Is A Wealth Tax Constitutional? The Moore Case

Published date30 July 2023
Subject MatterGovernment, Public Sector, Tax, Constitutional & Administrative Law, Income Tax
Law FirmCarter Ledyard & Milburn
AuthorRichard B. Covey and Jerome Caulfield

A. Introduction

President Joe Biden, in his State of the Union address before Congress on February 7, 2023, proposed a wealth tax on 'billionaires.' The lead editorial of The Wall Street Journal for February 11-12, 2023, at p. A12, captioned 'Biden's 2025 Tax Agenda' discussed the proposal and said:

Start with a reprise of his 'billionaire minimum tax.' This is a version of Sen. Elizabeth Warren's tax on wealth that voters rejected in the 2020 Democratic primaries. 'No billionaire should pay a lower tax rate than a schoolteacher or a firefighter,' the President said with no further explanation. Allow us to fill in the details that Mr. Biden didn't.

For starters, it isn't a billionaire tax and it isn't an income tax. It would apply to households worth more than $100 million in accumulated assets, and its target is wealth. The version the President first proposed in his 2023 budget outline would claim a minimum of 20% from high earners' 'total income.' A contrived term that includes unrealized capital gains on top of actual asset sales.

This means that if your assets rise in value during a year, you will pay taxes on that increase even if you realized no actual gains through a sale. If you lack the ready cash, you might have to sell assets to pay the tax bill or pay later with interest. If your assets fell in value, you would not be able to deduct the full loss from your overall income. Heads, the government wins, tails, you lose.

The proposal also flouts the Constitution, which says Congress may only impose 'direct taxes' if they are apportioned among the states according to their population. The Sixteenth Amendment lets Congress tax income that is 'derived' from a 'source,' which implies a realization. In precedents going back to 1920, the Supreme Court has never found that the income tax applies to unrealized gains.

The Treasury Department released on March 9, 2023, a 'General Explanations of the Administration's Fiscal Year 2024 Revenue Proposals' (the Treasury's Green Book) which contained more details about the wealth tax proposal and other proposals for change which will be dealt with in a later issue.

B. Background

A three-judge panel of the Ninth Circuit Court of Appeals recently decided, Moore v. United States, 36 F. 4th 930 (9th Cir. 2022), which may have significance concerning the imposition of a wealth tax or a tax in a decedent's estate on unrealized appreciation. It was discussed in an article on page A17 from The Wall Street Journal of January 26, 2023. Cox and Adler, The Ninth Circuit Upholds a Wealth Tax.

The taxpayers, husband and wife Charles and Kathleen Moore, purchased 11 percent of a small foreign corporation in 2005. They never received a distribution from the corporation. The amount at issue was modest, almost $15,000. The Moores did not participate in the management of the corporation which never paid dividends. Nevertheless, they became liable for a tax bill under the new law which applied to any shareholder with an interest of more than 10 percent. They contended that a new tax statute passed in 2017 which imposed a tax was unconstitutional under the Sixteenth Amendment to the U.S. Constitution. This argument was rejected by the panel. Part of the opinion is quoted below. The panel consisted of Judge Ronald M. Gould who wrote the opinion and Judges Jacqueline H. Nguyen and Mark J. Bennett. The taxpayers applied for a hearing en banc which was denied. An Order of the court quoted below contains a dissenting opinion written by Judge Bumatay, joined by Judges Ikuta, Callahan, and VanDyke, which disagreed with the decision not to have the full court review the panel decision. A copy of the Order and the dissent is quoted below. The Wall Street Journal article asserts that taxpayers plan to apply to the United States Supreme Court for certiorari.

C. IRC Sec. 965

Moore involved a provision in the 2017 Tax Cuts and Jobs Act, IRC Sec. 965, which imposed a retroactive and one-time tax on individual United States taxpayers and overseas corporate income repatriated to the United States through dividends. The 2017 Act eliminated this tax on overseas income. Under prior law, U.S. taxpayers paid taxes on overseas corporate income when the income was repatriated to the United States through dividends. The 2017 Act eliminated the tax on overseas income and brought the U.S. system in a consistent manner with those of other developed countries. However, it also introduced a 'mandatory repatriation tax' (MRT) on the corporation's undistributed income since 1986 payable by the shareholders but not the corporation. As a result, without selling their stock or receiving a dividend, United States taxpayers were deemed to have received 'income' and became liable for the new tax.

D. Analysis

Under a heading 'Discussion,' the panel opinion states:

The Moores raise two constitutional challenges to the MRT: (1) they contend that it violates the Apportionment Clause, and (2) they contend that it violates the Fifth Amendment's Due Process Clause.

