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PaperclipPerfector  5mo ago (text post)   25736 thread views

Culture War Roundup for the week of December 4, 2023

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(Mods, let me know if I need to delete this and repost in Small Questions Sunday.)

The US Supreme Court (SCOTUS) hears Moore v United States today. According to SCOTUSBlog, at issue is "Whether the 16th Amendment authorizes Congress to tax unrealized sums without apportionment among the states". Since that's not very helpful, I'll quote The Atlantic's summary instead:

The story of Moore starts in 2017, when President Donald Trump signed the Tax Cuts and Jobs Act. The law aimed to minimize the incentive for U.S. corporations to hoard money overseas by reducing certain taxes on foreign earnings. But, in exchange, U.S. investors would have to pay a onetime tax on accumulated foreign profits going back several decades—the so-called transition tax. Charles and Kathleen Moore are among the Americans affected by the change. In 2006, they invested $40,000 in KisanKraft, an Indian company owned by a friend. They allege that they never received any payments from the company because all of its profits were reinvested. The transition tax nevertheless stuck the Moores with a $15,000 tax bill based on the company’s retained earnings. The Moores countered that the transition tax is unconstitutional because it exceeds Congress’s power under the Sixteenth Amendment. That amendment, ratified in 1913, explicitly empowers Congress to tax incomes. But the Moores argue that unrealized gains aren’t income at all.

Mother Jones, NPR, CBS, and Foreign Policy (of all the friggin' places) are running articles breathlessly proclaiming DOOM! for the US tax code, or at least the ability of Democrats to pass wealth tax laws. This Forbes article seems to be a pretty good explanation of what's at issue but I'll admit that I'm not well-versed enough in tax law to understand the full ramifications of what a Moore victory would mean for the ability of the federal government to raise revenue. On the other hand, I can't say I'm sad about the idea of a wealth taxes getting a bullet to the head. What am I missing or not considering as I read about this from the various outlets?

According to SCOTUSBlog, at issue is "Whether the 16th Amendment authorizes Congress to tax unrealized sums without apportionment among the states".

Among the many things that have culminated in me having an incredibly low opinion of the ethics of the legal profession, I think obviously dishonest readings of plain text is number one. The Sixteenth Amendment reads, simply:

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.

I flatly don't believe that anyone sincerely thinks that this means that Congress can tax unrealized gains. At issue would be the meaning of the word "income", but again, I do not believe that anyone would have considered "income" to include your house appreciating in value or a share of a company you purchased becoming more valuable (or merely being subject to inflation). The process to amend the Constitution is well established, if you want to collect taxes on unrealized gains, you obviously need to amend it, but because that wouldn't prove politically feasible, a bunch of liars lawyers claim that "income" has a novel meaning that absolutely no one involved in passing the Sixteenth would have believed.

I flatly don't believe that anyone sincerely thinks that this means that Congress can tax unrealized gains.

Levine points out at least one case (Original Issue Discount) where you pay income tax on interest you won't receive until maturity on a bond as if you have received it. However, I don't think the fact that they're doing it means it's actually in accordance with the Constitution.

That also has the feature of a defined outcome determined at the beginning of the investment. That doesn't apply to the plaintiffs in this case, because there's no fixed term and no fixed return.

I can easily see leaving that alone while preventing taxation on anything that doesn't meet those criteria.

I definitely expect a narrow ruling; I don't know whether it will for or against the plaintiffs, but I expect it won't open the door too widely to more broad-based wealth or unrealized gain taxation, nor sweep away huge sections of the tax code.

I definitely expect a narrow ruling; I don't know whether it will for or against the plaintiffs, but I expect it won't open the door too widely to more broad-based wealth or unrealized gain taxation, nor sweep away huge sections of the tax code.

There are two obvious ways of ruling for the IRS in this case without saying that a wealth tax is constitutional:

  1. Rule that income of a corporate entity imputed to a shareholder is "income" for the purposes of the 16th amendment. This isn't a stretch - it is how S-corps, LLPs and LLCs are already taxed. This is the main argument in the IRS brief, so it is actually the most likely result.
  2. Rule that the transition tax is a tax in lieu of an income tax, and therefore justified by the combination of the 16th amendment and the Necessary and Proper clause. This is essentially the same argument as in Wickard and Raich that justifies treating everything as interstate commerce. So it is a very obvious way of giving the IRS a broader win while still leaving the wealth tax question open.

Reading the executive summaries of the briefs, I think this is an easy case and the IRS wins 8-1 or 9-0 (Thomas possibly dissenting) on the basis that the transition tax is an income tax. Given the clear precedents for imputing corporate income to shareholders, Moore is trying to reverse-ferret into an argument that the transition tax is a wealth tax (as opposed to a tax on undistributed corporate profits) because it potentially (not in Moore's case) taxes the shareholder on profits that were earned before they bought the shares, and is therefore a tax on share ownership.

My read of this case is:

  • overreaching litigant gets deservedly benchslapped by the 9th circus
  • 9th goes overboard by saying that there is no realisation requirement at all (as opposed to the correct position that the realisation at the corporate level is imputed to the shareholder). This confuses the law and creates the false impression that a federal wealth tax is constitutional
  • SCOTUS take the case in order to clear up the mistake, but aren't going to change the law and rule in favour of Moore - they just want to bash some sense into the 9th and are using Moore's overenthusiastic litigation as a tool to do so.

Analogizing corporations to S Corp’s, LLCs, and Partnerships entirely misunderstands the Code.

There is a fundamental difference between pass through taxation on one hand and corporate taxation on the other. When it comes to a partnership, the theory of the case is that while there are entity level aspects it is an aggregate of the partners (ie the partners themselves are earning the income) and therefore there is no entity level tax. An LLC merely defaults to partnership taxation but of course with both partnerships and LLCs taxpayers can elect to treat them as corporations.

Contrast this with a corporation which is seen as a separate entity for US tax purposes. See Moline Properties. This entity is taxable on its income. Only in extremely limited situations are it’s shareholders taxable on its income (generally related to earnings of a foreign corporation — these rules are necessary to prevent a taxpayer from creating holes in the US tax system).

And the key constitutional point is that a taxpayer by and large has a choice what form to operate in. If he wants to be subject to phantom tax (but only one layer) then using a pass through. If he doesn’t want to be subject to phantom tax, then use a corporation (but now subject to so called double tax).

So it is easy to say “this is a slam dunk case” if you aren’t familiar with the august and long standing differences between pass through taxation and corporate taxation.

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