Moore v. United States: What’s next?

The following is a verbatim output of transcribing from a webinar recording. Although the information in this transcription is largely accurate, in some cases it may be incomplete or inaccurate due to inaudible passages or grammatical, spelling and transcription errors.

Kevin Kao

So yeah, Ben, go ahead and introduce yourself and let everyone know who you are.

Ben Willis

Sure. Director here in Washington Tax Council at Baker Tilly specializing in corporations and transactional tax. Started off my career 16 years ago at PwC, spent four years in the government and spent a little bit of time writing and teaching. And now I'm very happy to be working with Kevin Kao here at Baker Tilly.

Kevin

And I think, Ben, you were, I guess my recollection is you were working on the Hill in 2017? Did you work on 1965 during your time there?

Ben

I did. I worked on a version of it. So I was fortunate enough to be on detail from the IRS over at the Senate Finance Committee and there were a bunch of iterations of 965's repatriation tax being floated. My son was born in July of that year and then I took paternity leave, and left in August. So I was out just a few months before the version of 965 that was ultimately enacted was released.

Kevin

OK, good deal, good deal. And for those who weren't already aware, we're going to be talking about the recent Supreme Court decision in the Moore case that really just happened. So I will jump into the background then.

Ben

Kevin, I got a joke.

Kevin

OK, let's hear it.

Ben

Why did the accountant break-up with the tax code?

Kevin

Why?

Ben

Because he realized the relationship was temporary.

I thought that was appropriate given the fact that we're about to talk about the temporary provisions that are in and out of the code and the many iterations of the tax code that we see. And now in this instance, whether or not anything will be realized or need to be...

Kevin

I was going to say I like the emphasis on realization there, which we'll dive into a bit.

So Charles and Kathleen Moore are the petitioners in this case. And they invested $40,000 into a Ford Corporation, KisanKraft Machine Tools. In exchange, they got a 13% interest in the company. Now, because the Moores owned at least the 10% interest of KisanKraft, they were subject to Section 965 otherwise, and you'll hear us call it the Mandatory Repatriation Tax (MRT).

For the audience's reference, Section 965 was enacted under the Tax Cuts and Jobs Act in 2017 and essentially was a transition tax to bring certain U.S. shareholders that own foreign corporations from what was, you know, a deferral system as it relates to controlled foreign corporations to a new participation exemption regime, you know, that came with that Tax Cuts and Jobs Act. So we're going to dive a bit more in, but 965 was essentially a toll charge on earnings that were deemed repatriated by those foreign corporations.

Under Section 965, U.S. shareholders of controlled foreign corporations or specified foreign corporations, which we'll talk about in a bit, were required to pick up a deemed dividend based on post 1986 deferred earnings of the foreign corporation.

So because KisanKraft had untaxed earnings during, we'll call them the relevant dates under Section 965, the Moores ended up owing $14,729 in tax based on their pro rata share of KisanKraft’s dividends.

The Moores then challenged 965 and argued that it violated the Direct Tax clause of the Constitution and the Due Process Clause of the 5th Amendment. The District Court dismissed the case, the 9th Circuit affirmed and the Moores appealed to the Supreme Court and the court granted cert.

That's kind of just a little bit of background, factual background and also procedural history. But Ben, do you want to talk a little bit about, you know, what exactly were the Moores trying to argue and what were really the issues before the Supreme Court?

Ben

Absolutely.

So they were trying to argue that realization was required in order for them to be taxed. And that led to a lot of politicization of other taxes that have been proposed that would not need realization, largely wealth taxes. And while those political topics are important, they're outside of the scope of today's discussion.

Kevin and I are a couple tax nerds who are very interested in this case and its importance, which it certainly has outside of that spectrum and here in the tax world, where realization matters. And the tax code is filled with a number of provisions in which realization is the cornerstone for when you actually are taxed. And a number of exceptions, particularly folks like me who are corporate tax subchapter C focused in their careers and have spent countless hours helping taxpayers understand, and the government understand exactly how those rules should, you know, be enforced with the policies related to realization.

But the Moore's brought forward this argument. And of course, as, as Kevin mentioned, the, the Supreme Court did not answer. The majority five justices concluded that answering that question was not necessary in order to find in favor of the government and hold that the attribution of a corporation's income was constitutional to a shareholder.

