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Almost That Time

In less than four months, the citizens of the United States[i] will be electing their next President to a four-year term.[ii] They will also be deciding which of the two major political parties will “control” the Senate, the House, or both, for at least the next two years.[iii]

In other words, the composition of two of the three branches of the federal government – specifically, those responsible for determining the direction of the country, and perhaps the world – will soon be up for grabs.

Some observers have described the forthcoming federal elections as perhaps the most significant in our country’s history since the elections of 1860.[iv] According to many, including the leadership of each of the two major parties, not since the Civil War have Americans been as divided as they are now, and not just on political issues.[v]

Notwithstanding their national nominating convention is just over a month away,[vi] the Dems are suddenly uncertain of who should be their standard-bearer – the incumbent President or someone else. Some Party leaders are stressing over the fact that several polls[vii] and political pundits are warning of a possible GOP sweep of the White House and both Chambers of Congress in November.[viii]

As politicians of all stripes are wont to do when they sense a threat to their continued ascendance,[ix] the Dems have begun to point fingers at persons outside the party.

Blame the Court

It is interesting, and very troubling, that one of the targets at which they are taking aim is the third and only unelected branch of government under the Constitution[x] – the U.S. Supreme Court.[xi] 

Driven largely by some recent decisions handed down by what they describe as a “conservative” Court,[xii] the Dems are now calling for term limits,[xiii] Congressional oversight of the judicial branch, and the expansion of the Court to thirteen justices.[xiv]


Fortunately, judicial interpretations of the Code,[xv] or even of the Sixteenth Amendment to the Constitution, rarely if ever elicit the kind of animated responses like the ones described above.[xvi]

That said, the Supreme Court had the opportunity to cause some fireworks – at least for tax advisers – when it issued its decision in Moore v. United States late last month.

Instead, the majority opinion tried to skirt the issue on which the taxpayer and the government had focused their arguments – specifically, whether the inclusion of income in a taxpayer’s gross income for purposes of the federal income tax requires a realization event.[xvii]

Some observers were disappointed.[xviii]

The Issue

Before considering the Court’s opinion, let’s briefly review the legislation in question.

With the enactment of the Tax Cuts and Jobs Act (“TCJA”)[xix] at the end of 2017, the U.S. sought to shift its corporate taxation regime from a worldwide system, in which corporations were generally taxed regardless of where their profits were derived, toward a territorial system, in which corporations are generally taxed only on their domestic source profits.  

As part of this change, the TCJA created a one-time transition tax: the Mandatory Repatriation Tax (“MRT”), pursuant to which the earnings and profits accumulated by a controlled foreign corporation (“CFC”) after 1986 – which had never been taxed by the U.S. – were required to be included in income by certain U.S. persons for their 2017 tax year.[xx] 

Under this new rule, which was added to Subpart F of the Code, any U.S. person owning at least 10-percent of a CFC was required to include on their 2017 federal income tax return their pro rata share of the CFC’s post-1986 earnings and profits.[xxi]


As a result of the TCJA, Taxpayer’s 2017 federal income tax liability was increased to account for the inclusion in Taxpayer’s gross income of Taxpayer’s pro rata share of Foreign Corp’s post-1986 earnings and profits.

Taxpayer challenged the constitutionality of the federal government’s ability to tax a CFC’s post-1986 income through the MRT.

The federal district court granted the government’s motion to dismiss Taxpayer’s case for failure to state a claim.

What Kind of Tax?

After the district court’s dismissal, Taxpayer appealed to the Ninth Circuit Court of Appeals (the “Circuit Court”), where Taxpayer argued that the MRT violated the Apportionment Clause of the Constitution,[xxii] which provides that “direct Taxes shall be apportioned among the several States . . . according to their Numbers.”

Of course, the Sixteenth Amendment to the U.S. Constitution granted Congress the “power to lay and collect taxes on incomes” – a direct tax –  “without apportionment among the several States.”

According to Taxpayer, the MRT could not have been an income tax within the scope of the Sixteenth Amendment because there was no realization event. Stated differently, before an income tax may be impose upon a taxpayer, the taxpayer must realize the income to be taxed; without realization, there can be no income.

Thus, Taxpayer argued, the MRT must have been a direct tax on a person’s property[xxiii] for which the Constitution requires apportionment among the states in accordance with their population, meaning the tax must be the same amount per person.[xxiv]

Taxpayer asserted that because the MRT was not apportioned among the states according to population, the tax was unconstitutional.

The Government

The IRS, however, asserted that income did not need to be realized in order to constitute income under the Constitution.[xxv] The MRT, the IRS argued, is a tax on income and, thus, may be imposed without apportionment.  

