The cases address a diversity of tax issues, ranging from the constitutional balance of governmental power to practical estate tax calculations. Moreover, the substantial judicial explanation and banter in the rulings provide insight as to how the Court will address future constitutional and financial legal issues.

Moore  

In Moore v. U.S., 36 F.4th 930 (9th Cir. 2022),^[1] the U.S. Supreme Court ruled on a constitutional challenge of I.R.C. §965, the mandatory repatriation tax (MRT). The MRT is a one-time repatriation tax (or deemed dividend) that passes through undistributed accumulated income of U.S.-controlled foreign corporations (CFCs). Section 965 is part of the 2017 Tax Cuts and Jobs Act (P.L. 115-97), which addresses foreign business earnings, including CFCs, inversions, and the GILTI^[2] tax. The act generally taxes U.S shareholders owning 10% or more of a foreign corporation on otherwise tax deferred foreign earnings. The MRT attaches to prior years (despite taxpayer compliance with prior CFC law).

• Facts of Case — Charles and Kathleen Moore were minority owners of KisanKraft, a CFC in India. The Moores paid $40,000 for 13% equity in the CFC in 2005. The CFC reinvested all profits into the business. Under the CFC rules (prior to MRT), tax did not generally accrue to CFC owners until distribution. The MRT eliminated the tax deferral (from prior years) by imposing income tax on CFC accumulated (undistributed) earnings. The Moores paid the MRT ($14,729) and sued for a refund in federal district court.

The Moores claimed that the MRT violates the Direct Tax Clause of the U.S. Constitution as an unapportioned direct tax on corporate shares. The Constitution states: “No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or enumeration herein before directed to be taken.” Direct taxes are generally imposed on people^[3] and property. The U.S. Constitution requires that direct taxes be apportioned among the states (according to population), while indirect taxes are not subject to apportionment, but must be uniform across all states. The required apportionment of direct tax may lead to unfair and random tax rates in the different states. Apportionment is, thus, a significant political obstacle to enacting enforceable federal tax legislation.

In 1895, SCOTUS ruled that direct tax (requiring apportionment) includes tax on income from property by reason of its ownership (Pollock v. Farmers’ Loan & Trust Co., 157 U.S. 429 (1895)). The Pollock ruling, thus, made income from property a direct tax.

The 16th Amendment to the U.S. Constitution (1909) reversed Pollock, to enable Congress to tax all income “from whatever sources derived” (i.e., services and property), without regard to apportionment. The amendment reads: “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.”

After passage of the 16th Amendment (1913), Congress enacted the federal income tax (on indirect earnings). A later case, Eisner v. Macomber, 252 U.S. 189 (1920), states that income tax (although avoiding apportionment) may only be imposed on income, the economic benefit from which is realized, through sale or conversion of capital assets. Income tax may otherwise be imposed on compensation and funds received as rents and interest (i.e., the “fruit of the tree”).

The Moores, thus, claimed that the MRT amounts to an unconstitutional taxation of unrealized income. The Moore’s contended that income must be realized under the 16th Amendment before becoming subject to tax. As they could not access or benefit from accumulated CFC earnings (i.e., realize the income), Congress may not tax the income.

The Moores claimed that the MRT (on undistributed earnings) is, thus, a tax on property, subject to required apportionment and, thus, unconstitutional (as not apportioned). The government claimed that the MRT is a tax on indirect income and that realization is not required

• Rulings — The trial court rejected the constitutional challenge to the MRT. The Ninth Circuit Court of Appeals affirmed, based on the government’s premise that income realization is not a determinative factor in assessing Congress’s power to tax. The appellate ruling raises the realization issue. Specifically: Does the U.S. Constitution require taxpayer realization (economic benefit) of income before Congress may impose tax?

SCOTUS affirmed the appellate court’s ruling that U.S. owners of a CFC are subject to the MRT. Justice Brett Kavanaugh (author of the majority opinion) restated the issue as “whether Congress may attribute an entity’s realized and undistributed income to the entity’s shareholders or partners, and then tax the shareholders or partners on their portions of that income. This Court’s longstanding precedents, reflected in and reinforced by Congress’s longstanding practice, establish that the answer is yes.”

The majority (Justice Kavanaugh, joined by Justices John Roberts, Sonia Sotomayor, Elena Kagan and Kentanji Brown Jackson) clarified that “the MRT does tax realized income, namely income realized by the corporation KisanKraft.” Justice Kavanaugh essentially equated the MRT to taxation of pass-through business income (such as K1 partnership or S income). The Court noted, “The Moores explicitly concede that partnership taxes, S-corporation taxes, and subpart F taxes are income taxes that are constitutional and need not be apportioned.”

Justice Kavanaugh explained that the Moores tried to distinguish the MRT from 1) partnerships (with income taxed to the partners); 2) “S” shareholders (who choose to be taxed directly on corporate net income); and 3) subpart F (taxing undistributed foreign corporate passive income). Justice Kavanaugh dismissed the Moores’ attempt to distinguish the MRT (without addressing 1) that the Moores never elected pass-through status and 2) complied with the CFC non-attribution rules for nearly 20 years prior to the ruling). Justice Kavanaugh seemed reluctant to interfere with existing tax policy (and revenue).

