SCOTUS case to be argued Tuesday could "fundamentally change the income tax"
"[I]t’s just very difficult to pull off [the Moores’] argument and maintain a stable tax system," law professor Donald Tobin says. A Law Dork Q&A.
On Tuesday, the Supreme Court is set to hear oral arguments in Moore v. United States, a case that is primarily known for two things right now: Justice Sam Alito has rejected calls for him to recuse himself from the case, and The Wall Street Journal is worked up over the “wealth tax” implications of the case.
But, that’s, of course, a hypothetical.
“I think the idea that we may totally upend the entire Internal Revenue Code based on the fact that someone is afraid that sometime in the future there might be a wealth tax is a huge mistake,” law professor Donald Tobin told Law Dork this past week.
There are other issues far more central to the case than those making the headlines. Additionally, there are potential consequences — beyond the “wealth tax” fear — that might not have been in the justices’ minds when the court took the case.
So, what is the case? Charles and Kathleen Moore were taxed for their interest in an foreign business under a one-time provision in the Tax Cuts and Jobs Act — signed into law by then-president Donald Trump. They say the “mandatory repatriation tax“ is a tax of an “unrealized” gain and not “income” permissibly taxed under the 16th Amendment.
To find out more, I got on the phone with Tobin, the counsel of record in a key amici curiae brief submitted in the case. He’s also a tax law professor and the former dean of the University of Maryland Carey School of Law.
Noting that tax cases are often “super-complicated,” Tobin said that their complexity “makes the downstream impact of them not always as clear.”
The Moores, “in their cert petition, tried to make this seem like a very simple question: ‘Well, of course, we only tax realized gains.’” But, Tobin said when we talked, “It's a far more complicated question than that, with far more serious implications.”
That’s, in part, why he and Ellen Aprill, a professor at Loyola Law School, teamed up to write an amici curiae brief that focused on the history — to highlight that “downstream impact” of the Moores’ argument by examining how broadly income was thought of at the time of the 16th Amendment.
“I think one of the things that we tried to do in the amicus briefs is to bring to the Court’s attention — not just not just the amicus brief that that Professor Aprill and I filed — but there were lots of amicus briefs, from conservatives and liberals, that articulated, ‘Here are the consequences of what the Moores are asking you to do. Let's be really careful about what happens here.’”
The oral arguments in the case are set to begin at 10 a.m. Tuesday.
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This interview has been edited for length and clarity.
LAW DORK: So, we have Moore v. U.S. arguments coming up. And let's be honest, a lot of us mainly know about it either because we said that Justice Sam Alito shouldn't be hearing the case or because they heard that Alito announced that he is not recusing himself. What is this case? Why does it matter? Why is it a case that The Wall Street Journal was editorializing about the day after cert was granted?
DONALD TOBIN: This case actually has the potential to fundamentally change the income tax as we know it. And I think that's not an exaggeration. So what looks like a tax involving this foreign provision that has nothing that most of us would care about is really, at its core, taking on the definition of “income” and what Congress's power is to tax.
And so those who want to limit the power to tax, especially in the income tax, are excited about the possibility that the Supreme Court will define the term “income” in a very limited way. And if they do that, that could broadly impact a significant number of provisions that already exist in the Code. And also what can be done in the future.
LAW DORK: Often the question presented is this very complex, detailed — multi-paragraph sometimes — thing. Here, we've got a question presented, “Whether the 16th Amendment authorizes Congress to tax unrealized sums without apportionment among the states.” There there's an underlying law at issue. There are questions about how it's enforced, as to the Moores. But right from the question presented, we see that the implications of a ruling can be very broad.
TOBIN: Right. We could pretend that this is about this small tax provision and the small amount of money the Moores actually owe. But the cert petition itself articulates one of the reasons that this should be granted is for fear of a wealth tax. Now, I think this is a huge problem. I think the idea that we may totally upend the entire Internal Revenue Code based on the fact that someone is afraid that sometime in the future there might be a wealth tax is a huge mistake.
Congress has the power to tax. That is in the Constitution, that is a broad power. There is a limitation on that power only to the extent it says: If it's a direct tax, it needs to be apportioned among the states. Now, I think and many other people think that when Congress added the direct tax language, they meant head taxes or direct taxes on property. So there would never would have been any concern about an income tax. And in fact, the United States had an income tax twice before the Supreme Court ultimately determined that it was unconstitutional.