The Ninth Circuit affirmed the District Court.[xxvi]

Taxpayer sought review by the Supreme Court, which granted certiorari.[xxvii]

The Court’s Opinion

The Court stated that the issue before it was whether the MRT exceeded Congress’s constitutional authority.

Before considering this question, the Court provided a brief history of the federal income tax.

It then summarized the parties’ respective positions. It was Taxpayer’s contention, the Court stated, that the MRT is a tax on property rather than a tax on income.

“What distinguishes income from property?” the Court asked.

According to Taxpayer, the Court continued, income requires realization, which “occurs when gains come into the taxpayer’s coffers – for example, through wages, sales, or dividends, as distinct from appreciation in the value of a home, stock investment, or other property.” Taxpayer contended that “the MRT does not tax any income that they have realized.”

At the point, the Court could have gone down the proverbial rabbit’s hole. Fortunately for the Court, however, it did not have to directly address Taxpayer’s position because “[c]ritically, . . . the MRT does tax realized income – namely income realized by” Foreign Corp.[xxviii] The Court explained that the MRT “attributes” the income of the foreign corporation to the shareholders, and then taxes the foreign corporation’s shareholders (including Taxpayer) on their share of that undistributed corporate income.

Because the income in question had, in fact, been realized by the foreign corporation, the Court re-framed the “precise and narrow question” before it as “whether Congress may attribute an entity’s realized and undistributed income to the entity’s shareholders,” and then tax the shareholders, including Taxpayer, “on their share of that undistributed corporate income.”  

The Court discussed how “Congress sometimes chooses to tax a business entity itself on the income that the entity earns. Alternatively, Congress sometimes elects to treat an entity as a pass-through – attributing the entity’s undistributed income to the shareholders or partners and then taxing the shareholders or partners on that income. Either way, this Court has held that the tax remains a tax on income – and thus an indirect tax that need not be apportioned.”

The opinion then turned to the tax treatment of partners and their partnerships, and of shareholders and their S corporations, to support its conclusion that the attribution of the undistributed income of “American-controlled” foreign corporations to their U.S. shareholders was within Congress’s constitutional authority to tax.

It observed that Taxpayer conceded that partnership taxes, S-corporation taxes, and subpart F taxes are income taxes that are constitutional and need not be apportioned. The Court reviewed and rejected the arguments[xxix] proffered by  Taxpayer to differentiate the MRT from those taxes, concluding that Taxpayer could not meaningfully distinguish the MRT from similar taxes such as taxes on partnerships, on S corporations, and on subpart F income.[xxx]

The MRT, the Court explained, “attributes the undistributed income of American-controlled foreign corporations to their American shareholders, and then taxes the American shareholders on that income. By doing so,” the Court continued, “the MRT operates in the same basic way as Congress’s longstanding taxation of partnerships, S corporations, and subpart F income. Thus, the Court concluded, “the MRT . . . falls squarely within Congress’s constitutional authority to tax.”

However, the Court also emphasized that its holding was narrow; specifically, it was

“limited to: (i) taxation of the shareholders of an entity, (ii) on the undistributed income realized by the entity, (iii) which has been attributed to the shareholders,(iv) when the entity itself has not been taxed on that income. In other words, our holding applies when Congress treats an entity as a pass-through.”[xxxi]

The Court could have ended its opinion there but, for some reason, it felt compelled to describe the government’s acknowledgment that the constitutionality of a hypothetical unapportioned tax on appreciation may depend on, among other things, whether realization is a constitutional requirement for an income tax. Taxpayer’s position, the Court stated, was that realization was a constitutional requirement, whereas the IRS argued that it was not. To decide this case, the Court continued, “we need not resolve that disagreement over realization. Those are potential issues for another day, and we do not address or resolve any of those issues here.”

Was the Court Right?

I don’t understand why the Court was so focused on  the taxation of partnerships and S corporations, and especially why it equated their tax treatment with that of controlled foreign corporations and, by extension, with the MRT.


The Code bestows favorable tax treatment on partnerships and S corporations. It treats them as pass-through entities, meaning the Code does not, generally speaking, impose a tax on either entity in respect of the entity’s taxable income.[xxxii]

The price of this favorable tax treatment is that the partners and the shareholders of these entities are required to report and pay tax upon their share of the taxable income realized by the entity whether or not the entity has distributed such income to its owners.[xxxiii]

In accordance with this pass-through treatment, the character of any income of income, gain, loss, deduction, or credit included in a partner’s distributive share is determined as if such item were realized directly from the source from which realized by the partnership, or incurred in the same manner as incurred by the partnership;[xxxiv] likewise for the shareholder of an S corporation.[xxxv]

By contrast, an entity-level income tax is imposed upon the taxable income of a C corporation and, when the corporation distributes its after-tax earnings to its shareholders, such earnings are subject to tax a second time, in the hands of the shareholders.

