Unrealized Gains Supreme Court Case Could Change Wealth Taxes

Does a one-time mandatory tax on unrealized foreign gains violate the Constitution? The U.S. Supreme Court has agreed to decide in a landmark tax case.

Supreme Court building for unrealized gains case
(Image credit: Getty Images)

Taxing unrealized gains is at the core of a case that the U.S. Supreme Court will soon consider that could change how wealth is taxed in the U.S. The plaintiffs in Moore v. United States argue that a mandatory repatriation tax introduced by the 2017 Tax Cuts and Jobs Act (TCJA) is unconstitutional.

  • The one-time tax is levied on U.S. taxpayers with a specified amount of ownership in certain foreign corporations. 
  • The Moores didn’t receive dividends or “income” from their ownership stake in a foreign company, so they assert that only realized income can be taxed under the 16th Amendment to the U.S. Constitution.

According to lead attorney Andrew Grossman, who represents the plaintiffs, Charles and Kathleen Moore, “The Constitution does not allow Congress to point at any pot of money and call it ‘income’ and then income-tax it.” However, the Ninth Circuit Court of Appeals rejected that argument in the Moores’ case, finding that “realization of income is not a constitutional requirement” for income tax.

The Supreme Court will hear the Moores’ case, brought by regulatory reform organization the Competitive Enterprise Institute and national law firm Baker Hostetler, in its next term, which begins in October.

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  • Outside groups, including public policy research organization the Cato Institute and the U.S. Chamber of Commerce business organization, submitted briefs asking the Court to take up the case in support of the Moores’ petition.
  • Since then, more than 20 groups have submitted briefs in the case, many supporting the Moores' contention that the tax on unrealized gains should be struck down. This includes a brief from West Virginia and 16 other states, arguing that taxing unrealized gains harms state economies.
  • Supreme Court Justice Samuel Alito was twice interviewed in the past by an attorney now involved in the Moore case. Alito recently issued a statement saying "there is no valid reason" to recuse himself from the case.

The Supreme Court’s decision to consider the constitutionality of taxes on unrealized gains will galvanize longstanding debate over Congress’ power to tax wealth and likely have landmark ramifications for wealth taxes going forward. 

Supreme Court case on taxing unrealized gains: The TCJA mandatory repatriation tax

The dispute in Moore v. United States is about the mandatory repatriation tax (MRT), a one-time transition tax under Section 965 of the Tax Code levied by the IRS on certain foreign holdings of U.S. taxpayers.  (Unrealized gains are essentially “on paper” profits because the investment involved hasn’t been sold.)

The MRT, enacted in the TCJA, is supposed to prevent shareholders from obtaining windfalls. As the Ninth Circuit Court stated when it ruled in the case, the mandatory repatriation tax is designed to keep shareholders from “never having to pay taxes on their offshore earnings that have not yet been distributed.” 

What happened in Moore v. United States?  

  • The Moores owned a stake in an agricultural equipment company in India. They held their stake for years and didn’t receive dividends or income from their investment.
  • However, the Moores paid close to $15,000 in taxes on the earnings attributed to them as shareholders in the company due to the mandatory repatriation tax.
  • The couple sued the federal government arguing that the MRT they paid was unconstitutional because, they say, income must be realized to be taxable under the 16th Amendment.

What does the 16th Amendment say? The 16th Amendment to the U.S. Constitution says, “The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”

In simple terms, the 16th Amendment essentially grants Congress the power to impose a federal income tax.

Is taxing unrealized gains unconstitutional? 

A federal district court and a federal court of appeals ruled against the Moores. But the Supreme Court will hear the case to resolve questions surrounding Congress’ taxing power. The key sticking point is whether income must be realized to be taxable under the Constitution. Groups including the Cato Institute argue an income tax can be imposed only on realized income, and if that weren’t the rule, Congress’ power to tax would essentially be unlimited.

In its amicus brief, the U.S. Chamber of Commerce argued that “income” has a plain meaning and “realization has been the defining event that turns something from an asset holding value to income subject to federal tax under the Sixteenth Amendment.” The Chamber says allowing unrealized gains to be taxed would mean companies wouldn’t control their realization decisions.

“Businesses and their shareholders could be subject to taxes on anything that the government later deems ‘income’ — even increases in value that could later disappear as valuations or markets fluctuate,” the organization wrote to the Court.

On the other side, the federal courts that ruled against the Moores found that the mandatory repatriation tax accomplishes a “legitimate purpose through rational means.” Specifically, in its ruling, the Ninth Circuit Court of Appeals noted:

  • "That courts have consistently upheld the constitutionality of taxes similar to the MRT notwithstanding any difficulty in defining income."
  • "The realization of income does not determine the tax’s constitutionality."
  • And "there is no constitutional ban on Congress disregarding the corporate form to facilitate taxation of shareholders’ income." 

How will the Court’s eventual ruling in Moore v. United States impact various wealth tax proposals involving unrealized capital gains going forward? Stay tuned. 

Kelley R. Taylor
Senior Tax Editor, Kiplinger.com

As the senior tax editor at Kiplinger.com, Kelley R. Taylor simplifies federal and state tax information, news, and developments to help empower readers. Kelley has over two decades of experience advising on and covering education, law, finance, and tax as a corporate attorney and business journalist.