Moore vs. US, Why It's an Important Tax Case
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| AI drawn picture. |
As to taxes, they are evidently inseparable from Government.
It is impossible without them to pay the debts of the nation, to protect it
from foreign danger, or to secure individuals from lawless violence and rapine.
Alexander
Hamilton
This is not a line in a song from
the musical Hamilton. It’s an actual quote from Hamilton, the nation’s
first Secretary of the Treasury and the architect of our governmental financial
system. Although the creation of the IRS (1862 some 58 years after his death)
was years away, Hamilton and other Founding Fathers long knew that the fledgling
republic could not survive without some kind of taxation system in place to pay
the costs of the Government. General Washington needed money to arm his
soldiers. President Washington needed money to run the country.
Currently in the news is the tax
case of Moore vs. USA. The case deals with a couple residing in
Washington state who invested in a controlled foreign corporation (India) and
the impact of provisions of the 2017 Tax Cuts and Jobs Act (TCJA) on their US
income.
Much of the press coverage headlines
that the Moore’s are retired and that the case deals with income that is not “realized”.
I find that both headlines take away from the real lesson of this case to most
Americans who don’t have ownership in controlled foreign corporations or deal
with realized or unrealized income.
Income realization, or rather determining
the timing of income for tax purposes, is an important part of our tax environment.
At first blush, this case seems to take
issue with the concept of realization,
which would shake the foundation of our tax system. Moore deals with
earnings from a foreign corporation and the Mandatory Repatriation Tax
provision (MRT) of the TCJA.
Still with me? The taxpayer’s argument
is that they should not pay tax on income which they never received in their
hand. This income exists on paper and is only deemed income by virtue of the MRT
provision of the TCJA. This is sometimes referred to as “phantom income” and is
considered the worst type of taxable income. You never received the actual
dollars, and yet you are taxed on this income as if you did receive the income.
Fortunately, phantom income is rarely seen by most taxpayers.
Normally, if this was a
corporation located in the US it’s income would be considered earnings and
profits and thus taxed at the corporate level. The income is realized when
earned. Corporate earnings and profits are taxed as dividends to the shareholders
if they are distributed (the double taxation of C corporation profits). An S
corporation’s income would be taxed to the shareholders via a k-1, whether distributed
or not. Here, you have the benefit of the income and reinvested those profits
into the S corporation by not distributing them.
More specifically, Moore
is a CFC located in India, that apparently has no connection with the US other
than it has US shareholders. This is where this story gets extremely technical
tax wise, as you are dealing with the foreign tax provisions of the US Tax
Code, as well as the foreign tax and repatriation provisions of the TCJA. For a
quick background on how large corporations shield income, Google “Double Irishwith a Dutch Sandwich”. Keep in mind
that the corporation at issue in Moore is closely held, but this illustrates
the point as to how corporations deal with US taxes.
I see another meaning in Moore.
As it has captured the public’s attention, at least for this new cycle, let’s
use this opportunity to understand that every change, every interpretation,
every IRS position, has an impact on the amount of taxes collected under any respective
provision of the tax code. Ultimately the tax burden falls on us, the
taxpayers, and we will benefit by understanding how our government is financed.
Sure, we all want lower taxes, but most of us have our own interests that we
are looking to protect.
One aspect of the TCJA was to tighten
the loopholes corporations use to reduce US taxes. MRT was the wrench to
accomplish part of that tightening. Congress passed the TCJA, with tax cuts in
other places to other taxpayers, and paying for it in part with increased
tax collections from corporations with foreign operations by way of the MRT.
For every action there is a
reaction.
There is no free lunch.
It’s too good to be true.
Use whatever expression you want to use here – any loophole that closes for one creates a benefit for another. You want to increase the standard deduction? Fine, how do you pay for the cost of that increase? Limit the deduction for state and local income taxes? The real estate industry would say that it would stimulate the real estate sector of the economy to lift the cap on SALT. True, but at what cost and to whose benefit?
This is the real lesson of Moore.
Is it fair to assign the tax cost to taxpayers similarly situated to the Moores,
in order to benefit the greater good of other taxpayers? Is it constitutionally
fair to tax the Moores on income that they did not actually receive? Most tax
scholars think the answer is yes. The Federal District Court and the Ninth
Circuit seem to agree. My bet is that the Supreme Court will find likewise –
its too important to the Government that the provisions of TCJA continue.
We all need to become better
consumers when it comes to understanding what’s being sold to us in the form of
tax legislation.
If a nation expects to be
ignorant and free, in a state of civilization, it expects what never was and never
will be.
Thomas
Jefferson