And there's points that'll come in and out as we discuss. One of them was raised in the District Court, which was due process that I just want to mention that was dropped. And the opinion went out of its way to mention that it would be following its normal rule, its general rule that it would not be addressing answers that were outside of the plaintiffs' arguments here. And so the Moores dropped that after the 9th Circuit said “no, we disagree that due processes indeed an issue.”

And one of the reasons that matters so much is that they were attributed income from nearly two decades of ownership all on one date through a system that has historically been known for supporting a deemed dividend type treatment in in the subpart F context.

And I mentioned that because the holding was to say, well, attribution of this income is fine because the Moores were subject to a pass-through regime and we are going to limit our holding to pass-through regimes. And it went out to spell a number of them, including that which applies to S corporations, small business corporations, partnerships and other provisions in the code which some of which are viewed as historically pass-through regimes. And a lot of that law that it actually went into detail about supports that some of those pass-through rules originally were premised on the fact that entities were not regarded, that partnerships could be created through an oral agreement among individuals to share profits and therefore it was truly income that was being earned by those people.

Of course, later there was state law or entities and trusts that were treated as various things and were benefited from that same pass-through treatment that largely disregarded those entities except for certain computational purposes and just allocated.

I wouldn't quite view those as attribution rules. And I think there's a lot of other technical technicians out there who would argue that there's a difference between attribution and pass-through. But their expansive rule here in saying that these pass-through regimes also include Subpart F, historic subpart F, I'll say, they did go out of their way to separate the discussion of the MRT, which operates differently and is applicable to a broader set of corporations and therefore American shareholders.

Following this majority of five justices out of nine who did not answer the realization question but did say that the tax was constitutional, we had a concurring opinion, one concurring opinion that specifically said that realization was not a requirement. That was Justice Jackson and then another concurring opinion that said a realization was a requirement.

And finally, a dissent by Justice Thomas, who's book I threw behind me right there, just because it was such a, a powerful dissent and explaining why realization is absolutely necessary in order for the majority of the taxing provisions, including the taxing clause itself, which gives the federal government its power to tax in order for that provision to have any meaning in the compromise between the states that it originally created, including Rhode Island, who objected to taxation by the federal government as broadly as they wanted it.

And, and I couldn't help but throw in, I took a class with former Governor Bruce Sullivan at University of Rhode Island, who taught me that Rhode Island was the first to fight and, last in peace based on our first declaration being the first to declare our independence from Britain, in part because of taxes, but our last to sign on to the Constitution as a willing party to be broadly taxed because we had some of our concerns based on that and religious freedoms.

And so I thought that history was something worthwhile just to bring from a personal perspective here, but also to say that that dissent made a wonderful point that if you have a direct tax that needs to be apportioned pursuant to this compromise by the states that signed on and created the Constitution, you need to respect the corollary to that for indirect taxes, which is the 16th Amendment, which lessened the strength of that taxing clause, but limited the taxing power to income.

And Thomas and Gorsuch's opinion did a wonderful job of saying, well, if you, if you don't have realization, you don't have income and therefore there's no difference between direct and indirect taxes. And so you render the whole protections provided by those provisions and, and the PILOT case and the and the amendment to expand it moot.

And so again, as a Subchapter C junkie who has worked through these provisions in depth, really understand when taxpayers are required to pay tax because there's been a realization event, a change in events. And the many exceptions to that rule that are based on realization and effectively continued ownership of underlying property and modified corporate form. Those modifications of the form itself are loan realization events.

And so that lays at a high level, Kevin, I think what the what the judges articulated and why. I don't know if you view so, so part Fs applicable to CFCs as a pass-through regime, but I don't know if that part of the opinion hits you.

Kevin

Yeah, I, I think it was an interesting classification. You know, I think I, I don't know that a lot of us in the national tax practice necessarily have referred to controlled foreign corporations themselves as pass-throughs, you know, in practice. But it was definitely, it was interesting dicta by then.

I do want to just mention quickly, I, I think Ben touched on this, but so everyone's on the same page. It was a seven - two ruling. So the Supreme Court did rule in favor of the government that the that 965 isn't being constitutional. And so, you know, I do want to kind of bring this back to 965 first as our first topic, I guess Ben what does this ruling mean for, you know, before we get to the broader topics, but what does this mean for 965 in particular?

