Moore Money, Moore Problems
Oral argument suggests narrow ruling to uphold disputed tax
Moore v United States, a potential landmark Sixteenth Amendment case was argued before the court on December 5 2023. This is a case about the constitutional limits on Congress’s power to tax.
I realize reading a summary of a two hour discussion on tax policy probably sounds about as fun as actually listening to a two hour discussion on tax policy. But this case has profound implications in constitutional law, including the direct tax clauses and the Sixteenth Amendment.
Let’s briefly review the question presented and discuss why this case is worth paying attention to:
Question Presented
The Sixteenth Amendment authorizes Congress to lay “taxes on incomes … without apportionment among the several States.” Beginning with Eisner v. Macomber, 252 U.S. 189 (1920), this Court’s decisions have uniformly held “income,” for Sixteenth Amendment purposes, to require realization by the taxpayer. In the decision below, however, the Ninth Circuit approved taxation of a married couple on earnings that they undisputedly did not realize but were instead retained and reinvested by a corporation in which they are minority shareholders.
It held that “realization of income is not a constitutional requirement” for Congress to lay an “income” tax exempt from apportionment. App.12. In so holding, the Ninth Circuit became “the first court in the country to state that an ‘income tax’ doesn’t require that a ‘taxpayer has realized income.”‘ App.38 (Bumatay, J., dissenting from denial of rehearing en banc)
The question presented is: Whether the Sixteenth Amendment authorizes Congress to tax unrealized sums without apportionment among the states?
This is a case about a really fundamental part of the tax system, the so called Realization Rule.2 And what that means is that if I have income and it’s appreciated in value, even though it’s worth more than I paid for it. I don’t pay a tax on those gains until I sell it. And the question is whether Congress does it that way because it’s a policy choice that they are free to change or revise at their discretion, or does the Constitution require it?
In order to avoid the cumbersome, abrasive, and unpredictable administrative task of valuing assets annually to determine whether their value has appreciated or depreciated, § 1001(a) of the Code defers the tax consequences of a gain or loss in property until it is realized through the “sale or disposition of [the] property.” This rule serves administrative convenience because a change in the investment’s form or extent can be easily detected by a taxpayer or an administrative officer.
~Cottage Savings Ass’n v. Commissioner, 499 U.S. 554, 559 (1991)
In other words, when the Sixteenth Amendment said Congress could tax income, was the Sixteenth Amendment saying income means realized income from a sale, or does it mean appreciated income from a rising valuation?
The Sixteenth Amendment was the brain child of President William Howard Taft, who looked at the Constitution and said “You know what this is missing? A provision that makes theft a plenary power of Congress.”
The Sixteenth Amendment got around previous constitutional complexities of instituting an income tax. Congress has the “power to lay and collect taxes,” including an income tax, but, under two constitutional provisions
Representatives and direct Taxes shall be apportioned among the several States
~Article I, Section 2, Clause 3
No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or enumeration herein before directed to be taken
~Article I, Section 9, Clause 4
Direct taxes must be apportioned— At least until the Sixteenth Amendment’s ratification.
The Congress shall have 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.
~Amendment XVI
The Sixteenth Amendment, approved by Congress in 1909 and ratified in 1913, made it possible for Congress to enact an income tax without having to worry about whether, under the rules applicable to direct taxes, the tax had to be apportioned among the states on the basis of population.
In 1920, in the case of Eisner v. Macomber, 252 U.S. 189 (1920) the Supreme Court would hold that for purposes of the Sixteenth Amendment, income needed to be realized to be taxable. While the Court have never overruled that holding in Macomber, their subsequent Sixteenth Amendment cases have gradually distanced themselves from applying the realization rule. But in Moore v United States, the court is considering whether maybe, to reaffirm that idea. This is such an important case because a great deal of the US tax system is based on an unstated and unproven assumption that realization is not constitutionally required. There are a lot of provisions that would potentially have to be reconsidered or abandoned. In this author’s humble opinion, reconsideration and potential abandonment not only could be considered— It should be considered.
This is now a distinct, though highly improbable, outcome— in the event the court rules for the petitioner, depending upon how broad that ruling would be.
Background Issues At Work
The reason this issue is coming up now goes back to August of 2022, President Biden, as part of budget negotiations, proposed a tax on people with more than $100 million of wealth. The basic idea was that if they had appreciated stock, they’d pay tax on the appreciation, even without a sale.
