- A significant part of 2017 tax reform was the so-called “transition tax” or “mandatory repatriation tax,” (MRT) which was enacted by amendment to Section 965 of the tax code.
- Section 965(h) gave taxpayers the option to pay the tax in interest-free installments over the course of eight years. Most taxpayers who made the election still owe nearly half of the total tax liability imposed by the MRT.1
- A pending case before the U.S. Supreme Court, Moore v. United States, No. 22-800, could eliminate these remaining payments. The U.S. Supreme Court is expected to rule on the Moore case no later than June 2024.
Eligible for a refund claim on Section 965 installment payments?
An ongoing U.S. Supreme Court case has many in the tax world wondering whether remaining Section 965 installment payments could be a thing of the past. Get the details to see if you may be eligible for a protective refund claim.
The Tax Cuts and Jobs Act of 2017 (TCJA) enacted the mandatory repatriation tax (MRT), which imposed a tax on undistributed earnings of controlled foreign corporations (CFCs).
Prior to 2017, U.S. federal income tax was generally not assessed on CFC earnings until distributions were made to the CFC’s U.S. shareholders. This allowed an indefinite deferral of CFC earnings — and deferral of IRS collection of tax on those earnings.
The TCJA introduced a new system for taxing CFC earnings, starting in 2018, which taxes the CFC’s current year earnings.2 The MRT was the mechanism designed to transition to this new system by forcing a deemed dividend of, and capturing tax on, the CFC’s post-1986 undistributed earnings.
Supreme Court case details
At the end of 2017, Charles and Kathleen Moore owned a minority interest in a CFC based in India. The Moores reported their share of the India CFC’s post-1986 undistributed earnings on their 2017 federal income tax return, paid the entirety of their MRT in one payment, and then sued for a refund challenging the MRT’s constitutionality. Federal district and appellate courts ruled against them, but the U.S. Supreme Court agreed to consider the case and heard oral arguments on December 5, 2023.
The Moores’ argument for claiming the MRT unconstitutional is based on the definition of “income,” as used in the Sixteenth Amendment.3 During oral arguments, the Moores’ attorney, Andrew Grossman, compared a CFC’s undistributed earnings to “appreciation in the value of a home, a stock investment, or other property [which] is not and never has been taxed as income.” Until actual dividends are paid, no income is realized and any tax on undistributed earnings violates the Sixteenth Amendment.
Supreme Court justices ask questions
The court repeatedly questioned Grossman how the MRT could be distinguished from provisions such as partnership taxation and subpart F rules. Justice Sonia Sotomayor questioned why the Constitution allows for taxation of partners who have not realized any income. Grossman claimed that a partnership, unlike a corporation, lacks a “separate personhood,” which allows for taxation of the partners.
Sotomayor and Justice Amy Coney Barrett both pressed Grossman on how subpart F is different from the MRT. Grossman conceded subpart F is constitutional while noting it deals with current year income, as opposed to the MRT, which taxes historic income.
The U.S. government’s argument
Solicitor General Elizabeth Prelogar, representing the U.S. government, said Grossman’s concession that subpart F is constitutional is “incredibly significant,” claiming she sees no distinction from the MRT because both “are taxing the increment of gain over time and generally only doing it one time, with any future tax looking to a new increment of gain over a new period of time.”
While the court clearly expressed concern for potential far-reaching impacts of a ruling for the Moores, it also questioned Prelogar on consequences of the government’s position. Justices Clarence Thomas and Samuel Alito asked whether appreciation of real estate and stock could be taxed, if the court ruled realization of income was not required.
Prelogar admitted these would be more difficult questions but opined “there is no bright-line realization rule or requirement under the Sixteenth Amendment” and there was no need for the court “to set out to define ‘income’ for all purposes or to announce any bright-line rules about realization.”
Some tax scholars, professionals, and commentators believe oral arguments favored the government’s position but questioned how narrow the court’s ruling would be. However, initial impressions and predictions are often wrong, and until there is an official court ruling, it's too soon to speculate.
Regardless of the outcome, some tax practitioners believe the real objective behind the case is to coax the U.S. Supreme Court into stating a hypothetical federal wealth tax would be unconstitutional.
Although such a direct declaration seems unlikely, some justices may be inclined to pepper their opinions with examples of when taxation of unrealized income would be deemed unconstitutional. Such examples could be used in the future by U.S. Congressional leaders who oppose a federal wealth tax to narrow the scope of legislation or kill proposals altogether.
Consider how a court ruling could impact you
While the court deliberates over the coming months, some taxpayers may file protective refund claims that could benefit them if the court’s ruling invalidates the MRT.
Since the applicable statute of limitations requires any refund claim to be made no later than two years after payment of the tax— or three years after filing the applicable tax return, whichever is later, per IRC Section 6511 — taxpayers should make protective refund claims before two years pass from the date their Section 965 installment payment was made in 2022. (The due date for this payment was April 18, 2022, for calendar year taxpayers.)
A formal protective claim is essentially an amended return for credit or refund filed as a provisional placeholder to stay within the statute of limitations when the refund depends on the outcome of a pending case that is unlikely to be resolved until after the statute expires.
Taxpayers who paid significant amounts of Section 965 taxes should consider filing a protective claim to preserve their right to a refund in the event the U.S. Supreme Court rules in favor of the Moores.
Protective claims must meet specific criteria to be valid, and filing a protective claim does not guarantee the IRS will issue a refund.
How we can help
The impact of U.S. Supreme Court rulings can be complex. CLA’s tax team can help you determine eligibility for filing a protective refund claim with the IRS. Contact us for details and to discuss potential benefits and pitfalls.1 Section 965(h) calls for 8% to be paid in each of the first five installments, with 15%, 20% and 25% to be paid in the sixth, seventh and eighth installments, respectively.
2 Income representing 10% of tangible capital investment, calculated based on net fixed assets, is excluded from this tax on Global Intangible Low-Taxed Income (GILTI).
3 “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.” U.S. Const. amend. XVI