You know, what does this mean for the Moores or, you know, other subsets of taxpayers that, you know, were affected by 965? Talk a little bit about, you know, what the decision did for those taxpayers.

Ben

Sure.

And I'll give a high-level discussion of this because in our last webinar, which we're going to go ahead and link to this one* so folks can find it easily. Kevin and I went back and forth for almost 25 minutes, largely covering this issue itself, which is that the Moores represented one class of taxpayers who did not have the most egregious facts as far as concerns that were raised by some of the Supreme Court justices, including the oral arguments in which the word due process was raised 20 times.

*Click here to view our previous webinar recording.

And here in the court opinion, the Supreme Court opinion, we have various references to due process again. And notwithstanding that the court, you know, properly did not address it because the taxpayer dropped it as an argument, it certainly is something to give some thought to as far as future claims, whether it be related to 965 or others, due process matters.

And the Moores, their situation is, is done.

They've brought their case to court, they've had their day in court and they've lost. So the Moores clearly are going to be responsible for this tax.

The Moores fall into a subset of shareholders who owned CFCS and therefore were on notice since their ownership began that the stock of their American controlled foreign corporation was subject to this, what the court refers to as a pass-through regime. Really it's, it was more of an anti-abuse regime focusing largely on passive earnings that would be attributed to their shareholders through effectively deemed dividends.

But the shareholders that may be looking at this 965 ruling and wondering if there are a possibility that they might have received a more favorable ruling from the Supreme Court, I think there's a good argument for that, and the arguments based entirely on the descent. Which one found that not entirely on the dissent, but mostly on the dissent and some due process additional points that I think they might want to consider, but the dissent went out of its way to say that one realization is required and two other justices said that as well.

So four, the nine do believe in a realization requirement and it it's hard to say whether or not the five and the majority opinion didn't really give an answer to that question, and I say that because there's been a number of comments since that case was released pointing out that one of the main focuses of their decision was that there was so much alarming concern that other provisions inside of the code would be rendered ineffective, and therefore, you know, subpart F not only but subchapter K, S corps market-to-market regimes might endure some sort of invalidity and therefore, you know, cause there to be a lot of disruptive chaos.

I view that is not actually right, those regimes are so much more clearly within historic lead tax principles that I, it's not too concerning.

Kevin mentioned the word SFC specified foreign corporation and that is the fact pattern that we talked about in our last webinar. That is where a U.S. shareholder can be taxed in a foreign majority owned corporation. So not a, a controlled foreign corporation, an American controlled corporation, but a foreign controlled corporation. And if a U.S. shareholder, say the Moore's fact pattern, except there was a 10% corporate shareholder that was also in the mix, and we'll say, you know, the the remaining percentage, 70% was owned by a foreign individual, that would have been a specified foreign corporation and they would have been hit by the same tax, but they wouldn't have fallen into this pass-through regime as the Supreme Court has called it, of Subpart F.

And therefore there would have been no notice that any income would have been attributed to them, you know, standard earnings across the board as opposed to these passive earnings and in the Subpart F regime historically, and for those taxpayers, there is still the possibility that the tax as applied to them could be an unconstitutional tax based on what we just discussed as well as additional due process arguments.

Kevin

Yeah. And just for the audience, you know, KisanKraft was a controlled foreign corporation. And so that's, that's kind of what Ben's referring to. And. you know, Section 965 really, well, if we take another step back, the court really refers to controlled foreign corporations, which are foreign corporations where over 50% of the entity is owned by U.S. shareholders. And so for controlled foreign corporations, the subpart F regime applies.

And so you know, one of the one of the things the court was saying was as it relates to controlled foreign corporations, you know, we attribute it income to them sort of or I guess we attribute income to the shareholders is pass-through remedies through the subpart F regime, right.

And So what Ben's referring to is, is really that 965 creates a new class where they say, OK, 965 is going to apply to either controlled foreign corporations. So similar to the subpart F regime, if you have a foreign corporation where over 50% is owned by U.S. shareholders, 965 applies, but 965 also applies if you have this new class known as specified foreign corporation. So all you really need for any foreign corporation to really be considered a specified foreign corporation is one 10% U.S. corporate shareholder.

