Can Congress Tax Both an Entity and Its Shareholders on the Same Undistributed Income? An Analysis of MOORE ET UX. v. UNITED STATES

Can Congress Tax Both an Entity and Its Shareholders on the Same Undistributed Income? An Analysis of MOORE ET UX. v. UNITED STATES

In the recent landmark case MOORE ET UX. v. UNITED STATES, the Supreme Court tackled a pivotal question: Can Congress tax both an entity and its shareholders on the same undistributed income? The case, which centered around the constitutionality of the Mandatory Repatriation Tax (MRT), has far-reaching implications for the U.S. tax system and international business operations. Let’s delve into the specifics of the case and explore the court’s reasoning and conclusions.

Understanding the MRT and its Implications

Congressional Taxation Power

Article I of the U.S. Constitution grants Congress broad powers to levy and collect taxes. This includes both direct taxes, which must be apportioned among the states, and indirect taxes, which must be uniform across the United States. The Sixteenth Amendment further clarifies that taxes on income do not require apportionment, placing them squarely within Congress’s purview.

In 2017, Congress enacted the Tax Cuts and Jobs Act, introducing the Mandatory Repatriation Tax (MRT). This tax imposed a one-time levy on the accumulated, undistributed income of American-controlled foreign corporations, attributing this income to American shareholders and taxing them on their pro rata shares.

The Moores’ Challenge

Charles and Kathleen Moore, investors in an American-controlled foreign corporation called KisanKraft, faced a $14,729 tax bill due to the MRT, applied to their pro rata share of KisanKraft’s accumulated income from 2006 to 2017. The Moores paid the tax but sued for a refund, arguing that the MRT violated the Constitution’s Direct Tax Clause and was an unapportioned direct tax on their shares.

The Court’s Decision

Constitutional Analysis

Article I, §8, cl. 1 and the Sixteenth Amendment provide Congress with broad taxation powers. The Court examined whether the MRT constituted a tax on income (an indirect tax) or a tax on property (a direct tax requiring apportionment).

  • Direct vs. Indirect Taxes: The Court reaffirmed that taxes on income are indirect taxes, which do not require apportionment. The income taxed by the MRT, realized by KisanKraft, was attributed to the Moores, making it taxable as income under existing precedents.
  • Longstanding Precedents: The Court cited numerous cases, including Burk-Waggoner Oil Assn. v. Hopkins, Burnet v. Leininger, Heiner v. Mellon, and Helvering v. National Grocery Co., which establish that Congress can tax either the entity or its shareholders on undistributed income without violating constitutional principles.
  • Eisner v. Macomber Revisited: The Moores relied on this 1920 case, which dealt with stock dividends, to argue against the MRT. The Court dismissed this reliance, clarifying that Eisner v. Macomber did not address the issue of attributing undistributed income and was thus irrelevant to the MRT’s constitutionality.

Key Legal Provisions and Their Relevance

  • 26 U.S.C. §§13611362: These sections relate to the taxation of S corporations, treated as pass-through entities where income is taxed at the shareholder level. This parallels the MRT’s treatment of American-controlled foreign corporations, reinforcing the Court’s stance on the constitutionality of pass-through taxation.
  • §§61(a)(12), 701, 1366(a)-(c): These provisions further support the taxation of undistributed income at the shareholder level, as seen in partnership taxation, aligning with the MRT’s mechanism.
  • §§951952: These sections pertain to subpart F, which similarly taxes American shareholders on undistributed income of controlled foreign corporations, supporting the MRT’s constitutionality.
  • §965(a)(1), (c), (d): These specific provisions of the MRT outline the taxation mechanism, further validated by the Court’s decision.

Court’s Conclusion

The Supreme Court held that the MRT, which attributes the realized and undistributed income of an American-controlled foreign corporation to the entity’s American shareholders and then taxes the shareholders on their portions of that income, does not exceed Congress’s constitutional authority. The decision emphasized that:

  • Congress can choose to tax either the entity or its shareholders on undistributed income.
  • The MRT is consistent with historical precedents and Congress’s long-established practices.
  • The Constitution does not require fiscal calamity by rendering vast swaths of the tax code unconstitutional.

Limitations of the Ruling

The Court’s ruling is narrow, limited to entities treated as pass-throughs. It does not authorize taxing both an entity and its shareholders on the same undistributed income or address whether realization is a constitutional requirement for income taxes.

The MOORE ET UX. v. UNITED STATES decision upholds the MRT and reaffirms Congress’s broad taxing powers. By drawing on historical precedents and statutory provisions, the Supreme Court has provided a clear framework for understanding the constitutionality of taxing undistributed income at the shareholder level. This ruling has significant implications for international business taxation and underscores the robustness of the U.S. tax system in adapting to modern economic realities.

***Disclaimer: This communication is not intended as tax advice, and no tax accountant -client relationship results**

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