So we have this move in the late 1800s, where the Supreme Court says [in Pollock v. Farmers’ Loan & Trust Co.] that the income tax is a direct tax and it needs to be apportioned, and because in 1895 apportionment was near impossible, that was really considered to be a decision that the income tax is unconstitutional. So there's a response to that, which is unbelievable — an amendment to the Constitution, the 16th amendment, to say that the taxation of income does not have to be apportioned among the states. So we had this institutional crisis that was created by the Supreme Court reinterpreting what a direct tax was, that I think if you apply originalist principles would actually be overturned. The court in 1895 wasn't applying originalist principles. But if you look at originalism, you would actually just overturn Pollock and we would be done with all this.
But instead, what the argument is [from the Moores] in this case is that the word “income” in the 16th Amendment is very limited, that it's limited to what’s called realized income. And, as is not a surprise, since we haven't had constitutional arguments about this for 100 years, we don't have good definitions of what “realization” even is. So what does it mean to have realized income. So the Moores have to say the word “income” in the 16th Amendment only means a certain type of income, that we have determined to be more important, and that is realized income. And then they have to claim that the type of income that they had is not realized income — when neither the word “income” nor “realization” are defined in the way that they'd like it to be defined.
If the Supreme Court determines that the word “income” means only realized income, then the question is: What are all the things that are impacted by this? Because we tax unrealized income all the time, and we were doing so at the time of the 16th Amendment. So, if you want to take originalist principles, or the amicus brief we wrote was more based on historical principles, and look at what was happening at the time, there was taxation of unrealized gains.
“This case actually has the potential to fundamentally change the income tax as we know it. And I think that's not an exaggeration.”
LAW DORK: What did that look like?
TOBIN: When the 16th Amendment was passed, the kinds of things that had already existed. We had an income tax. We had specifically — and it's what was overturned in Eisner v. Macomber [in 1920] — the goal of taxing gains in stocks that had not yet been passed through. The whole Eisner case was about a stock dividend. And the court said that wasn't income. So at the time of the 16th Amendment, we certainly taxed that. We also had what is called accrual accounting, which is what most businesses in the United States use and are taxed on what’s called the accrual basis, which means they deduct when an obligation is incurred — when they when they incur an expense, that’s when they deduct it. And when they have the right to receive income, that’s when they claim it. They haven't gotten it yet. And they certainly haven’t necessarily paid the expense yet. But for business that makes more sense. That was being done at the time of the 16th Amendment.
So, we had a series of understandings that it wasn’t just the money that came into your pocket.
The second concept that just destroys this — if you think about [their argument] that I actually have to receive the money — is that we’ve moved away from a barter economy. We certainly don’t want a barter economy, right? The idea that, “If I got something in property, it doesn’t count until I liquidate it.” And the Moores are trying to avoid saying that that’s their argument. They’re willing to say if you got property in exchange, then that would be taxed. So if I got a cow for providing my services, then I could be taxed on the value of the cow. But really their argument questions that, and, if so, then how come the moment that stock gains value and I could sell it on an exchange, that doesn't get taxed? They’re trying to create this “money income” concept, and make that all income, then try to cabin it to just sort of a limited situation, and it’s just very difficult to pull off their argument and maintain a stable tax system.
LAW DORK: We go into this and what is it that the federal government says in response, how do they defend this?
TOBIN: If you're a litigator, this is sort of a classic case, because there's lots of different arguments one could make and some the government is more excited about than others.
There are people who have written that Pollock, that 1895 case, was wrongly decided. Professor Calvin Johnson is like, “That's just wrong. And we need to overrule Pollock.” And if you overrule Pollock, none of this exists. This isn’t a problem. The government has not chosen to rely on that argument, but it’s a very legitimate argument if you apply the current interpretive principles that the court now uses. If the Court were to use the principles of originalism that it has been talking about, I think Pollock is easily overturned. It's not an originalism case.
LAW DORK: If that happens, then the 16th Amendment would be duplicative?
TOBIN: Correct, because they would return to an interpretation before Pollock, that basically said, direct taxes were only head taxes on people or direct taxes on property. What Pollock said is that an income tax is a direct tax because the income is derived ultimately from property, that you can't make the money unless you ultimately had it coming from property. That is such an expansive definition that is so far beyond what the framers were thinking about. I think it’s Bruce Ackerman, who has an article about the history of the direct tax clause, and it’s tied to slavery. And it’s tied to trying to maintain a balance of power, where the southern states were afraid that the tax code would be used to make slavery unprofitable. The history of that provision has got nothing to do with the income tax. And so one argument is, Pollock should be overruled.
