Supreme Court takes up meaning of ‘income’; decision could impact taxes

A Washington state couple’s fight to get a $14,729 tax refund – and the meaning of "income" under the 16 Amendment – made it all the way to the U.S. Supreme Court this week in a case that might upend the entire federal tax code and finally determine exactly what Congress can and cannot tax.

The issue in Moore vs. U.S. zeroes in on a section of the 2017 tax law signed by then-President Trump, that levies a one-time charge on profits that companies earn outside the U.S. It asks the Court to decide what exactly is income and can “realized” income be taxed before it is actually received.

Unrealized income at issue

The Moores, Charles and Kathleen, argue they were unfairly taxed on unrealized income from an investment they made in a company based in India. Their case is being watched closely by groups looking to do away with wealth taxes or taxes on unrealized capital gains. Depending on which way the court rules, the decision could also affect partnerships, S-Corporations, multinational companies, and bond investors. Former House Speaker Paul Ryan, who co wrote the 2017 tax revision, said the case could explode one-third of the nation’s tax code. If the Moores succeed, investors and companies might be in line for billions in refunds and the government would likely face an onslaught of legal actions challenging other tax-code provisions.

Since passage of the 2017 tax code revision, the U.S. has raised more than $350 billion mostly through profit taxes on huge companies like Microsoft, Apple, and Alphabet. But the provision can affect individual investors too if they own more than 10% of a foreign-based company, as did the Moores.

16th Amendment cited

During oral arguments before the Court on Tuesday, there were few signs of which way the justices might be leaning as attorneys for both the plaintiffs and the U.S. were aggressively questioned. However, the justices continually made the point there was ample precedent for Congress’ authority to tax both realized and unrealized gains. The debate largely centered on semantics, definitions, and the actual meaning and limits of the U.S. Constitution’s 16th Amendment, which authorizes Congress to raise taxes yet makes no mention of “realized” gains.

The Moors invested in a friend’s company, KisanKraft, based in India. The couple, with help from the Competitive Enterprise Institute and other conservative groups, sued for a refund claiming they hadn’t realized any of KisanKraft’s profits, so the one-time tax wasn’t within Congress’s 16th Amendment power. Lower courts disagreed, saying income doesn’t have to be received to be taxed. And the couple appealed to the nation’s top court.

“Unrealized gains are not income,” said the Moore’s attorney, Andrew Grossman. “The only way to make sense of the income tax as it's existed for a century, is to stick with the original meaning of the 16th Amendment. The court should reaffirm that there is no income without realization.”

Justices weigh in

Justice Sonia Sotomayor, though, pointed out that corporations and individuals are routinely taxed despite not realizing direct income.

“Why do we permit taxing of individual partners when either state law or their partnership agreement doesn't realize the income to them?” she asked. “In many states, a partner doesn't have personal ownership, doesn't get the value of the partnership, yet we've permitted that tax.”

Justice Elena Kagan also picked up on that argument.

“The concept of realization was very well established at the time that the 16th amendment was adopted,” she said. “But the amendment does not reference realization. Yet, there is quite a history in this country of Congress taxing American shareholders on their gains from foreign corporations. And you can see why because Congress, the U.S. government, can't tax those foreign corporations directly. And they wanted to make sure that Americans didn't stash their money in the foreign corporations, watch their money grow, and never pay taxes on it.”

Justice Brett Kavanaugh agreed there seemed to be ample precedent for taxing unrealized capital gains.

“We've long held that Congress may attribute the income of a company to the shareholders or the partnership to the partners and the only real wrinkle, I think, here is that it goes back and captures prior years' income,” he said.

But in response to a question by Justice Neil Gorsuch about the consequences of specifically including unrealized gains as taxable income, Grossman said it would open the door to taxing everything.

“I mean, all property that a person owns is the fruit of income at some point in time, whether it might be income that they received long in the past,” he said. “Congress could simply point at anything and say, ‘well, at some point, this was income to some person at some level and therefore can be subject to taxation without apportionment.”

Doug Bailey is a journalist and freelance writer who lives outside of Boston. He can be reached at [email protected].

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