After an introduction, the court deals with Item 1 as follows:

I. The MRT does not violate the Apportionment Clause

The Constitution's 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.' U.S. CONST. art. I, '9, cl. 4. 'This requirement means that any 'direct Tax' must be apportioned so that each State pays in proportion to its population.' NFIB, 567 U.S. at 570. The Apportionment Clause traditionally applied to only capitations and land taxes. See id. at 571 ('[D]irect taxes, within the meaning of the Constitution, are only capitation taxes, as expressed in that instrument, and taxes on real estate.' (quoting Springer v. United States, 102 U.S. 586, 602 (1881))). While the Supreme Court in Pollock v. Farmers' Loan & Tr. Co., held that income from personal property was subject to the Apportionment Clause, see 158 U.S. 601, 618 (1895), the Sixteenth Amendment overruled this result, further reinforcing the narrow reach of the Apportionment Clause, see NFIB, 567 U.S. at 571.

The Sixteenth Amendment, ratified in 1913, exempts from the apportionment requirement the expansive category of 'incomes, from whatever source derived.' See U.S. CONST. amend. XVI. In United States v. James, we noted the difficulty of categorically defining everything that constitutes income. See 333 F.2d 748, 753 (9th Cir. 1964) (en banc) ('The courts have given a wide scope to the income tax, but have realized that the borderline content of 'income' must be determined case by case. Essentially the concept of income is a flexible one . . . .' (quoting Stanley S. Surrey & William C. Warren, The Income Tax Project of the American Law Institute: Gross Income, Deductions, Accounting, Gains and Losses, Cancellation of Indebtedness, 66 Harv. L. Rev. 761, 770-71 (1953))).

Despite the difficulty in defining income, courts have held consistently that taxes similar to the MRT are constitutional. In Eder v. Commissioner of Internal Revenue, the Second Circuit held that the inclusion of foreign corporate income under a statute predating Subpart F was constitutional. See 138 F.2d 27, 28-29 (2d Cir. 1943). Thirty years later, the United States Tax Court upheld pre-MRT provisions of Subpart F against constitutional challenges, and the decisions were affirmed by the Second and Tenth Circuits. See Whitlock's Est. v. Comm'r, 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 constitutionally of Subpart F provision taxing 'a corporation's undistributed current income to the corporation's controlling stockholders.'); Garlock Inc. v. Comm'r, 489 F.2d 197, 202 (2d Cir. 1973) (affirming Tax Court's ruling that a CFC's Subpart F income was attributable to shareholders even if that income had not been distributed and stating that the argument it is unconstitutional 'borders on the frivolous in the light of [the Second Circuit's] decision in Eder').

Whether the taxpayer has realized income does not determine whether a tax is constitutional. In Heiner v. Mellon, the Supreme Court stated that whether or not a 'partner's proportionate share of the net income of the partnership' was distributable was not material to whether it could be taxed. 304 U.S. 271, 281 (1938). Similarly in Eder, the Second Circuit noted that '[i]n a variety of circumstances it has been held that the fact that the distribution of income is prevented by operation of law, or by agreement among private parties, is no bar to its taxability.' 138 F.2d at 28 (citing Heiner, 304 U.S. at 281; Helvering v. Enright's Est., 312 U.S. 636, 641 (1941)). And, the Supreme Court has made clear that realization of income is not a constitutional requirement. See Helvering v. Horst, 311 U.S. 112, 116 (1940) ('[T]he rule that income is not taxable until realized . . . . [is] founded on administrative convenience . . . and [is] not one of exemption from taxation where the enjoyment is consummated by some event other than the taxpayer's personal receipt of money or property.'); see also Helvering v. Griffiths, 318 U.S. 371, 393-94 (1943) (explaining that Horst 'undermined . . . the original theoretical bases' of a constitutional realization requirement).

What constitutes a taxable gain is also broadly construed. In Helvering v. Bruun, the Supreme Court determined that a lessee's improvements to the land were a taxable gain when the lessor regained possession of the land. 309 U.S. 461, 469 (1940). The Court instructed that a taxable '[g]ain may occur as a result of exchange of property, payment of the taxpayer's indebtedness, relief from liability, or profit realized from the completion of a transaction.' Id. We applied this precedent nearly half a century later, holding that the cancellation of indebtedness was a taxable gain. See Vukasovich, Inc. v. Comm'r, 790 F.2d 1409, 1415 (9th Cir. 1986)...

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