The Daily Signal By GianCarlo Canaparo and Cully Stimson
The Supreme Court heard oral arguments Tuesday in a little case with potentially huge implications. The high court’s eventual decision in Moore v. USA could give a green light to Democrats in Congress and in state legislatures to enact taxes on unrealized gains, what liberals call “wealth taxes.”
The Moore case doesn’t involve one of these wealth taxes itself, but the tax that Charles and Kathleen Moore are challenging operates along the same lines. That is, it taxes monetary gains that are “unrealized” and thus exist only on a balance sheet.
Background
Years ago, the Moores invested in a company that wanted to help India’s rural farmers—and turn a profit while doing so—by importing American-made tools into India.
The couple contributed $40,000 to help Ravi Agrawal found a company called KisanKraft and, in exchange, received about 13% of the company’s common shares.
Demand for American farm tools in rural India was large, larger than KisanKraft could satisfy as a small startup. So, the company reinvested all its profits to grow bigger.
The Moores, as minority shareholders, couldn’t force KisanKraft to pay them a dividend, but neither did they want to do that. They were content to keep their money in a company that was doing a lot of good for Indian farmers.
The Moores didn’t receive any payments from KisanKraft. But because the company was growing, their initial investment increased in value. That value, however, existed only on paper.
The Moores never received a dollar. And if the company suddenly went under, their investment would have disappeared.
For 12 years, all went well. And then the Internal Revenue Service knocked on the Moores’ door. The IRS insisted that under the “Mandatory Repatriation Tax” part of the Tax Cuts and Jobs Act of 2017, the Moores had to pay taxes on their share of KisanKraft’s reinvested earnings going back to the company’s founding 12 years earlier.
All those reinvested earnings were “income,” as far as the IRS was concerned, and the Moores owed the IRS its cut.
But where was the money? The Moores didn’t realize any income. They didn’t receive any distributions, stock dividends, or other payments whatsoever from KisanKraft. The “income” existed only on a balance sheet in a company half a world away.
How could the IRS demand a portion of money, the Moores wondered, that they hadn’t realized or received?
Under the Mandatory Repatriation Tax, the couple had to declare an additional $132,512 as “taxable 2017 income” and pay an additional $14,729 in tax.
The Constitution and Taxes
The Constitution limits the federal government’s taxing power. Under the 16th Amendment, the only direct tax (that is, a tax “upon property holders in respect to their estates”) that the government can take is an income tax.
And the historical definition of “income” includes the requirement that the money be “realized.” That is, the money is in the hands—or, at least, distributional control—of the person taxed.
The IRS disagreed. It claimed that realization isn’t necessary because that word doesn’t appear in the 16th Amendment.
This is essentially the same argument made by Democrats who support wealth taxes, such as Sen. Elizabeth Warren of Massachusetts and state legislators in seven blue states. These politicians argue that they can tax any unrealized gains, not just those from foreign investments.
Did the stock you purchased in June go up in value by Dec. 31? Then under their theory of government taxation, you must pay taxes on those unrealized gains.
The market crashed on Jan. 1 and wiped out your investments, you say? Too bad, you still owe taxes on the gains from Dec. 31. Where will you get the money from? That’s your problem. Pay up…
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