Taxes Imposed to Defeat . . . Tax Avoidance/Deferral

But what happens if a C corporation’s shareholders cause the corporation to forego the distribution of its after-tax earnings? Conceivably, the second level of tax can be deferred until such time as the shareholders sell their shares of stock in the corporation.

Is there anything wrong with that? From the government’s perspective, yes.

The government has identified situations in which a C corporation’s failure to distribute its earnings and profits to its shareholders arises from a non-business, tax-motivated purpose. Such a “failure to distribute” strategy may be especially attractive when the corporate income tax rate is lower than the rate applicable to individual shareholders.[xxxvi]  

Because it cannot compel a corporation to make a distribution to its shareholders, Congress has authorized the government to impose an additional corporate-level tax with respect to such undistributed earnings and profits.[xxxvii]

For example, the accumulated earnings tax[xxxviii] is imposed upon a U.S. taxable corporation that has accumulated after-tax earnings beyond the reasonable needs of the business. It is imposed in addition to the regular corporate income tax.

Likewise, the personal holding company tax is imposed upon the undistributed personal holding company income of certain closely held C corporations.[xxxix] It, too, is imposed in addition to the regular corporate income tax. In determining the base on which the tax is calculated, the corporation is allowed a deduction for dividends paid.[xl]

The same anti-deferral reasoning underlies the subpart F and GILTI rules.

In general, non-U.S. source income earned directly by a U.S. person from foreign investments or from the conduct of a foreign business is taxed currently. However, when such income is earned by a U.S. person indirectly through a separate foreign corporation it is generally not subject to U.S. tax until the income is distributed by the foreign corporation as a dividend to the U.S. person.

In order to counter the opportunity for the indefinite deferral of the U.S. income tax that would be imposed upon such income, Congress has enacted certain anti-deferral regimes that may cause the U.S. owner to be taxed currently in the United States on certain categories of passive or highly mobile income earned by the foreign corporation regardless of whether the income has been distributed as a dividend to the U.S. owner. Neither tax would be imposed if the foreign corporation in question distributed to its U.S. shareholders their share of the corporation’s earnings.

However, because these foreign corporations are beyond the jurisdictional reach of the Code, the IRS cannot impose an entity-level  tax upon them.[xli] Thus, Congress has authorized the imposition of a tax upon certain U.S. shareholders of such foreign corporations instead. Specifically, it requires these shareholders to include in their gross income their pro rata share of the foreign corporation’s subpart F income, which is defined as the amount of distributions which would have been distributed with respect to the shareholder’s stock, as determined under the Code.[xlii] The tax is imposed regardless of whether the income has been distributed as a dividend to the U.S. shareholder. Consistent with the foregoing, earnings and profits of the foreign corporation[xliii] that have already been taxed by the U.S. will not be included in the shareholder’s gross income when subsequently distributed.[xliv]

In light of the foregoing, it seems the Court could have concluded that there is a realization requirement, but in situations where the taxpayer intentionally prevents or avoids such realization in order to improperly defer the recognition of income or gain, the IRS may look through the entity and treat the taxpayer-owner as having received (i.e., realized) the income in question.[xlv]

The Court isn’t done yet with the realization of income issue.

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The opinions expressed herein are solely those of the author(s) and do not necessarily represent the views of the Firm.

[i] 18 USC Sec. 611. “It shall be unlawful for any alien to vote in any election held solely or in part for the purpose of electing a candidate for the office of President, Vice President, Presidential elector, Member of the Senate, Member of the House of Representatives . . .”

[ii] U.S. Constitution, Article Two, Section 1. See also the 22nd Amendment.

Although Election Day is on November 5, 2024, New York will allow early voting starting ten days earlier.

[iii] Until the mid-term elections in 2026.

[iv] In which Lincoln won the Presidency. The Civil War began just three months after his inauguration.

[v] One might say that the upcoming contest may determine who we are as a nation.

[vi] In Chicago. “Déjà vu all over again,” as Yogi said?

[vii] Why do we allow polls? How do they serve the voting public?

[viii] They have also seen many of their narratives of the last several years – in which the media seems to have been complicit – exposed as a lot of baloney.

[ix] And unwilling to accept responsibility for failed policies and various machinations. I would say the Administration and the Dems’ Congressional leadership have no one to blame but themselves for their current predicament.

[x] Some argue that the Washington bureaucracy represents a fourth, and also unelected, branch of government – one that is extra-constitutional.

[xi] U.S. Constitution, Article Third.

