Moore questions: Impressions from oral argument

The taxpayers were 11% owners of KisanKraft, a CFC that supplied modern tools to small farmers in India, and had the same ownership interest since the inception of the corporation. KisanKraft had retained earnings of $508,000 as of the relevant date in 2017, meaning that the taxpayers’ tax liability was increased by roughly $15,000 under section 965. The taxpayers unsuccessfully challenged the constitutionality of the transition tax in the US District Court for the Western District of Washington¹ and the Ninth Circuit.² For additional background, read our June 26, 2023 Legal Alert.

The Supreme Court has not invalidated a federal tax on constitutional grounds since Eisner v. Macomber,³ over a century ago. The oral arguments in Moore turned on the meaning and continued validity of the holding in Macomber that a tax imposed on a stock dividend was not an income tax under the Sixteenth Amendment⁴ and instead was an unapportioned direct tax on property which violated the Apportionment Clause.⁵

The oral arguments lasted for over two hours and featured a comparatively rare appearance at oral argument by the Solicitor General, Elizabeth Prelogar. Based on our impression of the oral arguments, the Court seems unlikely to invalidate section 965 on constitutional grounds and seemed to be leaning in the direction of a narrow decision in favor of the government.

1. The “Slippery Slope” – Questions for Both Sides About a Constitutional Realization Requirement
The parties presented diametrically opposed and somewhat absolutist views of the question whether there is a constitutional realization requirement. The taxpayer argued that Macomber clearly established a constitutional realization equirement and has never been overruled, and any contrary conclusion would create chaos in the tax law. The government argued that there has never been a constitutional realization requirement, either in Macomber or in subsequent cases, and that imposing one now would also create havoc with well-settled tax law.

The government’s proposed definition of “income” as “economic gain between different points in time,” clearly concerned several of the Justices. Justices Gorsuch and Alito seemed to be the most vocal proponents of a constitutional realization requirement based on Macomber.

The parties and the Court also addressed whether stare decisis should lead the Court to continue following Macomber (if not already overruled) or whether stare decisis would allow overruling it now (if not overruled already). Ultimately, there did not seem to be an appetite for taking on the meaning of Macomber directly.

The Justices also aired their views regarding the possible unintended consequences of a holding for either side. The Justices generally fell into two groups:

• Justices Roberts, Thomas, Alito and Gorsuch focused on the potential effect of the lack of any realization requirement on the ability of Congress to impose a wealth tax on unrealized appreciation in real estate or stocks and mutual funds used by working taxpayers to save for retirement.
• Justices Sotomayor, Kagan, Kavanaugh, Barrett and Jackson focused on the potential effect of a realization requirement on numerous provisions of the Code which arguably did not fit the taxpayer’s strict interpretation of realization, most notably Subpart F, partnerships, Subchapter S corporations, the accrual method, and mark-to-market.

Given doubts about whether Macomber adopted a realization requirement or whether it had subsequently been effectively overruled, as well as the potential unintended consequences with respect to the rest of the Code, most Justices seemed reluctant to decide Moore based on a broad pronouncement regarding the necessity of realization under the Sixteenth Amendment. The Solicitor General agreed, urging the Court not to try to set down “an explicit set of principles to govern all cases” under the Sixteenth Amendment.

2. A Potential Compromise – Focus on Income Attribution
The Justices ultimately focused on section 965 as analogous to several existing and historical taxes involving attribution of realized income from an entity to its owners rather than as a tax on unrealized gain inherent in the taxpayers’ ownership interest. At the outset of the argument, the Justices pressed the taxpayers’ counsel to take a position on the constitutionality of Subpart F, which generally requires certain current-year income of a CFC to be included in the taxable income of its US shareholders, regardless of whether the income was actually distributed.

The taxpayers’ counsel conceded that Subpart F was constitutional, in line with lower court precedent.⁶ The Justices then seized on the analogy, noting that the ownership requirements for section 965 and Subpart F were identical, and that the taxpayers had been owners of the CFC for its entire existence, so there was no potential unfairness raised under the facts that might prevent attribution of accumulated income of the CFC to the taxpayers.

Several Justices and the Solicitor General noted that attribution from a corporation to a shareholder was a historic practice, included in the taxes of 1864 and 1913. The Solicitor General and Justices Kavanaugh and Barrett also emphasized that the Court’s 1938 decision in Heiner v. Mellon⁷ held that partners could be taxed on their shares of partnership income even if state law prohibited any current distribution of the income. Ultimately, Justice Kavanaugh raised the possibility that a narrow holding could be crafted, finding that any realization requirement that could exist under the Sixteenth Amendment would be met under the facts of Moore.

