Administrative Convenience or Constitutional Limit? The Looming Threat of Moore in Fighting Inequity
Brian Ehrenkranz
Imagine two taxpayers: Laura and Cooper. At the start of the year, both have $100K in economic power. Laura’s $100K is invested in the S&P 500, while Cooper’s is in a savings account yielding 2% interest. Their economic status is otherwise identical: they work the same job, at the same salary, and are in the same tax bracket. At the end of the year, Laura’s investment has grown 10%. With inflation at 3%, Laura starts the following year with $110K in economic power, roughly a $7K increase adjusted for inflation. Cooper, conversely, has gained $2K in interest, but has lost $1K overall when adjusted for inflation. Yet the IRS taxes Cooper, not Laura, for his “gain.”
Expand the scenario further out. Imagine a third taxpayer, Harry, the CEO who started the company that Laura and Cooper worked at. As founder and CEO, most of Harry’s early compensation is in stock. But private equity firms loved his work, and after several rounds of funding, Harry and his partners filed an IPO. Harry’s stocks skyrocketed from $100K to $1B. Yet, until Harry sells his shares, the workers he pays for their labor (Cooper and Laura) will pay more in income tax than he will. Harry can still take out loans against his $1B in appreciated assets, as many billionaires often do, to receive the consumption benefits of this appreciation.[1] Because taking out loans or repaying them are not considered taxable income, Harry can still lead a lifestyle that reflects his newfound wealth. If Harry dies before he sells his shares, all that unrecognized appreciation is suddenly tax-free to his heirs. This is how the 25 wealthiest Americans gained approximately $400B between 2014-2018, while only 3.2% of that wealth was reflected in their federal income tax. Thisis the Realization Requirement.
But what if Congress wizens up to this scheme, and decides to tax Harry on his appreciated assets? If the government were to implement a statute that requires taxpayers with more than $10 million in appreciation per annum to pay a minimum 20% income tax on that appreciation, regardless of whether the stock was sold, do they even have the constitutional authority?
The Realization Requirement question dates to the ratification of the Sixteenth Amendment. The original U.S. Constitution imposed substantial limits on the federal government’s taxing power. To avoid burdening less populated farming states in the union, Article I of the Constitution required any direct tax be apportioned across each state’s population.[2] This meant any tax imposed must correspond to the representative power of that state.
As the needs of the nation changed, and a rising military budget began outpacing tariff rates’ ability to close the gap, the federal government switched from tariff-based to tax-based revenue.[3] These federal taxes continued without judicial interference until the Supreme Court’s controversial decision in Pollock v. Farmers’ Loan & Trust Co.[4] The Pollock Court held that Congress cannot constitutionally tax income is because it is a direct tax that is not apportioned among the states.[5] In response, Congress proposed and the states ratified the Sixteenth Amendment, granting the federal government the constitutional power to collect taxes on income from whatever source derived without apportionment.[6]
One would imagine the Sixteenth Amendment resolved the direct tax question. However, disagreement remained as to the meaning of “income.” Only a few years after the Sixteenth Amendment was ratified, SCOTUS was called to decide whether stock dividends constitute income in Eisner v. Macomber.[7]
Leading up to Eisner, The Standard Oil Company of California used their economic surplus from a successful year to issue a pro-rata stock dividend after reinvestment of capital.[8] This granted shareholders new shares without lowering their ownership stake. Mrs. Macomber was one such shareholder, receiving new shares and the resulting economic gain.[9] The IRS sought to collect income tax on that dividend under the newly passed Revenue Act of 1916,[10] and Macomber sued for a refund, arguing that the dividends did not constitute income.[11]
A divided Court held for Macomber, finding that an income tax on stock dividends is unconstitutional.[12] Per Justice Pitney’s opinion, income must be received or drawn, severed from the capital, and for separate use exclusively by the taxpayer.[13] Because Macomber’s stock dividends still constituted capital that was owned by the company, this was not a tax on income but an unconstitutional direct tax without apportionment. The decision created a constitutional requirement: economic gain must be realizedto constitute income.
