Judging as plumbing

In praise of a practical solution to Moore v. United States

On December 5, 2023, the Supreme Court will hear oral argument in Moore v. United States. The question presented in Moore is whether the Sixteenth Amendment authorized Congress to enact a particular provision of the 2017 federal tax code overhaul.

In my view, the Supreme Court should answer this question the following way: “The tax is unconstitutional. We have no idea where the line between constitutional and unconstitutional taxes lies, but wherever that line is, this tax crosses it. Our holding should not be construed to cast doubt on any other provision of the Internal Revenue Code.”

Legal purists will blanch. In addition to the unaesthetic nature of such a holding, it seems incoherent. How could the Court determine whether a tax crosses the constitutional line without deciding where the line is? Or put another way: implicitly, by holding that one tax crosses the constitutional line and other taxes don’t, the Court must have some idea of the line’s location. Why not just say where it is?

Answer: because any attempt to adopt a verbal formulation of the constitutional line is bound to be misleading and embroil lower courts in confusing disputes. Moore puts the Court into a zugzwang situation: whatever test it adopts will make things worse. The best way to do no harm is not to adopt a test at all.

Moore illustrates that judges are less like philosophers and more like plumbers. Their role is not to think deeply and elucidate the law’s True Meaning, but instead to provide practical solutions to concrete problems. Sometimes the judicial task is best performed by announcing and applying general legal rules. But not always.

(A judge fixing a sink. I think the thing he’s holding is supposed to be a wrench.)

The Moores win, we’re done

The easiest part of Moore is figuring out who should win. Spoiler alert: The Moores win Moore.

Oversimplifying matters dramatically, the question in Moore is whether a particular tax is a property tax or an income tax. If it’s a property tax, it’s unconstitutional. If it’s an income tax, it’s constitutional.

The parties refer to the tax at issue as the “Mandatory Repatriation Tax,” or “MRT.” Here’s how it works. Some foreign corporations are majority-owned by U.S. shareholders. If you were unlucky enough to be a U.S. shareholder of such a corporation in 2017, you had to pay the tax. Specifically, you were taxed on your pro rata share of all of the income that the foreign corporation had accumulated over the previous 30 years. Your pro rata share is determined based on the percentage of the corporation’s stock that you owned in 2017. So if you happened to own 15% of the foreign corporation’s stock in 2017, then 15% of the foreign corporation’s income over the previous 30 years would be considered your income for purposes of your tax return.

The Supreme Court will hold that the MRT is a property tax, not an income tax. It screams property tax. If you owned a particular amount of stock—property—in 2017, you paid the tax. It didn’t matter if the property had ever gone up or down in value. It didn’t matter whether you had ever, or would ever, gain anything from the investment. You own stock, you pay tax. That’s a tax on the ownership of the stock, just like property taxes are taxes on the ownership of your house.

The government’s theory goes like this. The tax applies to someone’s income—the corporation’s income. Sure, it’s the shareholder that’s being taxed, but it’s reasonable to deem a corporation’s income to be the income of its shareholders. As for the fact that the shareholder is being taxed on 30 years worth of income, well, if that seems unfair, maybe the taxpayer can bring a substantive due process claim.

Nice try, the Supreme Court will hold. An income tax is a tax on the taxpayer’s income. A taxpayer who pays taxes on income the corporation earned in 1987 merely because he owns some stock in 2017 isn’t being taxed on his own income.

That wraps up our legal analysis of Moore v. United States. Except, well, I’ve said nothing about the constitutional provisions involved, the relevant case law, or the legal standards proposed by the parties. And once you start looking at those things, the case gets harder.

Wait, you can amend the Constitution?

Article I of the Constitution says that a “direct tax” can’t be imposed unless it’s apportioned among the states—that is, the total amount collected from the taxpayers of each state must be proportional to the state’s population. Weirdly, Article I actually says this twice, in both Section 2 (“Representatives and direct Taxes shall be apportioned among the several States which may be included within this Union, according to their respective Numbers”) and Section 9 (“No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.”).

The phrase “direct Tax” should set off alarm bells in any lawyer’s head. The Supreme Court being the Supreme Court, one might expect some kind of ghastly 13-factor test to distinguish between “direct” and “indirect” taxes, the 13th of which is “any other factor tending to show the directness of the tax.” Happily though, this is not the case. It turns out that “direct tax” just means “property tax.” In NFIB v. Sebelius, 567 U.S. 519 (2012), for example, the Supreme Court held that a tax on not eating broccoli was not a direct tax because it was “not a tax on the ownership of land or personal property.”