The second argument is that the word “income” from the 16th Amendment is a broad-based definition of income, and that that broad-based definition of income should be followed. We spent some time looking at what economists and accountants and lawyers at the time thought about the word “income,” not the word in the tax code specifically, but the word “income.” And the reason it’s important is because Congress has a broad power here, it’s a power to tax, then the 16th Amendment makes it clear that it has the power to tax income. Now, what income we tax doesn’t define what that word means. The fact that Congress has chosen over time to mostly tax realized gains, and it mostly does, is actually a decision by Congress that this is the right way to run a tax code.
LAW DORK: That has nothing to do with the definition of the 16th Amendment.
TOBIN: Yes, it doesn’t mean they can’t do more. The fact that they’ve chosen a system that’s easier to administer, that makes sense, all of that just tells you that they've been, I don't know if “wise” is the word, but they’ve been restrained in how they have engaged in the code. But that doesn't mean that they don't have the power for a broader tax.
So there are types of income that are maybe not included in what we think of as money income, that are income. What we try to do in the brief is trace the way lawyers, but more importantly, I think, economists, were thinking of income. And the reason it’s important is I sometimes think there's a hubris by lawyers. And often that comes through in these kinds of originalist-slash-historical debates of whose history you're looking at. And economists have been talking about the word “income” for, I don't know, 75 years before the Supreme Court was getting into what the word meant. There were discussions about how we value income and what kinds of income and what it means to have gains in wealth and is income really the change in your wealth — which has been predominantly the way economists were thinking about income. And all of that deserves respect and deserves an understanding that when we talked about “income,” as a society writing these kinds of things, we were not thinking about solely money income.
Then, the third argument, and one the government makes, is if realization is required, there is realization here. These are foreign corporations that are mostly controlled by US citizens. They are often — and I’m not saying this is true in the Moores’ case —they are often used as tax-avoidance devices. They don’t pay tax on the profits they make abroad, because they don’t bring that money home to the United States. So we change tax systems, and in the change of that tax system, in order to realign, they needed to tax those gains that hadn’t been taxed. And so that’s what the Moores in effect are being taxed on.
Of course, the company made the money, so, there's a realized gain here. The question is whether that realization can be attributed to the Moores. And what the Moores say is it can't, because this is a corporation, and therefore, it’s not attributable to them until those amounts are distributed. And, and that could be true under US law, we could recognize — and do — the corporate form. But there’s nothing that says Congress has to recognize foreign-controlled corporations that are used in this manner. It can have a look-through, and that’s what it’s doing. It’s saying, “We’re going to look through the transaction, there was realization, the money was made. And so we’re going to impute that realization to the Moores.”
The argument there is, the government has that power to determine in a sense, where the realization was and what the realization was.
LAW DORK: If the case was decided on those grounds, it would be a decision that would leave unresolved the ultimate question of whether unrealized income can be taxed, yes?
TOBIN: Right. That's absolutely true. It would be, in a sense, to people like me, the least harmful decision. It would be back to the status quo.
Think about partnerships right now. If you if you are organized in a partnership, that's a pass-through entity, so the profits of the partnership are assigned to the partners, whether or not they received anything. They might receive a distribution, but the profits might be reinvested. Partners in a partnership get taxed on the partnership’s income even though they haven't had realized gain in the Moores’ sense.
Now, my understanding is the Moores’ argument is “Well, they’ve conceded to that treatment when they form as a partnership.” OK, maybe, but none of these things — the partnerships, corporations — they’re not written in the Constitution as a body that has to be respected or organized in a certain way. There’s nothing that says that Congress couldn’t say, for taxation purposes, not for state law, but for taxation purposes, we’re going to treat corporations as pass-throughs. I can’t conceivably see what reason that Congress couldn’t do that. If Congress can do that, then why can it not say that, for purposes of this transition [with the Moores], we’re going to treat them in a certain way?
So you have these things in existing law — from mark to market, where securities dealers mark to market at the end of the year their stocks. You have, as I’ve talked about, accrual accounting, which is the mainstay of the way corporations operate their books and records. You have pass-throughs from partnerships that that have been continually allowed. So this idea of realization, in the way the Moores conceive it, requires the word “income” to be read in a very sort of Moore-specific way that I just think is really harmful.
If you try to do it in the Moore-specific way, I think it has the likelihood of hitting a lot of other areas and we’re going to spend the next 20 years litigating each of those questions of whether or not this or that is a realization event worthy of taxation. It's going to open up a lot of litigation and a lot of questions. And maybe that’s good for a tax lawyer like me, but it's not good for our tax system.
