Supreme Court to Hear Landmark Case on Constitutionality of Taxes on Unrealized Gains

Supreme Court to Hear Tax Case Concerning Unrealized Gains. The Supreme Court granted a writ of certiorari on June 26 to hear a case regarding the constitutionality of a tax enacted in the Tax Cuts and Jobs Act (TCJA, Pub. L. 115-97). The case, Moore v. United States, concerns the section 965 mandatory repatriation tax (MRT), which requires taxpayers to recognize the deferred tax on certain foreign income. The provision was intended to impose a one-time tax (which taxpayers can elect to pay over an eight-year period) on the accumulated earnings of foreign corporations with U.S. shareholders in the transition to TCJA’s quasi-territorial tax system that excludes many sources of foreign-earned income from U.S. taxation.

The plaintiffs, Charles and Kathleen Moore, assert that the MRT violates the Constitution’s Apportionment Clause, which requires that any “direct taxes” must be applied so that each state pays a portion commensurate with its population. While the Sixteenth Amendment allows for an exception with respect to direct taxes on income, the plaintiffs argue that the MRT is instead an unapportioned direct tax on unrealized gains that does not qualify under the exemption. The Moores contend that because they did not receive a distribution with respect to the corporation’s foreign earnings subject to the MRT, they did not realize such income directly, which they assert is required under the direct-taxes exemption. Furthermore, the Moores claim that the tax is applied retroactively, violating the Fifth Amendment’s Due Process Clause.

The District Court for the Western District of Washington previously granted the federal government’s motion to dismiss the case in 2020, and on appeal, the Ninth Circuit affirmed the lower court’s ruling. In the opinion, the court held that “realization of income is not a constitutional requirement” for taxation. Moreover, the court upheld the broad authority of the federal government to tax unrealized gains, finding that “there [is] no set definition of income under the Sixteenth Amendment,” and accordingly, “[w]hat constitutes a taxable gain is broadly construed.”

In arguments before the Supreme Court, both parties, as well as others submitting amicus briefs, are likely to question the constitutionality of taxes on unrealized gains beyond the context of the MRT. Depending on how narrowly or broadly the court rules, the decision could have broad ramifications for the tax code, potentially calling into question current-law tax rules that impute the realization of income by a business entity, such as a partnership or S corporation, to its owners. Additionally, the decision could affect existing rules that mark certain gains and losses to market (so-called “mark-to-market” regimes) if the court applies a strict realization standard. A strict standard could also question the viability of wealth-tax proposals, for example, that would mark-to-market unrealized gains of wealthy Americans.

The Supreme Court will hear the case in the upcoming term that begins in October, although a date has not yet been set for those oral arguments.

Congressional Tax Writers Solidify Opening Stances for Bipartisan Negotiations. Lawmakers returned to Capitol Hill yesterday to commence the final three-week legislative session before the upcoming August recess. After six months of the divided 118th Congress, members have remained unable to reach bipartisan consensus on any substantial tax legislation. Notwithstanding ongoing disagreements, the House and Senate tax-writing committees considered several tax proposals last month that could lay the groundwork for a significant compromise package later this year.

Republicans in the House Ways and Means Committee approved a trio of tax bills along party lines during a markup on June 13. The economic-growth package, which is comprised of the Tax Cuts for Working Families Act (H.R. 3936), the Small Business Jobs Act (H.R. 3937) and the Build It in America Act (H.R. 3938), was described by Chairman Jason Smith (R-MO) as a “tax relief and jobs package” shaped by “specific concerns” raised during the committee’s field hearings earlier this year. Among other provisions, the bills would reduce businesses’ tax liability by extending retroactively for tax years 2022 through 2025 three expiring incentives for research and development, interest expenses and certain new capital equipment.

Complicating House passage, several off-committee Republican lawmakers representing high-tax districts are withholding support for the package due to the absence of state and local tax (SALT) deduction relief. The group met with Chairman Smith last month to begin negotiations over an amendment to address their concerns, but that process may delay floor consideration until September. Rep. Nick LaLota (R-NY) commented on the impasse, noting that “right now it’s fair to say the [Republican] conference is pretty far apart on an accommodation on SALT.”