But in Pollock v. Farmers’ Loan & Trust Co., 158 U.S. 429, affirmed on rehearing, 158 U.S. 601 (1895), the Supreme Court held that a tax on income earned from property—think rental income from land, or dividends from stock—was a “direct tax,” and hence had to be apportioned.

Pollock was a hugely significant decision because it effectively held that a federal income tax was unconstitutional. Although Congress could tax wages, Pollock held that Congress couldn’t tax passive income, and it would make no sense to force the working man to pay income tax while letting the robber barons in Connecticut, New York, &c., earn tax-free income while attending masked balls or spectating polo matches or whatever. Strictly speaking, Congress could apportion the direct tax, but this was unworkable given the dramatic disparities in wealth among the states.

Pollock was a bitterly divided 5-4 decision with an impressive total of six separate dissents (two from the original opinion, four from the rehearing opinion), which I think might be a Supreme Court record. The opinions are entertaining to read, I am quite fond of the old-school writing style. Mr. Justice White’s dissent from the original decision starts off with a bang:

My brief judicial experience has convinced me that the custom of filing long dissenting opinions is one “more honored in the breach than in the observance.” The only purpose which an elaborate dissent can accomplish, if any, is to weaken the effect of the opinion of the majority, and thus engender want of confidence in the conclusions of courts of last resort. This consideration would impel me to content myself with simply recording my dissent in the present case, were it not for the fact that I consider that the result of the opinion of the court just announced is to overthrow a long and consistent line of decisions, and to deny to the legislative department of the government the possession of a power conceded to it by universal consensus for one hundred years, and which has been recognized by repeated adjudications of this court.

He then rages about the decision for 45 pages of small font. The end of Mr. Justice Brown’s dissent from the rehearing decision is also pretty lit:

While I have no doubt that Congress will find some means of surmounting the present crisis, my fear is that in some moment of national peril this decision will rise up to frustrate its will and paralyze its arm. I hope it may not prove the first step toward the submergence of the liberties of the people in a sordid despotism of wealth.

As I cannot escape the conviction that the decision of the court in this great case is fraught with immeasurable danger to the future of the country, and that it approaches the proportions of a national calamity, I feel it a duty to enter my protest against it.

Nice! Pollock was intensely unpopular, particularly in the South and West. A movement grew to overrule Pollock via a constitutional amendment. Interesting fact, it is possible to overrule constitutional decisions by amending the Constitution, as opposed to today’s method of praying for a President from your party to be in office when a majority-flipping vacancy arises.

In 1909, Congress approved a constitutional amendment to overrule Pollock. By 1913, three-quarters of the states had ratified it, and the Sixteenth Amendment was born. Here’s what the Sixteenth Amendment says:

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.

It’s just a one-time thing, no biggie.

Fast forward 104 years.

In 2017, Congress enacted and President Trump signed an overhaul of the federal tax code. One of the many changes concerned the tax treatment of “Controlled Foreign Corporations” or CFCs—foreign corporations that are majority-owned by U.S. shareholders.

CFCs present a tax problem because they allow U.S. taxpayers to stick their money in some foreign entity and indirectly benefit from the foreign entity’s earnings without ever paying taxes. For many years, some CFC income, such as passive income—what our tax-lawyer friends refer to as (sigh) “Subpart F” income—was imputed to the U.S. shareholders. So if the CFC made money, the shareholders paid taxes on it. But other CFC income—such as active business income—wasn’t imputed to the U.S. shareholders. And, of course, the U.S. government couldn’t tax the CFC because it’s a foreign entity.

In the bad old days, when the CFC paid a dividend out to a domestic shareholder, the dividend was taxed. This created a problem. Suppose you’re a U.S. corporation that owns shares in a CFC. If the CFC earns money and spends it abroad, the U.S. corporation doesn’t pay tax. If the CFC earns money and sends it home in the form of a dividend to the U.S. corporation, the U.S. corporation does pay tax. This creates a huge incentive to keep dollars offshore. Bad! So in the 2017 tax code overhaul, Congress eliminated this incentive by essentially abolishing taxes on dividends that foreign corporations paid to domestic corporations.

But this created another problem—it would give a huge, unfair windfall to the CFCs who didn’t invest in the United States. Nice, patriotic CFCs who made money before 2017 and sent it home were taxed on that income. Mean, America-hating CFCs who made money before 2017 and didn’t send it home would never be taxed on that income under the new law.

