Supreme Court Upholds Congress’s Taxing Authority in Foreign Investment Case

Supreme Court Upholds Congress's Taxing Authority in Foreign Investment Case

The Supreme Court dismissed a challenge from conservative activists against a one-time tax on specific foreign investments, a decision that broadly upheld Congress’s taxing authority but deferred other complex issues.

Supreme Court Upholds Foreign Investment Tax

The ruling on Thursday maintains a tax on accumulated foreign profits enacted by Congress in 2017, avoiding potential complications from a decision that could have undermined congressional taxing power.

Thursday’s ruling upholds a tax on foreign profits, preserving congressional authority and averting potential legal challenges, acording to WSJ Subscription Offers

Precedent and Practice Upheld

In an opinion by Justice Brett Kavanaugh, the Supreme Court affirmed that the tax followed precedents and congressional practices. The Court held that attributing income from an India-based corporation to its shareholders aligned with the “pass-through” approach since 1962.

“This Court has long upheld taxes of that kind, and we do the same today,” Kavanaugh wrote. However, he noted that related questions about the extent of federal taxing power, including wealth taxes, were “potential issues for another day.”

Implications for Future Tax Policies

Tax attorneys and policymakers closely monitored the case, as the challengers’ arguments could have impacted many longstanding tax system features. A broad ruling for the government could have paved the way for progressive tax initiatives, such as taxes on unrealized capital gains and wealth.

Constitutional Debate Over Income Definition

The 16th Amendment’s ratification in 1913 granted Congress explicit authority to tax income without requiring proportional payment from each state’s residents. However, the amendment doesn’t define what constitutes income or whether it must be received or realized before being taxed.

Challengers’ Arguments and Case Background

Conservative activists targeted a 2017 tax law provision excluding unrealized gains from income. Charles and Kathleen Moore from Redmond, Wash., received a $14,729 refund after investing in a profitable overseas company. The Competitive Enterprise Institute and similar groups backed their lawsuit. They oppose minimum taxes for wealthy individuals and other revenue policies. These policies are proposed by President Biden and Senators Bernie Sanders and Elizabeth Warren.

Narrow Ruling with Broad Implications

Kavanaugh emphasized that the ruling narrowly applied to situations where entity owners pay tax on untaxed income. He clarified that the court did not endorse congressional attempts to tax both entity and shareholder on the same income.

Chief Justice John Roberts and Justices Sonia Sotomayor, Elena Kagan, and Ketanji Brown Jackson joined Kavanaugh. Justice Amy Coney Barrett, joined by Justice Samuel Alito, concurred with a separate rationale. Justice Clarence Thomas dissented, joined by Justice Neil Gorsuch.

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Reaction and Future Considerations

“This was a loss for the Moores, but it leaves the realization requirement intact, which is a victory for all taxpayers,” said Sam Kazman, an attorney with the Competitive Enterprise Institute, representing the couple.

The Justice and Treasury departments declined to comment.

“Right-wing billionaires aimed to upend the tax code through an obscure legal case, seeking to evade taxes owed. However, their attempt was rejected by the Supreme Court,” Warren stated on Thursday. “We continue to push for taxing the wealthy, implementing a wealth tax on ultra-millionaires and billionaires, and striving for a fairer system.”

Historical Context and Legislative Intent

The Internal Revenue Code has targeted unrealized gains to prevent tax evasion and loopholes in the system. Since 1962, Subpart F has mandated that American shareholders in foreign corporations pay taxes on undistributed passive income.

A Republican-controlled Congress passed the 2017 tax law, imposing a one-time charge on overseas profits. The tax affected individuals like the Moores, who owned over 10% of a foreign company. They argued that appreciating assets shouldn’t be taxed until payout. The Justice Department claimed the 16th Amendment allowed Congress to tax at any financial cycle stage.

Potential Consequences of a Different Ruling

Tax lawyers believed that a win for the Moores could have put sections of the tax code involving partnerships, S corporations, and other business arrangements at risk, potentially rendering vast portions of the Internal Revenue Code unconstitutional.

“It leaves the government’s taxing power in a pretty strong place,” said John Brooks, a Fordham University law professor, who co-wrote a brief urging the court to rule against the Moores. “It’s as good a result as they could reasonably have hoped for.”

Unresolved Issues and Future Challenges

Seven justices upheld the 2017 tax, but the court narrowly avoided addressing if the 16th Amendment requires income realization before taxation. The split on this crucial question remains significant..

Thomas, Gorsuch, Barrett, and Alito endorsed the view that realization is necessary for income taxation.

Rep. Richard Neal (D., Mass.) said the court rightly upheld the tax—part of a tax-cut law he opposed. “The Court ensured that our tax system would continue to function as it has for nearly a century while declining to give in to the chaos and confusion sowed by partisan advocacy groups, and wreaking havoc on our tax code,” he said.

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