In the Senate, Sen. Sherrod Brown (D-OH) led the majority of the Democratic caucus in reintroducing the Working Families Tax Relief Act (S. 1992) on June 14. The bill would expand the child tax credit (CTC) significantly by permanently restoring the increased per-child credit value, full refundability and monthly advance payment option provided during the COVID-19 pandemic. Other provisions in the Democrats’ tax package would bolster the earned income tax credit (EITC), especially for taxpayers without qualifying children.

Despite overwhelming Democratic support, many Republicans have asserted that they would only support the restoration of pandemic-era tax credits if significant work requirements were enacted. During a Senate Finance Committee hearing last month, Sen. Thom Tillis (R-NC) expressed skepticism in “declaring [previous CTC expansions] to be highly successful with only five months of data.”

With the two parties’ policy priorities established, lawmakers may look to craft an agreement in the coming months that incorporates both business- and family-focused tax relief. Senate Majority Leader Chuck Schumer (D-NY) sent a Dear Colleague letter on Sunday highlighting Senate Democrats’ proposed legislative agenda for the upcoming July work period. While the letter does not explicitly reference tax legislation, Leader Schumer noted several bipartisan policy priorities—such as competition with China, agriculture and appropriations—that provide potential vehicles for myriad tax provisions.

Republicans Release Information Regarding Mishandling of Hunter Biden Tax Case. The House Ways and Means Committee voted along party lines on June 26 to release the public whistleblower testimonies of two IRS employees who worked directly on the tax evasion case of Hunter Biden. The committee met in a closed executive session to discuss testimonies alleging that the Biden administration Department of Justice (DOJ) and Delaware U.S. Attorney’s Office took deliberate action to sabotage the IRS investigation. While information regarding private citizens’ taxes is generally barred from public disclosure, section 6103 allowed the committee to release the investigative documents with a simple majority of committee support.

The first whistleblower, Special Supervisory Agent Gary Shapley, highlighted several instances in which U.S. Attorney for the District of Delaware David Weiss was denied special counsel authority by both the DOJ and the D.C. District Court throughout the investigation. In his testimony, Shapley remarked that the case had “been handled differently than any investigation [he had] ever been a part of for the past 14 years of [his] IRS service.” The second whistleblower, who elected to remain anonymous, corroborated elements of Shapley’s account and noted that the prosecutors had “honestly been appalling.”

Following the public release of the documents, GOP members noted their dissatisfaction with actions taken by the Biden administration IRS and DOJ. Chairman Jason Smith (R-MO) highlighted perceived “unequal enforcement of tax law, interference and government abuse in the handling of investigations into criminal activity by President Biden’s son.” Justifying his opposition to releasing the documents, Ranking Member Richard Neal (D-MA) said that the committee needed more time to conduct detailed investigations because he believed “[t]here’s no corroboration of any of [the whistleblower accounts].”

On July 5, Chairman Smith led a bicameral group of Republican lawmakers in a letter to Special Counsel Henry Kerner calling for “an immediate review of reported reprisal against investigators who raised concern about the Hunter Biden investigation.” In response to the ongoing investigation, IRS Commissioner Daniel Werfel sent a memo to IRS employees on July 7 informing them of their right to raise concerns about internal conduct to the appropriate authorities, including congressional oversight committees. Chairman Smith expressed support for the memo, reiterating that “[t]he IRS must be clear with its employees that they have a constitutional and statutory right to make protected disclosures to Congress. Period. Full stop.”

Policy and Taxation Group is the Voice for Family Offices and Successful Individuals in Washington, DC focused exclusively on the critical tax and economic policies that impact them.

Since 1995, Policy and Taxation Group has been the leading advocacy group working to reduce and eliminate estate tax, gift tax, and generation skipping transfer tax while blocking increased income tax and capital gains taxes, the creation of a wealth tax, and other hostile tax policies that punish hardworking taxpayers and success.

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