Supreme Court ruling on Mandatory Repatriation Tax: What you need to know 

Moore case decision upholds corporate tax on foreign earnings

In a recent landmark decision, the Supreme Court of the United States affirmed the constitutionality of the IRC Section 965 Mandatory Repatriation Tax (MRT), imposed as part of the 2017 Tax Cuts and Jobs Act (TCJA). The case, Moore v. United States, challenged the tax, which targets undistributed income of American-controlled foreign corporations (CFCs), attributing it to American shareholders with certain exceptions.

This ruling may have significant implications for certain proposed legislation – especially a potential wealth tax – and thus should be closely watched by high-net-worth taxpayers.

Case background: Moore v. United States

The plaintiffs, Charles and Kathleen Moore, had invested in a CFC based in India. Between 2006 and 2017, the CFC accumulated income but did not distribute it to its American shareholders, including the Moores. As a result of the MRT, the Moores were required to include their pro rata share of that income on their 2017 income tax returns, resulting in a tax liability of $14,729. They paid the tax and subsequently sued for a refund, arguing that the MRT was an unconstitutional direct tax not apportioned among the states.

Supreme Court decision

In a 7-2 decision delivered by Justice Brett Kavanaugh, the Court held that the MRT under IRC 965 is constitutional. The ruling emphasized Congress’ broad taxing powers under Article I of the Constitution and the Sixteenth Amendment, which allows taxation of income without apportionment.

The Court rejected the Moores’ argument that the MRT constituted a direct tax on property, affirming that it is a tax on income realized by the corporation and attributed to shareholders. The Court noted that Congress has enacted similar attribution regimes such as on partnerships and S Corporations. It further noted that they did not consider this to be a tax on unrealized income, rather that the realized income of the CFC was attributable to its American shareholders.

Implications and reactions

This decision reaffirms the constitutionality of taxing shareholders on undistributed corporate income when Congress deems it necessary to uphold tax provisions designed to address tax avoidance and encourage repatriation of earnings.

A ruling in favor of the taxpayers could have had substantial implications for tax law and international corporate taxation. Specifically, a reversal of the Mandatory Repatriation Tax was estimated to cost the U.S. Treasury trillions of dollars in tax revenue, which would need to be made up for by either cutting federal programs and/or raising tax rates on other sources of income.

While Justice Kavanaugh wrote for the majority with four other justices joining, Justices Jackson, Barrett, and Alito concurred for different reasons. Jackson’s opinion stressed that she did not believe the Sixteenth Amendment required a realization event for income to be subject to tax. Justices Barrett and Alito expressed reservations about expanding Congress’ authority to tax unrealized income, so while they concurred in this opinion, they did so with reservations. Justices Thomas and Gorsuch filed dissenting opinions arguing that the tax was a direct tax on property, which violated the constitution.

The majority opinion took a narrow stance, emphasizing their holding “applies when Congress treats the entity as a pass-through.” Additionally, the opinion did not specifically address whether other kinds of taxes (e.g., wealth or holdings) may raise constitutional issues.

Looking ahead

While most tax practitioners expected this outcome, the range of options expressed in the concurring and dissenting opinions combined with the Supreme Court’s very narrow ruling leaves open the door for a possible wealth tax on unrealized gains in the future, either at the federal or state level.

It is possible there will be tax legislation before the 2017 TCJA sunsets at the end of 2025, and that legislation will depend largely on the November elections. However, one thing is certain: tax planning in 2024 and 2025 will be crucial, and taxpayers should proactively speak with their tax advisors to get ahead of any changes.

In light of this case, if you owned an interest in a CFC at the end of 2017, one specific area to address with your tax professional is to confirm you included your pro-rata share of the income under the MRT. If you did not do so, you could face penalties for non-compliance. Also, keep in mind that additional provisions apply for other types of ownership in foreign business entities beyond CFCs.

Contact Kaufman Rossin’s tax team for assistance with the implications of this court case and other international tax matters impacting your business.