This case also has wider implications as well because recently Congress was considering this idea of taxing so-called unrealized gains for people who Congress deems sufficiently wealthy. And this position has been a staple of several leading Democrats in their recent Presidential runs.
Especially Elizabeth Warren and Bernie Sanders, who both support a wealth tax on everyone who happens to be wealthier than them. (Seriously, was I the only one who noticed that Bernie Sanders’ rhetoric of “taxing the millionaires and billionaires who don’t pay their fair share”— Whatever that means, suddenly shift to “Taxing those greedy billionaires who don’t pay their fair share” just about 2 months before it came to light his 2016 book put his net worth in the million dollar range”)
…But I digress
The wealth tax, as proposed by people like Senator Warren and Senator Sanders is not taxing appreciation, its an annual tax on the value of what we have. Kind of like what the property tax does for homeowners. But the wealth tax would apply to all assets and it would be levied by the federal government, whereas property taxes are laid by state governments where apportionment is not a constraint on direct taxation.
And so this question of the limits on federal taxing power is very salient, in part because whether these novel taxes would be a constitutional exercise of the Congressional taxing power is still a matter of debate, and the outcome of this case may go a long way toward settling that debate— depending not only on how the Court rules, but also how broad that ruling is.
This is precisely why, during oral arguments, Justice Kavanaugh asked the Solicitor General Elizabeth Prelogar
“So let me ask you, what if the government tried to impose a wealth tax, would that be unconstitutional?”
Moore v United States, Docket No. 22-800 Oral Arguments (transcript)
I think given the salience in public policy circles of these possibilities, and the obvious importance of this case to all taxpayers has a great deal to do with why the Court have taken an interest in this issue.
Obvious Questions Being Obviously Ignored
This all raises another obvious question that has been completely overlooked by the wide coverage this particular case has received, especially from corporate media reporting on this issue, as well as the discussions of this case by politicians who have taken an interest in its outcome. Is this case a good vehicle to even decide these larger issues?
After doing a deep dive into the issues raised during oral arguments, my conclusion is that I think the answer is “no”. That became much more clear during oral arguments.
In an Amicus Brief, filed by the American Tax Policy Institute that argues for a narrow ruling in favor of the respondents in this case they gave an alternate example of what case would provide a better vehicle for a broad ruling that would speak to many of these larger concerns such as the constitutionality of a wealth tax they say:
When investors want to bet on oil prices, they get an oil future from an exchange through what is technically termed a 1256 contract. These regulated futures contracts are taxed by Congress every year, regardless of whether you sell. At the end of each year these contracts are treated as sold for their fair-market value. This constitutes something tax lawyers have termed a mark-to-market rule.
Brief amicus curiae of American Tax Policy Institute
And this is the quintessential example of taxing appreciation without a sale. So someone who’s done one of those contracts, who then pays tax at the end of the year, could go to court and say, give me my money back, I shouldn’t be taxed. It’s not okay. And then the court would squarely face the question of whether Congress has the power to tax on unrealized gains. But this case doesn’t quite present it. While I would contend the petitioners present a much stronger argument, any honest appraisal of this case has to concede that because of the additional complexities of the case, both sides do have valid legal and historical evidence as to whether or not Congress has the power to tax unrealized income. However, something that came out during oral arguments was that it seemed the Court seems to be leaning towards the conclusion Congress does not have the power to tax unrealized income, while simultaneously leaning away from reaching a decision that would affirm that conclusion…
The key point here is that the taxpayers owned shares in a foreign company organized in India, it had profits, the property has appreciated, the stock is appreciated. They’ve held it for many years. And because of an international tax reform that I’ll explain in a minute, Congress said, you know, what, we’re taxing shareholders on the earnings of the company. But here’s the rub, it’s not a tax on the appreciation in the stock, per se. It’s a tax on the earnings of the company. So if you ask yourself, did somebody realize gains here? The answer is, yes, the corporation did. The corporation has a realization. And the real question is, can the realization of the company be attributed to the owner.
So it’s not necessarily that they’re taxing the owner on its appreciation so much as they are taxing the owner on realized gains of the entity that it owns. And that actually is a different issue, which is why this case, may end up not really giving an answer to the question of whether unrealized gains can be taxed.