And so in Ben's example, he's saying, well, I've got a foreign corporation where I've got one 10% U.S. shareholder and I've got one 10%, you know, we'll call it U.S. individual. So in total, we've got 20% U.S. ownership. And you know, clearly as Ben said foreign-controlled, you know, for these specified foreign corporations, they're not subject to the subpart F regime. And so the court's ruling that, hey, you know, control foreign corporations are pass-through entities and therefore, you know, we've got the power to contribute similar to partnerships, similar to S Corps, you know, but I think Ben's question is, well, what about a specified foreign corporation that's not a controlled foreign corporation (CFC), it is not as subject to support.

Ben

That's right.

And that was not addressed. In fact, the Court went out of its way to fall narrowly as possible with its with its ruling focusing on American controlled foreign corporations subject to this tax and the Moores owned their stock in the CFC from inception, though the income it was attributed related to its period of ownership when it, you know, controlled this American controlled corporation.

Although with respect to the due process point that they dropped, the Supreme Court did go out of its way in footnote 6 in the majority opinion to say that their historic argument on due process related to the fact that the earnings were such over such a long period of time, up to three decades.

And so notwithstanding that they were attributed income for the their entire period of ownership, they could have been attributed, you know, 30 years of earnings and profits for owning stock on a, on a for a couple days. And that was actually an example that Justice Alito gave in the December 5th oral arguments. And there was no uncertainty about whether or not that was a better due process claim. It certainly was. And I, I thought was acknowledged.

Kevin

Yeah. And, and kind of moving on to some of their other arguments, I guess on our last quarterly tax discussion, you know, Ben referenced the the link that'll be there. But, you know, we talked a little bit about the Moores. You know, they dropped their due process claim after losing to the 9th Circuit. So the court didn't address due process. But you know, what if the Moores had kept that claim? I guess what you know, they didn't address it. And so is that a, is that a strong argument for the other taxpayers going forward?

You talked about the Moors kind of being stuck with the decision, but what about taxpayers like the Moors or, you know, taxpayers in the class that that you kind of talked about?

Ben

Yeah. And you know, of course, of course, as in all of our disclaimers, nothing we share is tax advice and, and, and, and funny enough and, and more importantly, nothing in this discussion is certain.

If anything, the, the this case is, is evidence of that evidence of whether or not a, a tax passed by Congress that takes another step forward and figuring out a creative way to tax taxpayers, there's no certainty there in any of the fact patterns that we might articulate here.

But if if they had mentioned due process, they would have had a slightly better argument. They they still owned the stock, I believe, they still own the stock for the entire period of time that it was a CFC and therefore would have been on notice that they were subject to this anti deferral regime that could shift and has certainly has been modified over the years for such transitions.

So when looking at the, the due process law out there, that effectively says whenever you have a wholly new tax like the MRT, then you have to give this consideration. And now the the 9th Circuit looked at Carlton, which is a case from the early 90s that said this, this had very little teeth, but it was largely referring to the fact that we didn't, we didn't have many taxes that were very retroactive, two years, four years, a lot different than 30 years that we have now in the MRT. That is an exceptionally long period of time.

And so I still think that it would have been interesting and they would have had better odds of winning in this Supreme Court if they did not own the stock for the entire period of the CFC’s existence. In other words, the CFC existed for 15 years, they bought in and then they were attributed notwithstanding they only own the stock for a year, 16 years of earnings and profits. Now you got to start wondering, why I just bought my stock from somebody else. What? Why didn't they pick up that tax bill? Why did I pick it up for them?

Oh, well, maybe you should have known.

Really I should have known that I was going to be attributed 30 years on what basis?

Tax law changes sometimes, sometimes we need to raise money and we gotta figure out creative ways to do it.

And so, but an even better fact pattern than that intermediary one is the one that we articulated just a little bit earlier and and discussed at length and and last webinar which is first specified foreign corporation who is not a CFC, not subject to subpart F, not subject to this court's pass-through regime.

And they made very clear to limit the holding to that.

So I, I would say folks will be looking at that that language very closely who may have a claim as they fall into these progressively better fact patterns.

Kevin

Yeah, that makes sense.