3. Is There a Sixteenth Amendment Limitation on Attribution?
Several Justices were interested in whether the fairness of attributing the CFC’s income to the taxpayers was a question solely implicating due process (a question not before the Court), or whether the Sixteenth Amendment had a role to play. Taxpayers’ counsel suggested that something extra, for example tax avoidance or a high level of control, was necessary to attribute income from a CFC to a shareholder. The Solicitor General suggested that it was perfectly fine to look at the question through the lens of the Sixteenth Amendment because the question would be the same, i.e., could income be fairly attributed to the taxpayer, a question she suggested should be answered in the affirmative unless the attribution chosen by Congress was “unrelated to any privilege or benefit.”

Justice Gorsuch and the Solicitor General engaged in a lengthy back-and-forth regarding what, other than a realization requirement, would keep Congress from walking through the “big open door” that the Justice perceived the government’s definition of income to create. The Solicitor General responded that, under the government’s position, the door is already open, but factors other than the Sixteenth Amendment, such as the desire to get re-elected, would still operate to constrain Congress. Justice Gorsuch, echoed by a number of other Justices, noted that it was a fact in favor of both Subpart F and section 965 that the use of a foreign corporation by a US shareholder created a potential for abuse due to the difficulty in directly imposing US tax on foreign corporations.

Returning to a narrow focus, Justice Kavanaugh proposed a hypothetical which could implicate the Sixteenth Amendment (rather than solely due process) in a determination of whether an entity’s income could be attributed to an owner. Justice Kavanaugh posited that the fact that a tax is outside the historical conception of an income tax could be a (non-dispositive) strike against a tax passing muster under the Sixteenth Amendment. The Solicitor General agreed that “more scrutiny” could be appropriate but that novelty alone should not be dispositive, and emphasized that historical precedent supporting attribution of income to shareholders would not support any novelty strike against section 965. Justice Kavanaugh agreed that longstanding precedent, including Heiner, Subpart F and Subchapter S, supported attribution of earnings to owners of an entity for tax purposes. The Solicitor General also noted that Congress is already effectively constrained by history, administrative workability, and political pressures from imposing novel taxes.

The taxpayers’ counsel’s rebuttal emphasized the serious consequences that, in the taxpayers’ view, would proceed from a narrow holding that did not reaffirm the realization requirement, but there were no further questions.

4. What’s Next?
The Supreme Court can be expected to issue a decision in Moore by next June at the latest.

In the interim, taxpayers may be contemplating what, if anything, they should do with respect to claims for refund or their accruals for the section 965 tax, or, for that matter, any of the myriad other taxes that were implicated in the slippery slope analysis so prevalent in the merits briefs and at oral argument.

Although it’s impossible to know for sure what went on in the Court’s conference room following the argument, it seems like a reasonable bet that the Court’s opinion will attempt to avoid either of the parades of horribles set forth by the parties. Accordingly, there does not seem to be a compelling reason, based on what we know now, to reexamine any protective claims for refund or tax return positions.⁸

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If you have any questions about this Legal Alert, please feel free to contact any of the attorneys listed or the Eversheds Sutherland attorney with whom you regularly work.

1 Moore v. United States, 2020 WL 6799022 (W.D. Wash. Nov. 19, 2020).
2 Moore v. United States, 36 F.4th 930 (9th Cir. 2022); Moore v. United States, 53 F.4th 507 (9th Cir. 2022) (denial of rehearing en banc).
3 Eisner v. Macomber, 252 US 189 (1920).
4 The Sixteenth Amendment provides that “Congress shall have the power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.” US Const. Amend. XVI.
5 The Apportionment Clause provides that “No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.” US Const. art. I, § 9, cl. 4.
6 See Eder v. Commissioner, 138 F.2d 27, 28-29 (2d Cir. 1943) (inclusion of foreign corporation income in a taxpayer’s income was constitutional); Whitlock’s Estate v. Commissioner, 59 T.C. 490, 508 (1972), aff’d in part, rev’d in part, 494 F.2d 1297, 1298-99, 1301 (10th Cir. 1974) (upholding constitutionality of Subpart F taxation of undistributed income); Garlock Inc. v. Commissioner, 489 F.2d 197, 202 (2d Cir. 1973) (upholding constitutionality of attribution of CFC’s undistributed Subpart F income to shareholders).
7 Heiner v. Mellon, 304 US 271, 280-81 (1938).
8 For details regarding filing protective claims for refund and the statute of limitations see our earlier Legal Alert.