The criticism of Macomber was sharp and immediate.[14] Perhaps in acknowledgement, the Court shortly thereafter cabined Macomber to cases involving stock dividends rather than all cases of realization.[15] By the 1950s, prominent tax scholars no longer considered Macomber to be good law, and felt the decision to tax realization was solely a choice of administrative convenience, reflecting the impracticalities of requiring taxpayers to assess value change on all their assets annually and pay cash – or, in the case of depreciation, receive a refund – for that change in value.[16] It would be far more administrable to report the value received during disposition events. As these tax experts analyzed existing holdings, they concluded that the decision to tax on realization was a matter of legislative ease, not a constitutional requirement.[17]
SCOTUS may have declined to overturn Macomber by name,[18] but they continue to affirm the administrative convenience argument as late as 1991 in Cottage Sav. Ass’n v. Comm’r.[19] This case arose as a result of the Savings and Loans crisis in the 1980s, when regulators allowed Savings and Loans (“S&L”) banks to transfer interests in devalued mortgages with other S&L banks, allowing the benefits of tax losses without risking the banks’ closures.[20] The IRS refused the loss recognition under §1001(a), given it was an exchange of properties not materially different, and lacked actual realization. The Supreme Court held it did constitute a realization event, but also took the opportunity to weigh in on Macomber and the realization requirement: “As this Court has recognized, the concept of realization is ‘founded on administrative convenience.’”[21]
Once again the Supreme Court faces the specter of Macomber, this time in Moore v. United States. In 2017 Congress passed the Tax Cuts and Jobs Act, which included a one-time mandatory repatriation tax (“MRT”). The MRT constituted a one-time tax on earnings after 1986 by foreign corporations majority owned by American corporations (“CFCs”).[22] Prior to this Act, the CFCs earned approximately $2.6 trillion for their U.S. ownership, which remained untaxed due to the nature of their corporate structure.[23]
The Mooressued the IRS to contest the MTR, alleging that the one-time tax violates the apportionment clause.[24] They rely heavily on Macomber to argue that realization is a constitutional requirement for taxation, and that Congress lacks the power to tax unrealized appreciation.[25] The Ninth Circuit rejected the Moores’ claim, but the Supreme Court has just granted certiorari to review.
The Supreme Court faces three options in Moore. They can hold for the government, overturn Macomber v. Eisner and reaffirm concretely that income under the Sixteenth Amendment need not be realized. Alternatively, they can hold broadly for the Moores and resurrect Macomber, implicitly overruling decades of understood tax law precedent and setting off a mass chain of tax avoidance and economic inefficiencies. Lastly, SCOTUS can take the middle route, either cabining Macomber once again, finding the repatriation tax unconstitutional and severable, or even punting the question further down the line by holding the MRT did tax realized income.
A broad holding for the Moores would be devastating. First, wide swaths of the tax code have been predicated on “Nonrealization Rules,” and would be at risk of being overturned or, at the minimum, supporting widespread noncompliance.[26] Placing the burden on the IRS to defend their Nonrealization rules in court would encourage tax shelters and similar instruments for high net worth taxpayers.[27] Beyond the lost tax revenue, experts also argue a pro-Moore decision would substantially disrupt the American economy, burdening pass-through businesses, disincentivizing capital investment, and promoting economic inefficiencies.[28]
Additionally, constitutionalizing the Realization Requirement would preclude any Congressional tax on wealth. By the Moore’s appraisal of the Sixteenth Amendment, any one-time wealth tax or tax on unrealized appreciation of assets would be unconstitutional.[29] As Congress continues to toy with new methods to tax the richest Americans, whose accession to wealth is predicated on asset appreciation,[30] a decision in Moore v. United States could create a firm constitutional barrier.
Constitutionalizing an administrative convenience could also upend agency decision-making. Regulators could fairly interpret this as a “use it or lose it” judiciary response on the constitutional scope of their powers. This could disincentivize decisions of administrative convenience and instead force agencies to utilize their power to the constitutional ceiling. Naturally, this invites a flood of litigation and inefficiencies.