To redress that unfairness, Congress decided that all of the CFCs’ income that accumulated between 1986 and 2017 had to be taxed. Thus the Mandatory Repatriation Tax (MRT) was born. The MRT was a one-time transitional tax intended to ensure that pre-2017 CFCs who paid dividends were treated the same way as pre-2017 CFCs who didn’t. The CFC couldn’t pay the tax because it’s foreign, so the income was imputed to U.S. shareholders.

In my opinion, the tax is fair and reasonable. But sad to say, sometimes fair and reasonable things don’t comport with the Constitution.

I realize it’s a hard case

The Sixteenth Amendment authorizes Congress to “lay and collect taxes on incomes.” The Moores paid the MRT and then sued for a refund, claiming the MRT was unconstitutional. In Moore, the Supreme Court will decide whether the MRT is an income tax, and hence authorized by the Sixteenth Amendment.

(The astute reader will observe that even if the MRT isn’t an income tax, that doesn’t necessarily mean it’s unconstitutional. Instead, the MRT is unconstitutional only if it’s a direct tax. If it’s neither an income tax nor a direct tax, it’s constitutional. And indeed the government has a backup argument that it’s a third type of tax—an “excise tax.” In my opinion, the MRT is pretty clearly a direct tax under Pollock, but do we really want to give the much-loathed Pollock precedential effect at this point? Fun question but I’ll skip over it.)

As framed in the petition for certiorari, the question presented is whether the Sixteenth Amendment incorporates a “realization” requirement. The Moores take the view that “income” requires realization; the income that is taxed by the MRT was never realized; ergo, the MRT isn’t an income tax under the Sixteenth Amendment. The government says that “income” means gain, and realization of that gain isn’t needed.

So, does income require realization? To paraphrase Bill Clinton, it depends on what “realization” means. If the Court says that “income” requires “realization” without clarifying what “realization” means, then it will be engaging in the classic jurisprudential tactic of interpreting a vague term by replacing it with a different, equally vague term.

If “realization” means “you actually get the money in your pocket,” the answer is probably no, because that would have all kinds of bad implications I’ll get to below. But even the Moores don’t take that position. Instead, they contend that “realization” encompasses not just “getting the money in cash,” but also what they call “constructive realization,” which are things that are sort of like realization but not actually realization.

So the question in Moore is whether “income” includes cash in your pocket, and situations where you sort-of-but-not-really get cash in your pocket, but not situations that seem really different from getting cash in your pocket.

Seriously, it’s a hard case

It’s a vague question. And as struggling through the briefs makes clear, vague questions yield vague answers.

Would the ordinary public meaning of “income” in 1913 have included an ill-defined “realization” requirement? It’s hard to say. Both parties cite ratification-era dictionaries and secondary sources that support their position. The Moores cite sources saying that income requires receiving something. The government cites other sources saying that income requires gaining something. IDK.

As for case law, the Moores rely heavily on Eisner v. Macomber, 252 U.S. 189 (1920). In Eisner, Standard Oil decided to make a “book adjustment” that increased its total number of shares while correspondingly diluting the value of each share. For example, if a shareholder previously held 100 shares at $1.50 per share, the shareholder would now own 150 shares at $1.00 per share. The Supreme Court said that these new shares weren’t “income,” which doesn’t surprise me because the shareholders got no value from them. But it then threw in the Dictum that Launched a Thousand Tax Protestors:

Here we have the essential matter: not a gain accruing to capital, not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital however invested or employed, and coming in, being "derived," that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal; — that is income derived from property.

In the 103 years since Eisner, there have been several cases in which the Supreme Court has applied that language narrowly and upheld various federal taxes, but without ever overruling Eisner. The parties fiercely debate the implications of those cases.

There’s a famous Jewish parable involving two neighbors caught in a dispute who take their case to the Rabbi. The first neighbor explains in detail why his position is correct, and the Rabbi nods and says, “you’re right.” Outraged, the second neighbor explains his diametrically opposite position. After listening patiently, the Rabbi says, “you’re also right.” The Rabbi’s attendant says, incredulously, “they had completely opposite arguments, they can’t both be right.” The Rabbi thinks for a moment and says, “you’re also right!”

That is what the dispute over Eisner is like. The Moores say that Eisner has been applied narrowly for 103 years, and so we should stick with it. They’re right about that. The government says that Eisner has been applied narrowly for 103 years, and so we should stick with that trend. It’s right about that too. If you think these two arguments lead to diametrically opposite implications, you’re also right.