In Federalist Paper No. 78, Alexander Hamilton refers to the judiciary as “the weakest of the three departments of power.” According to Hamilton. “the judiciary, from the nature of its functions, will always be the least dangerous to the political rights of the Constitution; because it will be least in a capacity to annoy or injure them . . . [it] has no influence over either the sword or the purse; no direction either of the strength or of the wealth of the society; and it can take no active resolution whatever. It may truly be said to have neither FORCE nor WILL, but merely judgment; and must ultimately depend upon the aid of the executive arm for the efficacy of its judgments.” After explaining that the judiciary “is in continual jeopardy of being overpowered, awed, or influenced by its co-ordinate branches,” Hamilton asserts that “nothing can contribute so much to its firmness and independence as permanency in office.”

[xii] In particular, (a) the elimination of the Chevron Doctrine and its judicial deference to an agency’s interpretation of an ambiguous statute, and (b) the determination that the President’s “core” powers – obviously regardless of the President’s party affiliation – are immune from criminal prosecution.

All too often, where one stands depends upon where one sits. Members of Congress would do well to stretch their legs more frequently, take more walks, maybe even cross the aisle occasionally.

[xiii] People in glass houses (pun intended) and all that. How about term limits in Congress? Age limits? Absolute bans on trading in securities. Temporary “post-retirement” bans on lobbying, joining corporate boards, and publishing memoirs (say, five years?). The elimination of PACs.

[xiv] Of course, they would never support such a move if the President making the appointments was a Republican and the Senate was also controlled by that Party.

More importantly, such an expansion to secure a Court that was more favorably disposed to a single Party’s view of the world would violate the principle of judicial independence under Article III of the Constitution.

[xv] The Internal Revenue Code of 1986, as amended. All other codes merit only a lower case “c”.

[xvi] Think of the fictional chess players attending the fictional chess tournament in the 1980’s song, “One Night in Bangkok,” from the musical Chess. (Thailand banned the song in 1985.)  

[xvii] That said, the Court left open the possibility that realization may not be a prerequisite to the imposition of tax in all instances.

[xviii] Including me.

[xix] Pub. L. 115-97.

[xx] IRC Sec. 965. Also referred to as the repatriation tax.

[xxi] These were taxed at a rate of either 15.5% for earnings that were held in cash, or 8% otherwise.

[xxii] Article I, Section 2, Clause 3.

[xxiii] Not on income for which the Sixteenth Amendment provides an exception to the apportionment requirement.

[xxiv] New York would bear just over 6% of a federal tax that is subject to apportionment because the State has just over 6% of the U.S. population.

[xxv] Specifically, under the Sixteenth Amendment.

[xxvi] 36 F.4th 930 (2022).

[xxvii] 599 U.S. ___.

[xxviii] Emphasis in original.

[xxix] Including one based on “constructive realization.”

[xxx] The Court added that the upshot of Taxpayer’s argument, “taken to its logical conclusion, could render vast swaths of the Internal Revenue Code unconstitutional.”

[xxxi] The Court clarified that “nothing in this opinion should be read to authorize any hypothetical congressional effort to tax both an entity and its shareholders or partners on the same undistributed income realized by the entity. In such a scenario, the entity would not simply be a traditional pass-through.” It then explained that the foregoing issue was distinct from Congress’s well-established practice of taxing the corporation on corporate income and then taxing shareholders when they receive a dividend. 

[xxxii] IRC Sec. 701 and Sec. 702; IRC Sec. 1363 and Sec. 1366. Compare to a non-grantor trust or an estate – these are taxable entities that may avoid tax only by distributing (basically, shifting) their taxable income to their beneficiaries. As in the case of a pass-through, only one level of tax is imposed. In the case of the former, the tax is only on the partner/shareholder; in the case of the latter, the tax is imposed on either the entity (the default) or the beneficiaries.

[xxxiii] IRC Sec. 702 and Sec. 1363.

[xxxiv] IRC Sec. 702(b).

[xxxv] IRC Sec. 1366(b).

[xxxvi] Think about reinvesting corporate profits in corporate-owned investments. Over time, this approach may yield significant tax savings.

[xxxvii] The Court’s opinion does not mention these.

[xxxviii] IRC Sec. 531 and Sec. 532. Unlike the income tax, the accumulated earnings tax is not self-assessed by the taxpayer – it depends upon the IRS’s determining that a corporation’s failure to make dividend distributions was improper.

[xxxix] IRC Sec. 541.

[xl] IRC Sec. 545(a) and Sec. 561.

[xli] As it does in the case of the accumulated earnings tax and the personal holding company tax.

[xlii] IRC Sec. 951(a), Sec. 951A, and Sec. 952.  

[xliii] Foreign-sourced and not effectively connected to a U.S. trade or business.

[xliv] IRC Sec. 959.

[xlv] Under this reasoning, query how Senators Warren and Wyden could argue that taxpayers who do not sell appreciated property should be treated as having done so? Where is the abuse or improper deferral?