Justice Kavanaugh clarified that the MRT taxed income realized by the Indian CFC (avoiding the necessity to review any income realization issue). As income was realized at the entity level (in India), the Court found that defining “realized” became unnecessary. By attributing income (realized by an entity) to its owners, the Court avoided the issues of 1) forced recognition of involuntary “pass-through” income earned in prior years and 2) whether taxing “unrealized” income (without a direct economic benefit) is constitutionally permissible.

The majority relied on historical precedent that either (but not both) the entity or its owners may be taxed on undistributed income. Specifically, Congress may tax either the entity or owner/shareholder (on income realized, whether from a domestic entity or CFC). The taxpayers were, therefore, “attributed” with their portion of accumulated (undistributed) earnings of the Indian CFC.

Justice Kavanaugh made clear that the majority ruling only applies to pass-through income:

“That said, we emphasize that our holding today is narrow. It is limited to: (i) taxation of the shareholders of an entity, (ii) on the undistributed income realized by the entity, (iii) which has been attributed to the shareholders, (iv) when the entity itself has not been taxed on that income. In other words our holding applies when Congress treats the entity as a pass-through.” Justice Kavanaugh disclaimed any opinion on a realization requirement to taxing income. Although, Justice Kavanaugh suggested that taxing the entity and shareholders on the same income may not be permissible; tax on wealth or unrealized capital gains “are potential issues for another day.”

Justice Ketanji Brown Jackson concurred with the majority opinion that tax may be imposed. Justice Brown rejected any realization obstacle to taxation.

Justice Clarence Thomas (joined by Justice Neil Gorsuch) adhered more strictly to existing constitutional limitations on taxation. Justice Thomas objected to the majority’s concept of income attribution, without realization of any economic “fruit from the tree.” Thomas and Gorsuch read the 16th Amendment to require income realization before Congress may impose tax (without apportionment). Justices Thomas and Gorsuch therefore consider the MRT unconstitutional:

The majority’s Sixteenth Amendment attribution doctrine is a new invention. The majority justifies its creation by plucking superficially supportive phrases from an eclectic section of tax cases. But, none of the cases supports the proposition that the Sixteenth Amendment empowers Congress to freely attribute income to any taxpayer it reasonably chooses.

Justice Amy Coney Barrett (joined by Samuel Alito),^[4] concurred with the majority ruling (seemingly because the taxpayers conceded that Subpart F is constitutional). Justice Coney Barrett found Subpart F (a pass-through tax on passive CFC income) “not meaningfully different from the MRT” and joined the majority ruling to impose tax. Justice Coney Barrett, however, sided with Justice Thomas and Gorsuch, that taxable income must be realized (analogous to a cash distribution of “profits from capital” from a non-pass-through entity or receipt of “something new and valuable”).

Justice Coney Barrett explained, “because they have not received a dividend, profit from selling their shares, or any other pecuniary benefit from their stock ownership, the Moores have not yet received a return on their original investment in the company. In short, they have not derived income from their shares because nothing has come in.” Justice Barrett rejected the constitutionality of a tax on unrealized appreciation, as the stockholder received nothing for his or her separate use or benefit. Four justices, therefore, condition taxation on the realization of income.

• Commentary — The case leaves several open questions. For example, when income tax is paid abroad by a foreign non-pass-through entity, should tax be considered unpaid (allowing for the imposition of a shareholder level (pass-through) tax on undistributed earnings from prior years)? Retroactive attribution of taxable income (reinvested by the CFC) to a U.S. shareholder seems onerous (especially when the CFC reinvested available cash, leaving no distribution available to a U.S. owner).

Hopefully, SCOTUS will soon accept review of a case involving a wealth tax or tax on (unrealized) appreciation. With the exception of Justice Brown (who rejects realization as a constitutional obstacle to taxation), if only one of the three other justices under the Kavanaugh opinion side with Justices Thomas, Gorsuch, Coney Barrett, and Alito, income tax on wealth or unrealized appreciation may be ruled unconstitutional.

Loper Bright

In Loper Bright Enterprises et al. v. Raimondo, 544 F. Supp. 3d 82, 103-04 (2021),^[5] the U.S. Supreme Court overturned the Chevron doctrine, a mandatory policy of deferring court discretion to federal agency regulations.^[6] Chief Justice Roberts authored the majority (6-3) opinion.

• Facts of the Case — Two commercial fishing companies challenged an administrative rule by the National Marine Fisheries Service, requiring the companies to cover the cost of a mandated government observer.
• Rulings — In an opinion delivered by Chief Justice Roberts, SCOTUS overturned the longstanding judicial deference to administrative agencies on interpretation of federal statutes. The U.S. Constitution^[7]and the Administrative Procedure Act (1946) leave statutory interpretations to the courts. The APA establishes the guidelines for implementation of federal administrative rules but allows for judicial review in §10 of “all relevant questions of law.”