The reason this is now coming up has to do with a longstanding government ambition to tax foreign companies on their earnings, but only when those earnings are distributed to US shareholders. Only when they receive their dividend, or unless they sell their stock. This means they can’t tax the foreign company itself. And in 2017, Congress decided that it was not a good idea to tax these dividends, because it was encouraging companies to keep cash overseas, the price of bringing money back to the US was that they had to pay tax on it. So about two and a half trillion dollars of earnings were not coming back.
And so Congress said, we’re not going to do that anymore. We’re going to tax the earnings when these companies earn them at a reduced rate. But since we haven’t been doing that before, we’ll have a onetime transition tax on the earnings that haven’t been taxed, and haven’t been brought back. So the Mandatory Repatriation Tax (called the MRT in their case briefings) was imposed on the taxpayers here. This is the reason this case almost certainly cannot lead to the kind of clear outcome we might expect from such a simple and direct Question Presented before the Court. Nor does this case present a clean vehicle for delivering any bright line test on Congress’ power to tax unrealized income without apportionment under Sixteenth Amendment jurisprudence. Because these were earnings realized by the corporation, not the individual these taxes are imposed upon.
Competing Vision Of Realized Income
There are really two ways the court can go in deciding this case. One is the question presented, which is does the Sixteenth Amendment allow Congress to tax unrealized gains. Gains from property that hasn’t been sold yet? That’s what I would call the broader issue. And they could resolve it.
But it’s more likely that they’re going to go with a narrower issue, which doesn’t decide whether the Constitution requires a realization. The issue is not presented here, because there were realizations at the corporate level. The company that they have an ownership stake in had realized income. The question here is not whether realization is required, but whether the realization can be attributed to the owner. Whose realization was it?
Insights From Oral Arguments
What’s interesting was that, going into this case right after the Court decided to grant cert, it seemed most probable to me this case would turn on answering the broader question that fully addresses the QP the Court agreed to grant judicial review on, but oral arguments completely changed the calculus on that probability. Virtually the entire two hour session was dominated by discussions focused on the narrow issue. Several Justices, including Justices Kagan and Sotomayor seemed very much on board with that particular vision for deciding this case on the more narrow grounds and several of the Justices, including Kavanaugh, Barret and Jackson appeared to have been persuaded by the Solicitor General’s arguments in favor of resolving this case along those narrower grounds. Especially with the parts of her argument that relied on first principles of the Sixteenth amendment’s text and history.
It just started off that way from the very first question. Justice Thomas asked about the difference between realization and attribution.
When you say “realization,” what — do you have a definition for that or an explanation as to exactly what it is, and — and how is it different from, say, attribution?6
Justice Thomas, Oral Arguments, 5:15 (December 5, 2023)
And it just went on from there. Justice Kavanaugh, at one point, sort of followed up, Justice Alito was saying, so are there limits? Are there constitutional limits on taxing without realization? And Justice Kavanaugh jumps in and said, Well, you know, we really don’t have to decide that now. We can decided more narrowly by just asking whether it’s okay to attribute the attribute this to, to the owner.
We don’t have to agree with you on that for you to prevail I think you’ve said in your opening as well because, even assuming or leaving open whether realization is a constitutional requirement, there was realized income here to the entity, and then it’s attributed to the shareholders in a manner consistent with how Congress has done that and this Court has allowed.
Justice Kavanaugh, Oral Arguments, 65:22 (December 5, 2023)
So long way of saying it does seem like the court could decide this narrowly. And based on the argument, I predict that they probably will, but only time will tell.
Furthermore, between these broad or narrow options we find additional competing arguments.
When it comes to a narrow interpretation, what the government is saying is that It’s fine for Congress to tax the owners of a business instead of the business itself. And that’s all that they’re doing here. And they’ve done it since the beginning of the income tax with partnerships. So I think the best argument that the government has here is this is just like a partnership. And the Supreme Court said decades ago that was okay. So, in the US, when we operate a business through a partnership, partnership earns money, but it doesn’t pay tax on the money. It’s the owners that are taxed on the money the partnership earns. And this is the same thing, basically the government is asking for this foreign corporation to be taxed as a partnership.