And I, I think the last topic that, you know, we really wanted to touch on today was as, as we all know by now, I think that the interest in this case went beyond whether 965 itself is constitutional. 965 obviously affected plenty of taxpayers, and you know, and there were still taxpayers who may, who may be looking to find it kind of as we talked about here. But really I think the key question that most people were interested in for the court to potentially address is what we talked about earlier.

And, you know, it's really whether the 16th Amendment requires realization of income before taxation. And so as we discussed, they decided not to address it. They went with a really narrow ruling, you know, that the mandatory repatriation tax is constitutional, you know, based on the attribution of income. And I've seen some commentary, you know, where there's maybe some frustration for the court, you know, kind of having the chance to address realization and, and, and not addressing realization. And, and I guess I, you know, I wonder if maybe this particular case just didn't, didn't quite take it there for them.

It almost, you know, the Moores had conceded subpart F sub chapter S, you know, S corporation, sub chapter K partnerships, you know, all these provisions were were constitutional and really tried to distinguish 965 from those provisions. You know, should the case have been made harder to go after realization? And, you know, is really is the door open to still rule on realization? Because it, it kind of seems like for for as wide as the door was open to the for the court to kind of talk about realization, it maybe they were always just as open for a narrow ruling because of the way the arguments were framed.

Ben

Yeah, So my thoughts are that this case was so perfect for for tax geeks.

The tax geeks out there who, you know, appreciate the the immense complexity of the issues inside of Moore v. U.S. can't help but be thankful for this opinion.

The Supreme Court largely reached a conclusion that represents the divide among tax practitioners and that includes the array; the folks on the Hill, the folks in academia who largely support the fact that realization is for administrative convenience, the folks who work with the rules and know that to practically apply them and understand how taxes can be calculated, who do appreciate that realization is necessary to have any certainty about taxes and, and their computation, as well as the constitutional enthusiasts who believe that the Constitution does offer the people some protection.

And so for, for those folks who are looking to glean something from, from this case, I think they can glean the fact that it's a tough topic that a lot of people are divided on. And the division here is clear. We thought we saw, you know, four people say there's realization, 5 people saying we're not sure, maybe not.

And and while they, they, they, they warned in their dicta that, you know, wealth taxes should not be viewed as passing muster, we see people like Elizabeth Warren and others already out there saying this is, you know, not too bad. This is a pretty good opinion for the possibility that, you know, it's, it's, it's not out of the, the realm of possibility. And certainly some over there are our advocates for it. From a, from a practical standpoint, it, it's extremely complex to make such a prediction as to whether or not these wealth taxes could end up in, in play.

I would assume that those drafting them would be thoughtful to this opinion to try to do so in a way that would minimize any due process concerns, any constitutional requirements that many believe do exist, limitations like realization on income. But there are taxes that better aligned with, you know, an economic change.

Here we saw a number of corporations get a DRD, a benefit from the system. So now under 245 cap A, they participate in this new system and, and you could view that as a change in, in economic entitlements to some extent, just like they viewed in 2004 when they passed 877 A for expatriates who were leaving the U.S. and they were saying, well, now they're no longer subject to U.S. tax and therefore it, it constitutes a change in their economic entitlements. And now it's a good realization of that.

Notwithstanding all they did was, was leave the the U.S.

And so there are better taxes out there to look towards say, well, what kind of a deemed realization or realization actually occurred? And what can we we hook to for a real change as opposed to, for U.S. shareholders of specified foreign corporations?

Nothing.

They got no benefits. There was no transitional change for them. They got nothing but a, a tax bill because, you know, Congress thought it was a good time to raise more money. And, and for folks like the Moores, there's a lot of others who are in similar facts patterns who are concerned about this.

You know, when the Moores put their $40,000 investment inside this small corporation, they could have just as easily put farming equipment. And if that farming equipment was used and had a gain inside of it, perhaps some, it might have been depreciated, i could have appreciated as we've seen happen in some markets recently with demand fluctuations, if, that easily could have been taxed that initial investment of $40,000 of property.

Why?

Because it's a realization event.

That's how that's how they're using them to tax them and the front end. So of course, these folks have advisors like me who say, well, wait a second, you're putting money on a corporation, You might want to fall within Section 351 of the code to make sure that you won't pick any game up on that contribution. And I helped them see all the requirements that Congress has said are sensual, essential to ensuring there's continuing ownership in that invested property, 80% control thresholds, others to benefit from this non recognition exception.