The parties spend considerable time debating the practical implications of a ruling in the Moores’ favor, which to me is where the rubber hits the road in a tax case. As the government points out, there are lots of situations in which gains are considered “income” without cash going into the taxpayer’s pocket.

In some cases, income received by someone else is imputed to the taxpayer. For example, as many a law firm partner has sadly learned, partners pay taxes on their share of the partnership’s income, regardless of whether that share has actually been distributed. In other cases, a taxpayer pays taxes on economic gain that has yet to be liquidated. For example, if you own a futures contract that has gone up in value during the year, you sometimes have to pay tax on the gain, even if you haven’t sold the contract.

In large part these statutes exist to undermine creative tax-avoidance schemes (e.g., avoiding U.S. taxes via a foreign corporate shell, or buying a futures contract on December 31 and selling it on January 1). It would be extremely undesirable for the Supreme Court to hurl a thunderbolt declaring all of these statutes unconstitutional under the Sixteenth Amendment, and the Moores wisely do not advocate this. Instead, they declare that all of these statutes satisfy the Sixteenth Amendment because they involve “constructive realization.”

As the government rightly observes, however, in our legal system, the word “constructive” means “it’s not, but let’s pretend that it is.” “Constructive notice,” for example, refers to the situation where notice is required, but a person didn’t get notice, but it would be convenient if the person did get notice, so we’ll simply pretend the person got notice via the dulcet phrase “constructive notice.” If the Moores accept “constructive realization,” they accept that actual realization isn’t required. And if that’s true, why not say that the Moores “constructively realized” the CFC’s income?

Do nothing, there is no try.

Let’s take stock, so to speak, of where we are.

There are at least four reasons one would be very tempted to rule for the government in this case.

Uncertainty on the merits. One theory of constitutional interpretation holds that an Act of Congress shouldn’t be invalidated unless one is really sure it’s unconstitutional. This theory is contested, but if you subscribe to it, you should be reluctant to strike down the MRT based on the highly unclear question of whether “income” includes a poorly defined “realization” requirement.

Lack of sympathy for the plaintiff. OK, this shouldn’t affect our legal judgment, but it’s hard to avert one’s eyes. The Moores held the stock for the past 30 years, so all the income at issue is at least indirectly theirs. They’re seeking to pay $0 in taxes on this income because they kept it parked in a low-tax foreign country. These plaintiffs are not exactly the 93-year-old woman whose home equity was stolen to fund Burning Man.

Lack of sympathy for the plaintiff’s proposed rule. It doesn’t make sense that property taxes have to be apportioned and income taxes don’t. Admittedly this is in the Constitution, but it’s still difficult to come up with a coherent theory about how this particular distinction protects liberty.

Practical consequences that are uncertain and possibly disastrous. This is the big one. If the plaintiffs win and the Court announces some kind of “constructive realization” rule, then it will be Christmas for tax lawyers, who will dream up all manner of tax-evasion schemes premised on income not being “constructively realized.”

I’m sure the government will fight this, but tax litigation is already too complicated. It’s hard enough for judges with little knowledge of tax law to get slammed with disputes over the calculation of the allocable share of partnership liability under the debt-financed distribution exception to the disguised sale rule or whatever. Do we really want to superimpose an additional layer of analysis in which the court has to divine how Theodore Roosevelt would have applied the “constructive realization” standard?

This problem cannot be solved merely by refining the precise legal standard for “constructive realization.” No legal standard is satisfactory. The Justices have no familiarity with the various and sundry statutes and Treasury Rules that might be at risk. They have no idea how their verbal formulation of the legal standard will affect incomprehensible tax disputes they cannot even imagine.

All of this is almost a reason to support the government’s position. But not quite. I’m going to get dewey-eyed here … we do live under a written Constitution that judges must follow through thick and thin. And there’s simply no way that money earned by a company 30 years ago is a taxpayer’s “income” merely because the taxpayer has bought some stock. The opinion just won’t write.

That’s why I want the Moores to win without the Supreme Court saying anything about the legal standard beyond that the Moores win. Circling back to where I started: the Moores win because this isn’t income. Exactly where the line between income and non-income is, I do not know. Don’t get your hopes up, tax shelter designers.

It’s an ugly solution, but it’s practical. Or to put some better spin on it, it’s a victory for the rule of law, a victory for the tax base, and a victory for America.