Supreme Court Upholds Repatriation Tax on Overseas Earnings in Landmark Case

Background

The transition tax under Section 965 of the Internal Revenue Code, enacted in 2017 as part of the Tax Cuts and Jobs Act (TCJA), required certain U.S. taxpayers to repatriate their overseas earnings. It imposed a one-time tax on certain accumulated post-1986 undistributed foreign income held by certain specified foreign corporations. Specified foreign corporations include U.S.-controlled foreign corporations (CFCs) and foreign corporations with a domestic corporation as a US shareholder. This, in effect, taxed U.S. shareholders on their foreign earnings, even if it remained undistributed.

The Challenge

The petitioners in Moore v. United States argued that the transition tax was unconstitutional because it taxed undistributed income – income that the shareholders hadn’t received as dividends. They contended this violated the Sixteenth Amendment’s limitation on Congress’s taxing power to incomes “from whatever source derived.”

The Court, however, disagreed. It reasoned that the Sixteenth Amendment allows Congress broad authority to define what constitutes taxable income. The Court pointed to established precedent allowing Congress to tax undistributed income in certain structures like partnerships and S-corporations.

The Ruling: Clarification and Impact

The ruling clarifies the scope of income taxation. Strictly concerning its focus on pass-through entities and limiting its ruling in other respects, the Court says the transition tax is a constitutional way to tax undistributed income of certain foreign corporations owned by US shareholders.

What’s Next

It is always important to remember that tax laws are subject to change. In this case, as with all rulings by the Court, there is now a precedent for future tax legislation. This ruling clearly strengthens and affirms Congressional authority with the transition tax and its validity.

However, the Court’s reasoning leaves open the possibility for future legal challenges in other ways with how Congress taxes income. For example, can Congress tax both income at the entity level and then again with the entity’s shareholders? Does this open the door for challenges related to how realization is viewed related to income tax? What other taxation challenges might arise through other areas of income like appreciation?

We will continue to monitor this and other taxation laws and regulations and update you as needed. Should this situation impact you or if you have questions, please do not hesitate to reach out.