On Tuesday, the Supreme Court takes a new look at the 110-year-old Sixteenth Amendment – the grant of power to Congress to impose a tax on income. The Court is focusing on when a gain is actually income subject to tax.
Today’s hearing: Moore v. United States
The Constitution and the power to tax: One of the basic compromises that the Founders reached in writing the Constitution in 1787 was to balance representation in government with a duty to pay for its services.
Since the basic document that had governed previously, the Articles of Confederation, gave Congress no power to raise funds, depending instead upon voluntary state contributions that were only sporadically paid, those who wrote the new Constitution wanted to assure adequate funding for the national government they were creating.
Being realists, they thought states would try to minimize their burden under new federal tax laws. They also expected the states to try to gain more representation in Congress by claiming more in population. This second temptation supposedly was strong among the slave-holding states, seeking to count their slaves in their population totals. The Founders found two ways to reduce both of those temptations.
On slavery, they wrote in a provision that a slave could only be counted as three-fifths of a person for purposes of assigning a state’s seats in the House of Representatives. (That clause was deleted by the Fourteenth Amendment in 1868, after the Civil War.)
To deal with the tax question, the Founders linked the reluctance to paying taxes to the eagerness for more representation. The result were these provisions, written into Article I: (1) Congress could impose taxes, and (2) any tax to be paid directly by the people (“direct tax”) had to be in proportion to the census of a state’s “actual enumeration” of population.
James Madison of Virginia explained in one of the Federalist Papers in 1788: “By extending the rule to both objects [tax and population], the states will have opposite interests, which control and balance each other, and produce the requisite impartiality.”
Twice during the 19th Century, Congress passed laws to impose direct taxes on people’s income. In 1864, during the Civil War, Congress passed a tax on individuals’ annual “income, gains and profits.” The Supreme Court unanimously upheld that tax in Springer v. U.S. in 1881.
In 1894, Congress enacted a new income tax, assessing it on income from rents of property, on interest on investment securities and on corporate profits, at an annual rate of 2 percent on income above $4,000. All of those provisions were ruled unconstitutional by the Supreme Court in 1895, in Pollock v. Farmers’ Loan & Trust Co. – described by one historian as “doubtless the most controversial case of its era.” Those taxes, the Count found, were invalid as direct taxes because they were not apportioned to state population.
The return of economic prosperity around the turn of the century quieted the controversy over that decision and over an income tax, but the Democratic Party repeatedly called for a constitutional amendment to overturn the Court’s 1895 ruling. That finally succeeded in early 1913, with ratification of the Sixteenth Amendment.
That Amendment reads: “The Congress shall have the power to lay and collect taxes on income, from whatever source derived, without apportionment among the several states and without regard to any census or enumeration.”
The tax at issue in this case: When Congress and the Trump Administration worked together to pass a giant tax-cutting measure in late 2017, they looked for ways to raise revenue to offset the $1.9 trillion impact on the Treasury.
One was a new levy, the Mandatory Repatriation Act. This in essence was a loophole-closing measure. Previously, Americans who owned 10 percent or more of the shares of a foreign company were not taxed in the U.S. on all of such a firm’s overseas income. If those earnings were not paid out to Americans as dividends, that income was not taxed. That had allowed more than $2.6 trillion in overseas earnings to accumulate, free of tax, since 1986.
In the Tax Cuts and Jobs Act of 2017, Congress imposed a new, one-time tax on that deferred income, for the years 1986 through 2017, with the taxpayer allowed to spread out paying that liability over a period of several years. For the future, the measure imposed a continuing tax obligation on overseas earnings by the foreign companies, even if the company had plowed earnings back into the company instead of distributing those profits in the form of dividends.
The facts of this case: A Redmond, Wash., couple, Charles and Kathleen Moore, are seeking a refund of $14,729 (plus interest) that they had paid with their 2017 tax return, under the repatriation provision on earnings that had accumulated in a small farm implement company in India. That company, KisanKraft Ltd., had been founded by a friend with whom Charles had worked for Microsoft Corp.
The couple insists that the tax they are challenging “was based on earnings retained by and reinvested by the company that the Moores never received. Simply for owning a stake in their friend’s overseas business, they were on the hook for thousands of dollars.”
They sued in federal court, arguing that the Mandatory Repatriation Tax is unconstitutional under the Sixteenth Amendment because it is a direct tax that is not apportioned among the states and because “it is not based on income at all, but on the fiction that taxpayers subject to it received income in the absence of an actual gain received or drawn by the taxpayer…for use or disposal.”
They interpret a 1920 Supreme Court decision, Eisner v. Macomber, as having made clear that income is not income subject to tax until it has been “realized” – in other words, received and available for use.
A federal trial judge granted the federal government’s motion to dismiss the case, ruling that the repatriation provision did not violate the Constitution and that the 1920 Supreme Court precedent was narrow in scope. The judge declared that there have been numerous provisions requiring taxation of unrealized gain, and all have survived legal challenges.
A federal appeals court upheld that ruling, saying that “whether the taxpayer has realized income does not determine whether a tax is unconstitutional.” That court concluded that the repatriation tax serves “a legitimate purpose” by preventing American shareholders of foreign companies “who had not yet received distributions from obtaining a windfall by never having to pay taxes on their offshore earnings that have not yet been distributed.” The dissenting judges in that court asserted that this marked the first time that any court in the U.S. had ruled that an income tax does not depend upon whether the income was realized.
The Moore couple took the case on to the Supreme Court. The Biden Administration’s Justice Department urged the Court to bypass review, contending that the appeals court ruling did not deviate from a string of similar precedents. The Court granted review anyway.
The question before the Court: Is any federal tax on business income that has not been handed out to a company owner or investor unconstitutional under the Sixteenth Amendment?
Significance: The Justice Department has told the Court that, if the appeals court ruling in this case is upheld, that would “call into question the constitutionality of many other tax provisions that have been on the books.”
The fact that the tax at issue may be producing billions of dollars in tax revenue for the Treasury surely adds to the importance of this case.
Also, there are a number of proposals in Congress, by liberal lawmakers, seeking to create new versions of “wealth taxes” to apply to America’s richest people, and that prospect gives this case a wider potential impact.
In deciding the case, the Court will be focused on what Congress intended in enacting this tax six years ago, and on the continuing meaning of its own precedents. For a Court that has a deep fascination with constitutional history, the Moores’ case offers a chance to parse anew the scope of the Sixteenth Amendment.
There has been another issue on the sidelines of this case: liberal critics of Justice Samuel A. Alito, Jr., have tried unsuccessfully to get him to disqualify himself from the case because one of the lawyers for the Moore couple conducted an interview with Alito for The Wall Street Journal, giving the Justice a forum for defending his ethical conduct. Alito has formally rejected the plea, finding no conflict of interest, and he will participate. His critics have no other option to force him off the bench for the hearing and decision.
Today’s hearing on this case will begin at 10 a.m. and is scheduled for one hour. The audio (but not the video) will be broadcast “live” on the Court’s homepage, supremecourt.gov To listen, click on “Live Audio” and follow the prompt when the courtroom scene appears lower on the page. The audio also will be available, under the title of the case, on C-Span TV at this link: cspan.org/supremecourt