LAW DORK: Let’s say you have a decision that says these unrealized sums can’t be taxed, what does that change overnight?
TOBIN: To the extent that there are provisions that one would consider to be taxation of unrealized gains in the code, then all of those in a sense are unconstitutional, or at least arguably unconstitutional.
So is partnership tax an appropriate method of taxation? Are all the corporations’ books and records that are done on an accrual basis? Because they haven't realized that gain yet, or loss? Are all of those sort of fundamental ways that they've kept their books and records invalid? And do they have to now keep their books and records in a different way? And do we have to reevaluate the entire way that the corporate tax system works? The trading for mark to market, which is designed to stop some abuse in traders of stocks? Is that all of a sudden, unconstitutional?
We would have to go through and see, what are the provisions that potentially tax unrealized gains, and are those provisions now unconstitutional.
“The 16th Amendment was a response to a conservative court decision limiting the power to tax. And its response was: Congress should have that power.”
LAW DORK: In some ways, it seems to me that that you’re saying that, the use of the wealth tax as a reason we’re bringing this up is almost beside the point because there are already existing provisions that could be affected and could dramatically curtail the way that Congress even currently taxes things.
To understand a wealth tax, we would actually need to know what the tax was. We have a corporate tax that was upheld by that same Supreme Court back then. We have an estate tax — you want to talk about what thing seems like a tax on wealth. But the Supreme Court held that that wasn't a direct tax. So, this may have nothing to do with the wealth tax depending on how it’s written.
Finally, though, why isn't it Congress’s job to decide? Maybe the wealth tax is a terrible idea. Maybe it’s a good idea. We have all kinds of taxes that are good or bad, and we vote people in and out of office partially on their decisions to support those. So why does this particular kind of tax have to rise to this level of constitutional issue? Why is it important in that way, and what I would argue, is the constitutional structure which gives Congress the power to tax — a broad-based power to tax — and then the 16th Amendment, which clearly was designed to provide that the income tax did not have to have a direct tax. We should let Congress exercise that broad power. And there's consequences to that. We can have a fight about whether that's good or bad. But why isn't that Congress’s fight?
When you read a lot of the economists and lawyers — and the Moores have tried to make a lot about this — they say over and over again, “Income should only include blah,” whatever blah is. But most of the time, what they’re saying is, “If we’re going to run a good tax system, this is how we should run it.” Maybe [the Moores are] trying to impute that into the definition, the constitutional definition. But really, they’re arguing about what a good tax base is and what the tax system should be. And that’s what we should argue about: Is a wealth tax good or bad? Well, let’s argue about that. But is it really the Constitution’s job to limit that tax based on our structure? And I say, based on our structure, the answer is no.
So let me give you one example. It’s an example that people will easily understand. There are a lot of people in this country who are incredibly wealthy because of the appreciation of stock. Those stocks are traded on exchanges, we know exactly what they’re value is. Those stocks have real value. They can live very well borrowing against that stock and paying no income tax, because borrowing against stock is not taxable, because you have to repay it. But if you imagine people with this kind of wealth, they could borrow forever because they have enough wealth to keep borrowing against stocks. So they're allowed to borrow against the stock. But somehow, that’s not their wealth. That increase in wealth is not income to them, subject to tax, but why not? If I had a million dollars in XYZ stock, and it went up to a billion dollars, did I not have close to a billion dollars of income? They say, “Oh, well, you could lose it at any time.” Well, you could, but you could sell it at any time. It’s yours. It’s your money. Had Congress said, “We want to tax the gain of stock, and we’re going to measure whether you have gain or loss on December 30 of every year.” I think that would have been totally appropriate. And you could say, “Well, it's unrealized,” meaning it hasn't yet been sold. But it’s realized, to the extent that you have the value of the stock, it’s yours. You can sell it, you can keep it, you can do whatever you want with it.
Now, for lots of good reasons, for liquidity and otherwise, Congress has decided not to tax those things. But could it? Could we decide that we’re going to tax, immediately, realization on gains when they’re over $10 million? I think Congress could, and then we could fight about whether that was good. But why would you say — constitutionally — that when stock goes on a public exchange, so we know its value, from a million to a billion none of that could be taxed under the Constitution of the United States? I just think that’s silly. That’s just not a constitutional principle that our forefathers, or the people when they passed the 16th Amendment, would have held.
And just to finally finish up — and it’s not as attractive an argument to the Supreme Court — but what was the 16th Amendment about? The 16th Amendment was a response to a conservative court decision limiting the power to tax. And its response was: Congress should have that power.
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