Congressional proposals to raise taxes on the wealthy have lurked in the background of the case, brought up by outside groups such as Saving America’s Family Enterprises and former Sen. John Breaux, D-La. In a joint brief in the case, they argued that if the Supreme Court rules against the Moores it would risk opening the door to wealth taxes such as those proposed in the past by the Biden administration and Democrats in Congress.

Those wealth taxes may start at the top income brackets, but Breaux and the taxpayer group argued they would soon trickle down to small-business owners.

Income taxes themselves started as a “class tax” on wealthier individuals before becoming the “posterchild for a mass tax,” the brief said.

“These proposals have some political appeal because they look like they target only the wealthiest individuals and most successful family businesses. But the history of taxation in this country illustrates that there is no reason to expect Congress to stop there,” the brief said.

It’s the latest dispute where the justices could upend how the federal government works this term, after hearing cases in the past two months on the constitutionality of federal agency funding and the ability of agencies to enforce federal law outside of the courthouse.

The justices are set to decide the Moore case, along with the others argued this year, before the conclusion of the term at the end of June.

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