From Whatever Source Derived
The United States filed its response brief yesterday in Moore v. United States of America. That’s the case involving the attempt to tax unrealized gains. The outcome will have profound impact on the distribution of the tax burden, most likely by increasing the weight carried by wealthy taxpayers whose income is sheltered in long term assets already taxed at lower rates. We’ve mentioned briefly in passing that the outcome might impact a big loophole affecting charities. If unrealized appreciation is taxable, the double tax benefit available by donating appreciated stock could disappear. It doesn’t take a constitutional amendment to fix that, Congress could simply limit the deduction to basis. Taxing unrealized appreciation would only add more illogic to allowing a deduction for the value of untaxed appreciation. Here is the summary of the argument:
SUMMARY OF ARGUMENT
I. The MRT is an income tax.
A. The Sixteenth Amendment authorizes Congress to tax shareholders’ pro rata shares of undistributed corporate earnings as income. The Amendment’s Framers understood its reference to “taxes on incomes,” U.S. Const. Amend. XVI, as permitting taxes on undistributed corporate earnings. From 1864 through 1870, Congress repeatedly enacted income taxes of that nature—and this Court upheld its power to do so. Collector v. Hubbard, 79 U.S. 1, 18 (1871). Although the decision in Pollock v. Farmers’ Loan & Trust Co., 158 U.S. 601 (1895), temporarily undermined Hubbard, the Sixteenth Amendment overturned Pollock, thus reinstating Congress’s power to impose the types of income taxes that predated Pollock. Petitioners err in contending that the Sixteenth Amendment created a realization requirement. Realization was a well-established concept when the Sixteenth Amendment was adopted—yet the Amendment never references it. Petitioners cannot read that requirement into the term “income,” which encompasses all economic gains. Nor can petitioners read that requirement into the phrase “from whatever source derived,” U.S. Const. Amend. XVI, which was designed to overturn Pollock’s source-based analysis of income taxes, not to restrict Congress to taxing only realized gains.
B. Post-ratification practice shows that Congress may tax individuals on their pro rata shares of undistributed business earnings. Within months after the Sixteenth Amendment’s ratification, Congress included undistributed corporate earnings within certain shareholders’ taxable income. That 1913 law also taxed partners on undistributed partnership income. And Congress soon applied the partnership-tax provision to personal service corporations. Petitioners cannot distinguish Congress’s longstanding method of taxing partners. From before the Sixteenth Amendment through today, many States have treated partnerships as entities separate from their partners—just as States have treated corporations as entities separate from their shareholders. Because Congress may (as petitioners concede) tax partners on undistributed partnership income, it likewise may tax shareholders on undistributed corporate income. In the decades after the Sixteenth Amendment, Congress continued to enact income taxes that reached individuals’ pro rata shares of undistributed business earnings. In 1937, for instance, Congress began taxing U.S. shareholders of foreign corporations on the corporations’ undistributed income. And in 1962, it expanded that approach through Subpart F. Petitioners concede Subpart F’s constitutionality but offer no principled distinction between Subpart F and the MRT.
C. This Court’s precedents recognize Congress’s power to tax individuals on their pro rata shares of undistributed business earnings. In arguing that the Sixteenth Amendment’s grant of power somehow stripped Congress of the preexisting authority upheld in Hubbard, petitioners stake their case on dictum from Eisner v. Macomber, 252 U.S. 189 (1920). But that dictum was poorly reasoned and has been abrogated by many later decisions limiting Macomber to the stock-dividend context in which it arose. Stare decisis thus has no role to play. Under this Court’s precedents considering the decision’s reach, Macomber is not controlling in this case.
D. The MRT taxes income. It taxes U.S. persons owning at least 10% of a CFC on their pro rata shares of the CFC’s undistributed income—materially indistinguishable from Subpart F and numerous similar income taxes dating back to 1864. Petitioners’ contention that the MRT is a tax on property cannot be squared with the MRT’s terms or longstanding historical practice.
II. The MRT is independently constitutional as an excise tax. In Flint v. Stone Tracy Co., 220 U.S. 107 (1911), the Court held that a tax on a corporation’s income was “an excise upon the particular privilege of doing business in a corporate capacity.” Id. at 151. The MRT can be similarly viewed as a tax upon the privilege of doing business through a CFC. At minimum, the Court should remand for the court of appeals to consider that argument in the first instance, rather than prematurely invalidating the MRT, which could cost the government hundreds of billions of dollars in revenue.
darryll k. jones