The Supreme Court could gut a wealth tax before it exists — and upend tax law

After years of debate on wealth taxes, the fight over how to increase taxes for the country’s richest people could be spilling into the U.S. Supreme Court.

On Tuesday, the court will hear arguments about one part of the 2017 Trump tax cuts, which levied a tax on foreign subsidiary earnings of U.S. parent companies.

The arguments hinge on the deeper question of whether the Constitution allows the the government to tax gains that never become a real-world payout.

The idea of taxing “unrealized income” is the premise of several proposals targeting super-rich households, including President Joe Biden’s Billionaires Minimum Income Tax. Congressional Democrats reintroduced the tax proposal last week. Biden touted the tax to Colorado crowds the same day.

So the case, Moore v. U.S., has the attention of wealth tax opponents. When the justices rule on the 2017 provision, opponents say the court also has a golden opportunity to rule in a way that nixes the concept of taxing a wealthy household’s paper gains.

But a sweeping decision against the government could do much more than short circuit any future taxes on the super-rich.

A range of wealth tax supporters and opponents say a ruling that requires “realization” before taxation would unleash questions for other parts of the tax code — and jeopardize massive sums of tax revenue.

“What will be interesting is not so much who the Supreme Court rules in favor of, but how broad the decision they hand down,” said Joe Bishop-Henchman, executive vice president at the National Taxpayers Union Foundation, a right-leaning think tank.

Bishop-Henchman submitted a friend of the court brief that argued wealth taxes are unconstitutional, but didn’t support either side. “When we decided to amend the Constitution to allow the taxation of income, we meant just that and not a paper gain that hasn’t resulted in distribution,” he said.

A sweeping decision against the government would be “a pretty strong barrier to any future wealth tax,” he said. Still, he hopes the court can be clear on wealth taxes without introducing confusion elsewhere.
Wealth tax supporters see the stakes too.

Sen. Elizabeth Warren, a Democrat from Massachusetts with her own wealth tax proposals, said well-heeled organizations reflecting the interests of the super-rich “are asking the Supreme Court to unravel large swaths of the tax code to avoid paying their fair share.”

“It’s irresponsible and inconsistent with the law — and the Court should reject these baseless claims,” she told MarketWatch in a statement.

A White House spokesperson declined to comment on the case.

“If the door is open at 100% now” on wealth taxes, the court “could close it 98% of the way,” said Bob Lord, senior advisor on tax policy for Patriotic Millionaires, an organization of wealthy people that pushes for more taxes on rich households.

That’s a problem for fairness in the tax code and the growing wealth gap between super-rich households and everyone else, he said. “I think of the tax system being the last line of the defense, the firewall against wealth concentration.”

Income for all adults in America grew 2.2% year-over-year during the first quarter, according to a gauge on income inequality from University of California, Berkeley economists. Meanwhile, income for the top 0.01% — which does not include the value of unsold assets — grew by 5%.

Whatever the result in the Moore case, the ruling will come less than a year before the next presidential election and two years before many parts of the Trump tax cuts sunset. Without Congressional action, five of seven income tax brackets revert to their previous rate. That includes the top rate, which would climb back to 39.6% from 37%.

What is taxable income?

The case is rooted in retired Washington couple Charles and Kathleen Moore’s $40,000 minority stake in a business geared at rural farmers in India. The business grew and reinvested earnings. The couple “never received any distributions, dividends or other payments,” their lawyers said in court papers.

Enter the Mandatory Repatriation Tax, a tax aimed at U.S. corporations with foreign subsidiaries. While the Tax Cuts and Jobs Act of 2017 trimmed the overall corporate tax bill, the tax in question was a one-time tax on earnings accumulated abroad and now brought back domestically.

The tax is projected to produce $340 billion in tax revenue, according to Congress’ Joint Committee on Taxation. That sum included more than $130,000 in income the Moores had to declare through their stake in the India-based company.

The IRS hit the Moores with a $14,729 tax bill and they sued for a refund.

The tax on the undistributed earnings didn’t count as a valid income tax because the business stake was property that never converted to income with a payout, the Moores’ lawyers said.

The couple’s legal team includes lawyers at the Competitive Enterprise Institute, a libertarian-leaning think tank with a long list of lawsuits challenging the federal government’s reach.

A key focus for CEI and its array of court cases “is to ensure the government follows its own laws and rules,” said Dan Greenberg, the organization’s general counsel and an attorney for the Moores.

“We view the Mandatory Repatriation Tax as an income tax — on income that the Moores never received,” Greenberg said, adding, “We hope this case will clarify and further emphasize this basic principle of realization, which is deeply rooted in the law and which we believe has constitutional grounding.”

The Moores urged the Supreme Court to hear the case after two lower courts sided with the government.

That includes a ruling from a Ninth Circuit Court of Appeals panel. The Supreme Court has been clear that there’s no constitutional requirement for gains to turn into real-life income in order for income taxes to kick in, the panel said.

Circuit Judge Patrick Bumatay said his colleagues got it wrong. “Now, I fear, any tax on property or other interests can be categorized as an ‘income tax,’” the judge wrote in dissent after a panel refused to put the case in front of all the Ninth Circuit judges.

The swirl of tax proposals aimed at high earners was a good reason for the Supreme Court to take the case, the Moores’ attorneys said. “There is every reason for the Court to resolve the pivotal constitutional question of realization now, when its judgment can inform lawmakers and stands to head off a major constitutional clash down the line,” they wrote in court papers asking the Supreme Court to take the case.

‘Be careful what you ask for’

Inside the court docket, the briefs and amicus filings are a back-and-forth flurry on the 16th amendment — which allowed a federal income tax without an equal split of the tax per person — and the definition of the word “income.” It’s also a point and counter-point on the significance of a 1920 Supreme Court decision about Standard Oil stock dividends.

Outside the courthouse, some of the focus is on the side effects if the Moores prevail in a consequential way.

For example, six of the existing tax provisions that collect on unrealized income will bring in $87 billion in revenue this year, according to a Tax Policy Center analysis. The projected revenue will rise to $125 billion by 2028, the study said.

Many of those rules pertain to business activity. But bond investors might know one of the tax rules well. While bonds typically pay interest on a steady basis, a “zero coupon” bond pays all the accrued interest at maturity. Nevertheless, the IRS still taxes the imputed interest each year, even though the investor doesn’t receive the payments.

“I’m not for a wealth tax, but I think if you use this as the argument to spike a wealth tax, you’re going to basically get rid of, I don’t know, a third of the tax code,” former House Speaker Paul Ryan said at a Brookings Institution even in September. Ryan led the Republican-majority House when the 2017 Tax Cuts and Jobs Act became law.

“Be careful what you ask for,” Ryan added.

Now the question is how the court decides.

“Except for the Moores and their lawyers, I don’t think anybody predicted that the Supreme Court would take this case. At least in tax world, it caught everybody by surprise that they agreed to take it,” Bishop-Henchman said.

A sweeping decision that sides with the government “could mean the door is open” on wealth taxes, he said. “That could really super-charge the political drive for [a wealth tax]. Because right now, it’s at best uncertain whether it would be held to be Constitutional if it were ever enacted.”

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