Supreme Court to Decide Whether Unrealized Income Can Be Taxed

William Stromsem, CPA, J.D., George Washington University School of Business

 

In December, the Supreme Court will hear a Ninth Circuit case that held in favor of the government when it taxed income before a realization event, specifically the “transition tax” on unrepatriated accumulated earnings. In Moore v. United States, the Moores were minority shareholders in a controlled foreign corporation (CFC) that realized income but reinvested earnings in the foreign country. The government has agreed that the Moores never received a dividend or other corporate distribution. 

 

IRC Section 965 generally requires U.S. shareholders to pay a one-time transition tax on the accumulated foreign earnings of a CFC – earnings that had not been repatriated to a U.S. taxpayer in the form of a dividend or other taxable distribution. This was part of the anti-deferral regime enacted by the Tax Cuts and Jobs Act of 2017 to encourage repatriation of earnings to the U.S. to build capital and create jobs here instead of in foreign countries where the earnings were taxed at a possibly low rate in the source country.

 

The Constitutional problem comes from prior Supreme Court cases defining income. In Eisner v. Macomber, 252 U.S. 189 (1920), the Court held that a shareholder who had not received cash or other property had not received income that could be taxed under the Sixteenth Amendment. Since then, court cases have consistently held that for income to be taxed, there had to be a realization event. However, the Ninth Circuit said that "realization of income is not a constitutional requirement." 

 

This sets the stage for a variety of other possible efforts to tax income of high-net-worth individuals, such as proposals for a “wealth tax” on net worth or a “mark-to-market” tax on appreciated assets. Also, the new 15% corporate minimum tax on book income of large corporations may not have a realization event for tax purposes.