But for them to say, well, if I invest, if I jump through all these hoops to make sure that I, I didn't realize income or, or recognize income that was realized, you're now telling me that at any time Congress could just convert it to a pass-through regime perhaps and say, well, now you're getting tagged with that corporation's income. It's it's not out of the realm of possibility that that happened. There's proposals on The Hill now integration, others that aim to think about how are the most quickest ways to to draw money from taxpayers.

And so the, the point is, is that this case reverberates throughout tax, not just a wealth tax. And so while it has been politicized to say, Oh, well, look at this proposal, let's make it happen or let's not make it happen, this is a lot more in in this tax geek's mind about taxpayer rights.

That's how I view the Supreme Court's decision and, and their willingness to accept it, to say, hey, we should give this some thought. When should the government be able to take money from taxpayers? What constitutes an event that they can be taxed on? And are there any limits?

We now know that to some of the justices, well, at least one, there's no realization requirement for the others, uncertain and for four, there are. So I know that's not the answer everybody would like, but it's more consistent with many tax answers, which it's not entirely certain what will happen next.

Kevin

Yeah, yeah. And I, and I guess just to kind of sum it up a bit, I, I think the idea was, you know, I think people were looking to this case to address realization because, you know, Ben mentioned the wealth tax and, and everything that kind of went with that. But, you know, I think people were, you know, there are two sides of the coin, right?

On one side, people are hoping if 965 is constitutional and they say that realization, you know, is not required, then potentially, hey, we can, we can implement a wealth tax whereby folks are, are taxed, you know, without actually getting this, this realization of, of income. And on the other side, it's well, you know, if they could put a stop to it and say realization is required, then maybe, you know, you, you get a more definitive answer as to whether wealth tax can be implemented.

So I think the, the general idea here is that because the court ruled so narrowly, we, we don't really have an indication as to whether or not it's more or less likely, you know, that, you know, or I guess you know, how likely is the wealth taxes passed. But at least we do know that realization wasn't, wasn't addressed. And so it can still, you know, someone could potentially still have their day in court, so to speak. And if the court decides to address it on that day, maybe we have more clear direction. But as Ben said, you know, it's just a little more complicated.

And so we'll kind of see where it goes. I, I agree with Ben. I, I think we're, we're not necessarily in a more clear direction before the decision as we are here today after, but you know, so goes tax.

Ben

We, we definitely know it's uncertain.

We definitely know the answers are not clear and that the court is divided, which we didn't know before. And so I'm thankful for that.

I'm thankful that the Supreme Court took on this case. We know there's some uncertainty and we know there's a split within the Supreme Court. So let's be honest, there's got to be some uncertainty among the district courts out there and the others who are judges who might weigh in on similar type issues, whether it be due processes applied to 965 in a different fact pattern or other taxes, it matters and it could have mattered in this instance.

I can't help but think of Duncan Campbell, who will be speaking on wealth planning generally in an upcoming tax trends webinar that we're going to be having on the 11th. I, I'd be curious, I will ask him at that time whether or not we're seeing a shift in how people are planning for wealth in light of this decision. It's, you know, it seems to have fueled the same people who were pushing towards wealth taxes and others who are not seem to point to it as as safe. So everybody's basically saying what they've been saying before and after the case. Not, not, not a big surprise.

But for reading the tea leaves here and appreciating the value that these justices did provide by, you know, really letting us examine how how closely these tax regimes are related, their differences and whether or not they might create constitutional protections for some versus others and who may and may not have better arguments, even if it is dicta, it’ certainly interesting.

And I know Kasey Pittman, who leads our policy practice here in in Washington tax, she'll she'll have some insights on future proposals coming in, in 2025 and another policy broader policy implications then I could certainly weigh in on.

Kevin

Perfect.

Well, you know, that kind of concludes our that concludes our discussion today.

You know, again, Ben, Ben mentioned the July 11th webinar as well, and so you know, Duncan will hopefully touch a little bit about a little on that and we will we'll see you all then.

Ben

Great talking with you, Kevin. Thanks everybody for joining.

Kevin

Thank you.