Whereas the petitioners in this case, Charles and Kathleen Moore make such an obvious argument that you would have to be a bureaucratic government tool to be foolish enough to disagree with it. Their argument is that this corporation isn’t a partnership. It’s a corporation. And this brings us back to the case I mentioned at the start. Eisner v. Macomber, 252 U.S. 189 (1920), where part of the reasoning in the case was to say that ‘Yes, partnerships can be taxed that way, but we don’t do it for corporations.’ Corporations are a real solid legal entity, whereas partnerships just aren’t. We should just tax a taxpayer on their own realizations, just tax the owner on what the owner does, not what the corporation does.
However, even though the language in Macomber is very clear on that point, that part of the opinion is dicta. It is ancillary to aspects that are necessary to the primary holding. And so in a whole bunch of later courts have narrowed the way Macomber is read. In Moore, the petitioners best hope here is to revise and revive the original meaning and scope of the larger majority opinion in Macomber, not just the holding. To say yes, with a corporation, it’s different. We can’t do that. But on the other hand, if they want to go with the partnership analogy, then the government wins here.
Competing Case Outcomes
Petitioner (Argued by Andrew Grossman)
Let’s look at how the court may decide to rule on the broader question, that is, does the Sixteenth Amendment require a realization? What are the competing arguments here?
Looking at that broader issue, does the word income in the 16th Amendment mean realized income? There are some interesting arguments on both sides there. Petitioners in this case have emphasized the phrasing “income from whatever source derived”. The primary word for them is “derived”. They assert that it isn’t enough to be income, it has to also be derived. And they say that the word derived implies a realization. And that would be a proper reading of the provision “income from whatever source derived.”
Respondent (Argued By Solicitor General Elizabeth Prelogar)
But the government has its own reading of that language, which is different. They remind the court that US had an income tax. In 1894, Congress passed the Wilson-Gorman Tariff Act,8 which lowered tariff rates and made up for some of the lost revenue by introducing taxes on income, corporate profits, gifts, and inheritances. And then in 1895, in Pollock v. Farmers’ Loan & Trust Co., 157 U.S. 429 (1895).9 the Supreme Court said at least certain income, such as income from property is not constitutional. Meanwhile, there was still an argument that an income tax from labor was constitutional. But during President Taft’s administration there was a strong political groundswell to enact an income tax.
President Taft, in 1909, proposed a constitutional amendment be passed to that effect. This was the birth of the 16th amendment. In any event, the argument the government makes is that when discussing the meaning and scope of ”Income from whatever source derived” the controlling precedent doesn’t come from Macomber. It comes from Pollock v. Farmers’ Loan & Trust Company, 157 U.S. 429 (1895), they’re saying, Look, the Court said income from property was not okay. The 16th amendment effectively overruled Pollock by making income from whatever source derived taxable, that phrase includes property, so the MRT is fine.
The government reinforces the constitutionality of the MRT through a textual argument as well. They say the word “realization” doesn’t appear in the amendment. And Congress could easily have said
The Congress shall have power to lay and collect taxes on realized income, from whatever source derived.
Their argument here is that the petitioners are adding a word to the amendment that isn’t there.
In Conclusion
So, in closing, as I already mentioned I believe the Court will be ruling on the narrow issue… but in whose favor?
I think that the government is going to win here. Which, I must admit, comes as a surprise to me. I believe the petitioners in the case are squarely in the right and I had assumed when the case was taken up, based on the acceptance of the broader question presented, the Court’s intention was to rule on that broader issue in the QP… But after oral arguments I think its clear the Court wants to kick this can down the road a ways, and the government has offered them a pretty solid argument for doing just that. It looks like there are a number of votes for the idea that we don’t have to reach the question of whether realization is constitutionally required. Enough of the Justices seem ready to say there was a realization here at the corporate level, and it can be attributed to the owners in the same way we allow it with partnerships. I think that’s what they’ll do.
However, assuming that’s how it goes, the one bright spot for those of us who do think the petitioners have the better part of this case is that I think it’s likely we will see concurring opinions from Justices Gorsuch, Alito, Thomas and even perhaps Chief Justice Roberts that will clarify that this opinion should not be construed as deciding unrealized income can be taxed. That they await a case that will allow them to consider that issue, that there are some serious questions about the validity of such a finding that this Court may address in a future case.
Cartago Delenda Est
