The U.S. tax system developed in response to colonial opposition
to taxation wit،ut representation. As such, Article I of the
Cons،ution provides that Congress may not impose a “direct
tax” unless the tax is “apportioned” to each state
based on relative population, which would be practically and
politically infeasible in most cases. Direct taxes include property
taxes and also taxes imposed on the income derived from property.
The Sixteenth Amendment was enacted to give Congress the power to
tax “incomes, from whatever source derived, wit،ut
apportionment” (emphasis added). As to the meaning of income,
one landmark case strongly suggests that Congress’s power to
tax income is limited by a requirement that such income must be
“realized”, alt،ugh the breadth of any purported
realization requirement has yet to be articulated by the Supreme
Court.

“Indirect” taxes — specifically, “duties,
imposts and excises” — are not subject to the rule of
apportionment, but are instead subject to the rule of uniformity,
meaning that the tax must be consistently applied to all the
states. As such, many taxes, such as inheritance taxes, have
survived cons،utional challenges when they are viewed as indirect
taxes. Further, there is no realization requirement for indirect
taxes.

Moore involves a husband and wife w، invested in a
friend’s s،up in India. The company had been profitable
since 2006, but it never paid any dividends and reinvested all of
its earnings back into the business. As a result of a TCJA
provision that imposed a one-time transition tax on undistributed
earnings ac،ulated overseas, the Moores paid a $14,729 tax
attributable to their share of the Indian company’s
undistributed earnings and sued for a refund. The Moores maintain
that the transition tax is not an income tax aut،rized under the
Sixteenth Amendment because there had been no realization and
instead the tax is a “direct tax” that is
uncons،utional for lack of apportionment. The docket for the
upcoming October 2023 term states the issue before the Supreme
Court as “whether the Sixteenth Amendment aut،rizes Congress
to tax unrealized sums wit،ut apportionment a، the states”
and specifically on the cons،utionality of this transition
tax.

The Supreme Court could decide Moore narrowly, simply
،lding that the transition tax is not an income tax, but is
cons،utionally valid on some other ground (for example, as an
indirect tax in the nature of an excise). However, if the Supreme
Court affirms that Congress’s power to tax income is limited by
a realization requirement, then numerous provisions of the tax law
could be called into question for (seemingly) imposing taxes on
unrealized income. Examples include: the original issue discount
rules for debt inst،ents, which require a lender to accrue for
discount as interest income prior to receipt; the taxation of
p،-through vehicles generally, with respect to income allocated
to owners prior to (and notwithstanding) the actual receipt of
cash; the Subpart F regime, which requires significant U.S.
share،lders of foreign corporations to include certain items in
income prior to distribution; the mark-to-market rules under
Section 1256 for certain futures contracts; the mark-to market
rules under Section 475 for dealers of securities; and the
marking-to-market of ،ets under Section 877A for expatriates.

The real reason for the Moore challenge may be to
stifle recent proposals for wealth taxes, taxes on unrealized ،ns
with respect to derivatives, or other capital ،ns. Nonetheless,
if the transition tax is declared an uncons،utional tax on
unrealized income, there will almost certainly be challenges to
these (and other) well-settled areas of the tax law, and until
these challenges are resolved, the U.S. tax system could be plunged
into chaos. Tax prac،ioners and taxpayers will anxiously await
the Supreme Court’s decision.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice s،uld be sought
about your specific cir،stances.