Lastly, a broad ruling for the Plaintiff could severely impact the U.S.’s involvement in the OECD Global Tax Deal, an initiative to set corporate tax minimums and fight international tax shelters that has been years in the making. [31] Implementation of Pillar Two of the deal would face substantial judicial hurdles should the realization requirement be constitutionalized.[32]
While there is no indication how the Court is leaning, the bipartisan support for the IRS, demonstrates the significance underlying the realization requirement as an administrative choice.[33] Notably, several tax institutes support the government here, though a decision for the Moores would supercharge demand for tax law professionals. One thing is certain – a decision for the Moores would create new avenues for wealthy taxpayers to permanently shield their wealth while those who derive their value from labor would be – at best – no better off than before.
[1] Rachel Louise Ensign & Richard Rubin, Buy, Borrow, Die: How Rich Americans Live Off Their Paper Wealth, Wall Street Journal (July 13 2021), https://www.wsj.com/articles/buy-borrow-die-how-rich-americans-live-off-their-paper-wealth-11625909583.
[2] Michael J. Graetz and Anne K. Alsttot, Federal Income Taxation: Principles and Policies 46 (9th Ed. 2022).
[3] Id. at 6.
[4] 158 U.S. 601 (1895).
[7] Eisner v. Macomber, 252 U.S. 189, 190-91 (1920).
[8] Id.
[10] Revenue Act of 1916, Pub. L. No. 64-271, 39 Stat. 756 (1916).
[12] Eisner, 252 U.S. at 197.
[13] Id. at 193.
[14] Helvering v. Griffiths, 318 U.S. 371, 374 (1943).
[15] Koshling v. Helvering, 298 U.S. 441, 445 (1936).
[16] See, e.g., Edward T. Roehner & Sheila M. Roehner, Realization: Administrative Convenience or Constitutional Requirement, 8 Tax L. Rev. 173 (1953).
[17] Id.
[18] Griffiths, 318 U.S. at 404.
[19] 499 U.S. 544 (1991).
[20] Id. at 557.
[21] Id. at 559.
[22] Moore v. U.S., 36 F.4th 930, 931 (9th Cir. 2022) (“A CFC is a foreign corporation whose ownership or voting rights are more than 50% owned by U.S persons.”) cert. granted, 143 S. Ct. 2656 (2023) (No. 22-800).
[23] Id. at 933.
[24] Id. at 937.
[26] Brief for Avi-Yonah et al. as Amici Curiae Supporting Respondents, Moore v. U.S., 143 S. Ct. 2656 (2023) (No. 22-800) at 29.
[27] Id.; see also Brief for Brill et al. as Amici Curiae Supporting Respondents, Moore v. U.S., 143 S. Ct. 2656 (2023) (No. 22-800) at 15-22.
[28] Brief for Brill et al., as Amici Curiae Supporting Respondents, Moore v. U.S., 143 S. Ct. 2656 (2023) (No. 22-800) at 15-22.
[29] Moore, 36 F.4th at 937 (Moores arguing that Congress can only constitutionally tax income defined as “[1] undeniable accessions to wealth, [2] clearly realized, and [3] over which the taxpayers have complete dominion”).
[30]See, e.g., Ultra-Millionaire Tax Act of 2021, 117th Cong., § 510 (2021).
[31] Daniel Bunn et al., How the Moore Supreme Court Case Could Reshape Taxation of Unrealized Income, Tax Foundation (Aug. 30, 2023), https://taxfoundation.org/research/all/federal/moore-v-united-states-tax-unrealized-income/ (“A ruling that §965 does not comply with a realization requirement, expressed in broad terms applicable to other international provisions, would restrict the U.S. from implementing Pillar Two constitutionally.”).
[32] Id.
[33] Amici briefs filed on behalf of the government include support from a coalition of 16 states + Washington D.C., tax economists from the American Enterprise Institute, two national coalitions of small businesses, and around two dozen tax law professors across various academic institutions. See The Tax Law Center, Guide to Amicus Briefs Filed in Moore v. United States, https://www.law.nyu.edu/centers/tax-law-center/work/Moore-v-US-Compendium.