Federal tax law is somewhat complex when it comes to the earnings of business entities. Some business entities are considered “pass-through” with all earnings being treated as income of the members/shareholders with the entity paying no taxes. “Traditional” corporations pay corporate income taxes, and the shareholders are only taxed on distributions. Usually, the “retained” income of these corporations builds up the value of the company which is reflected in capital gains income when a shareholder sells her stock.
But these rules are the rules that apply to U.S. corporations. Different rules apply to Americans who invest in foreign corporations. Some income, mostly things that are characterized as passive income, is “passed through” to U.S. shareholders for the purposes of federal income tax (and many states tie their definitions of income to the federal definition). However, traditionally, other income was not “passed through” with the U.S. shareholder only getting taxed when that income was distributed as dividends or through capital gains when the shareholder sold his stock.
During the Trump Administration, in part to hide the actual price of Trump’s tax cuts and in part due to Trump’s “America Only” philosophy, Congress changed the rules for stocks in foreign corporations and imposed a “one time only” repatriation tax which taxes American shareholders their interest in the corporate earnings which had been retained by these foreign corporations and not distributed to the shareholders as interest. Some of these shareholders challenged the suit claiming that the tax was not authorized by the Sixteenth Amendment.
The gist of the complaint is that, excluding the Sixteenth Amendment, the U.S. Constitution only permits certain types of taxes. For any tax imposed on persons, the tax must be apportioned among the states based on the state’s population (which is the reason why there is no federal property tax because the percentage would have to be recalculated for each state with residents of wealthier states paying a lower rate than residents of poor states). After the U.S. Supreme Court in the Nineteenth Century struck down the first attempt at an income tax, as violating this rule the Sixteenth Amendment was adopted to authorize an income tax. As such, the question is whether this type of repatriation tax is an income tax.
In Moore vs. United States, the U.S. Supreme Court decided that this type of tax was an income tax. In holding for the government, Justice Kavanaugh, writing for the majority of the Court, agreed with the government that this tax on “unrealized” income was still a tax on income and rejected the taxpayers argument that this tax was a tax on property value. This opinion was a 5-2-2 decision. Justice Kavanaugh, for the majority, sees this type of law as simply a decision reclassifying what is passthrough income. Justice Barrett, joined by Justice Alito, believes that there are limits to the ability of Congress to disregard the corporate form and attribute corporate income to shareholders but thinks that the particular law in question is valid. And Justice Thomas joined by Justice Gorsuch finds that this type of tax is a property tax.
Given the split in this opinion, it is pretty clear that a wealth tax would be rejected by the U.S. Supreme Court. There is a possibility for one additional tax that the federal government does not currently impose, but it is unclear how this Court would treat that tax, and that would be a tax on stock options as executive compensation. For those not familiar with stock options, a stock option is the right to buy a stock at a certain price. For some, stock options are contracts generated on the open market with one investor selling a contract that, on a certain date in the future they will offer to sell to the contract holder 1,000 shares of Acme Corporation for $25.00 a share. The purchaser pays $2,000.00 for this right in the hope that Acme (which is currently selling for $23.00 a share) will gain enough value that $25,00 a share would be a bargain price. As a form of executive compensation, it is the company which is offering to sell the shares to its executives in exchange for the executive continuing to work for the company (i.e. it is part of the executive’s salary). Under current law, the option is not income, nor is income realized when the executive takes advantage of the option to buy stock for less than its market value. The executive is only taxed (on capital gains) when they sell the stock or accept payment to surrender their option without purchasing the stock. In theory, this case might allow the government to tax the executive on “unrealized” capital gains on the difference between what they paid for the stock and the market price of the stock on the date of purchase. But whether there is any interest among Democrats in pursuing this type of tax on executive compensation is unclear.
In short, the opinions in this case demonstrate that this Court is likely to place significant restrictions on some ideas that progressive are proposing.
