The provision in the 2017 Tax Cuts & Jobs Act calling for a one-time tax on foreign investments survived an appeal to the Supreme Court. But the High Court didn’t clarify the answer to a broader, underlying question in the legal challenge.
That question being — can an unrealized capital gain be taxed under the 16th Amendment? Conservative jurist Brett Kavanaugh, writing for the 7 to 2 majority, skirted around the argument brought to the table by Charles and Kathleen Moore.
The 2017 Republican tax law included a one-time charge on foreign profits held by American company subsidiaries as well as individuals who owned more than 10% of a foreign company. The Moores owed more than $14K in taxes as a result of the mandatory repatriation tax. The couple paid, then promptly sued under the 16th Amendment, which reads: 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.”
Court: Precedent for Taxing Foreign Profits
Like many investors, the Moores put their profits back into their company, KisanKraft, which sells tools to rural farmers in India. The couple argued the Constitution doesn’t allow for taxation on money not earned or realized — aka income. The feds argued the $14K was a tax on income earned.
A victory for the Moores would mean Congress would need to “either drastically cut critical national programs or significantly increase taxes on the remaining sources available to it — including of course, on ordinary Americans,” wrote Kavanaugh. “The Constitution does not require that fiscal calamity.”
The High Court noted, “longstanding precedents plainly establish that, when dealing with an entity’s undistributed income, Congress may either tax the entity or tax its shareholders or partners. … Since 1962, Congress has likewise treated American-controlled foreign corporations as pass-throughs. That 1962 law (known as subpart F) attributes certain income, mostly passive income, of American-controlled foreign corporations to their American shareholders and then taxes those shareholders on that income.”
Bottom line: Precedent is precedent. The government does tax passive (or unrealized) income. Whether it’s Constitutional per the 16th Amendment is an argument for another day and another case.
