Can Congress Tax Unrealized Gains as Income? Supreme Court May Decide

What You Need to Know

A couple owed $15,000 on an investment in an Indian farm on which they had realized no gains.
The case, Moore v. United States, could have implications for the debate over wealth taxes.
The DOJ has said other provisions in the tax code pertaining to businesses allow for taxation of undistributed income.

The U.S. Supreme Court on Monday agreed to hear a case examining whether Congress had the authority to enact a “repatriation tax” on past foreign investments held by U.S. taxpayers who received no dividend, distribution or other payment.

The appeal by a California couple could loom over the constitutional debate surrounding “wealth taxes.”

In their orders list, the justices said they will consider the couple’s challenge to the mandatory repatriation tax Congress passed as part of the 2017 Tax Cuts and Jobs Act. The case could have major implications for Congress’ ability to tax unrealized gains through a wealth tax or other new tax policy.

The Supreme Court is expected to render a decision before July 2024.

The MRT was a one-time tax on the past earnings of foreign companies owned by U.S. nationals that the U.S. government estimated would generate $340 billion in revenue. It was intended as a way to “repatriate” offshore profits as the United States shifted from a worldwide tax system toward a territorial one.

Under the repatriation tax, Charles and Kathleen Moore owed an additional nearly $15,000 in taxes over their investments in an Indian farm equipment distributor, though they had yet to realize any gains from their stake in the company because all of its earnings were reinvested back into the business.

The case involves a complicated argument over the largely abandoned “apportionment clause” of the Constitution, which requires that “direct taxes” be divvied up among the states based on population. This provision is said to have originated over Southern fears about federal taxes directly targeting slavery or land ownership, with apportionment requiring that Northern states also contribute toward an aggregate revenue goal.

Under the 16th Amendment, however, federal income taxes do not need to be apportioned. By the time of the amendment’s ratification in 1913, apportionment had fallen out of favor as a method of taxation. According to one scholar, the last apportionment tax was passed by Congress in 1861.

The issue at the heart of Moore v. United States is thus whether the MRT qualifies as an income tax exempt from apportionment, or a direct tax subject to that requirement. 

A panel of the U.S. Court of Appeals for the Ninth Circuit said the MRT is not subject to apportionment. At bottom, the appeals court said, “whether the taxpayer has realized income does not determine whether a tax is constitutional.”

The full appeals court refused to hear the case en banc, prompting a strong dissent from Judge Patrick Bumatay, joined by three other judges. According to Bumatay, the Ninth Circuit had “become the first court in the country to state that an ‘income tax’ doesn’t require that a ‘taxpayer has realized income’ under the Sixteenth Amendment.”