WASHINGTON (CN) — The Supreme Court’s review of a Trump-era tax law has sparked questions about what a ruling could mean for taxes on billionaires, but businesses and states say the challenge could cause chaos for current tax laws as well.
A group of tax law professors warned the court that reversing the tax law would invalidate many sections of the Internal Revenue Code, calling into question Congress’ ability to collect income taxes.
“Creating this new requirement would break with history and would have severe practical consequences to the administration of the income tax that Congress has authority to implement under the Sixteenth Amendment,” the professors wrote. “Indeed, without the authority to determine when realization is required and when it can be disregarded, Congress would lose the power to lay and collect taxes on all incomes.” (Emphasis in original)
At issue in the case is the taxation of overseas investments. Typically, a person’s assets are not taxed until they are realized — the point at which the person actually receives a profit.
Former President Donald Trump’s 2017 Tax Cuts and Jobs Act included a one-time tax on foreign investments. Before this law, investors were able to avoid taxes on these funds until they were repatriated into the U.S., incentivizing corporations to keep their money overseas to avoid taxes.
Trump’s law gave overseas funds more immunity from taxation in exchange for the one-time tax intended to offset lost revenue. The tax forced corporations to pay a percentage of the money kept overseas. Since these investments have yet to be formally received, the law taxed unrealized gains.
A Washington state couple who received a $15,000 tax bill as a result of the law claims this is unconstitutional.
“This court has consistently held that ‘income’ within the meaning of the Sixteenth Amendment turns on realization,” Andrew Grossman, an attorney with Baker & Hostetler representing the couple, wrote in their brief before the court.
Grossman says an appeals court ruling that upheld the tax law flies in the face of those precedents and the history they were built upon.
“The Ninth Circuit’s contrary holding not only defies those precedents, it sweeps away the essential restraint on Congress’s taxing power, opening the door to unapportioned taxes on property (as in this case) and anything else Congress might deem to be a given taxpayer’s ‘income,’” Grossman wrote.
Charles and Kathleen Moore claim to have invested a small amount in KisanKraft Machine Tools Private Limited, which aimed at supplying tools to farmers in India. In the couple’s recounting, they have not received any profits from their investment.
Subsequent reporting from Tax Notes has poked holes in the Moores’ claims. In filings, the Moores have said they invested only $40,000, but statements from the company show that Charles Moore invested $150,000, loans the company $245,000 to be paid back with interest, and received $14,000 in travel reimbursements. He was also the second-largest shareholder in the company at one time.
The Moores sued the government after receiving their 2017 tax bill, arguing the tax law was an unapportioned direct tax. The lower court dismissed their case at the government’s request and the federal appellate court affirmed.
Arguing against a Supreme Court reversal, the government characterized the 2017 tax law as an income tax permitted by the 16th Amendment.
“In 2017, consistent with our Nation’s longstanding framework for taxing Americans who own certain foreign corporations, Congress enacted a one-time tax on U.S. shareholders’ pro rata shares of undistributed corporate income, which petitioners call the Mandatory Repatriation Tax,” U.S. Solicitor General Elizabeth Prelogar wrote in the government’s brief.
Although the Moores claim the tax is novel, the government says taxes on investments date back to the 1900s.
“Petitioners attack the MRT as a ‘novelty’ for lacking a rigid realization requirement that they contend is constitutionally required,” Prelogar wrote. “But as early as 1864, just three years after the first federal income-tax law, Congress enacted unapportioned income taxes reaching individuals’ pro rata shares of undistributed corporate earnings — and this court upheld Congress’s authority to impose those taxes.”
How the justices rule on the case could define the future of a wealth tax, which has been a goal for many progressives, most notably Senator Elizabeth Warren. In 2020, Warren proclaimed the country’s need for a tax on most wealthy individuals. She proposed placing a 2% tax on Americans worth over $50 million.
The proposal proved controversial and some see the case before the Supreme Court as a test of the justices' appetite for the idea.
“The tax imposed on the Moores’ unrealized capital gain is not an income tax within the meaning of the Sixteenth Amendment,” Former Attorney General Edwin Meese told the court in an amicus brief. “It is instead a wealth tax, and wealth taxes are direct taxes, which must be apportioned among the States.”
However, several states say the opposite, arguing that they rely on uniformity with the federal tax code.
“State tax codes generally rely on substantial uniformity with the federal tax code, which also allows states to piggyback on federal compliance efforts,” almost two dozen states led by Arizona told the court. “And states receive over a third of their revenue directly from the federal government. Prolonged, rampant tax sheltering — not a law intended to mitigate tax sheltering — poses the true threat to states’ fiscal health.”
Businesses will be watching closely to see how the justices receive the challenge. Owners and investors of partnerships and limited liability companies pay taxes on their share of an entity’s income. If the court invalidates the 2017 law, legal experts worry others will follow.
“A reordering of the U.S. tax-system to a realization-based regime could result in, among other things, more than $50 billion in annual new tax liability for private equity firms organized as limited liability companies or limited partnerships, and would delay more than $20 billion in annual losses now claimed by real estate companies using those business forms,” tax economists told the court (emphasis in original). “These tax consequences would likely have a significant impact on the ability of these firms to raise and retain capital at a time when commercial real estate is particularly vulnerable.”
The justices will hear arguments on Dec. 5.
Follow @KelseyReichmann
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