Although caselaw (prior to Chevron) interpreting the APA allowed judicial intervention based on the thoroughness, reasoning, and consistency of the applicable administrative regulation, Chevron USA v. National Resource Defense Council, Inc., 467 U.S. 837 (1984), removed federal court interference from any permissible administrative interpretation. Thus, even if a federal court disagreed with an administrative interpretation, the court would yield to it if reasonable.

Chevron mandates a two-part process for courts to review a challenge to a statutory interpretation by a federal agency. First, if Congress addressed the issue, the law is clear and requires no administrative or other interpretation. If, however, the statute is ambiguous, the court must assess whether the regulatory agency has adopted a “reasonable interpretation” of the statute. The court must enforce any such reasonable regulatory interpretation.

The Chevron doctrine, thus, directs federal courts to defer to the reasonable interpretation by federal agencies regarding ambiguous federal law. Such judicial deference to regulatory agency interpretation essentially presumes enforceability when Congress reflects its intention that a regulatory body fill any gap in statutory coverage. Chevron, thus, requires judicial deference to regulatory agency interpretation of ambiguous law or situations not addressed by federal statute. The Chevron doctrine had been followed for 40 years.^[8]

The D.C. District Court in Loper found the federal statute silent on whether boat owners may be forced to pay a government monitor and authorized the regulatory mandate (and the associated cost to be paid by the fishing company). The D.C. First Circuit Court of Appeals affirmed that the regulation provides a reasonable interpretation of the statute (i.e., leaving the determination to the agency, per Chevron).

Justice Roberts, for the majority, vacated the lower court rulings and overturned Chevron. Justice Roberts relied on the traditional role of the courts to interpret all law. SCOTUS rejected the idea in Chevron that “statutory ambiguities are implicit delegations to agencies.” Justice Roberts harkened to the founders and the role of the courts “to decide legal questions by applying their own judgement.”

Justice Roberts ruled that the courts are free to defer to administrative regulation, based on the court’s assessment of its thoroughness, reasoning, and consistency. The courts must then, however, apply their independent judgement. Federal courts may now freely interpret otherwise ambiguous federal statutes without being bound by an administrative interpretation that a court does not believe to provide the best interpretation. Justice Roberts explains:

The Framers also envisioned that the final “interpretation of the laws” would be “the proper and peculiar province of the courts” (A. Hamilton). Unlike the political branches, the courts would by design exercise “neither Force nor Will, but merely judgment.” To ensure the “steady, upright and impartial administration of the laws,” the Framers structured the Constitution to allow judges to exercise that judgment independent of influence from the political branches. This Court embraced the Framers’ understanding of the judicial function early on. In the foundational decision of Marbury v. Madison, Chief Justice Marshall famously declared that “[i]t is empathetically the province and duty of the judicial department to say what the law is.”

The Court clarified that prior decisions, based on Chevron, remain enforceable. Unambiguous grants of power by Congress to the applicable administrative agency will also continue to be enforced. Legislative delegation of power is not a statutory gap or ambiguity.

Justice Thomas, concurring, confirmed that “Chevron deference also violates our Constitution’s separation of powers.” Justice Thomas expounds:

To provide “practical and real protections for individual liberty,” the Framers drafted a Constitution that divides the legislative, executive, and judicial powers between three branches of Government. Perez, 575 U.S., at 118 (opinion of THOMAS J.). Chevron deference compromises this separation of power in two ways. It curbs the judicial power afforded to courts, and simultaneously expands agencies’ executive power beyond constitutional limits. Chevron compels judges to abdicate their Article III “judicial Power.” §1. “[T]he judicial power, as originally understood, requires a court to exercise its independent judgment in interpreting and expounding upon the laws.” Perez, 575 U. S., at 119 (opinion of THOMAS, J.);accord, post, at 17-18 (opinion of GORSUCH, J.). The Framers understood that “legal texts…of often contain ambiguities over time.” Perez, 575 U. S., at 119 (opinion of THOMAS, J.); accord, ante, at 7-9.

The dissenting opinion from Justice Kagan (joined by Justices Sotomayer and Jackson) is based on judges having inadequate subject matter expertise to properly apply the regulations. No mention was made of the potential benefits of 1) judicial reliance on a non-governmental technical expert or 2) shifting administrative authority away from a potentially over-zealous enforcement agency.

• Commentary — Although existing rulings will be respected, SCOTUS recently confirmed that even long enforced regulations are exposed to challenge. In Corner Post, Inc. v. Board of Governors of the Federal Reserve System, 603 U.S. ___ (2024), SCOTUS clarified that claims against the U.S. government would not be barred by older regulations. SCOTUS ruled that the six-year statute of limitations on challenges to regulations will not start to run until the plaintiff is injured by agency action.

The courts may now rely on their own interpretation of laws in dispute. Loper will impact tax as well as environmental, healthcare, and other laws subject to any federal regulation. Interestingly, technical experts outside the government will likely become more integral to the judicial process, as courts may now freely question even permissible administrative statutory interpretation. The Loper ruling balances the scales from essentially mandatory enforcement of agency interpretation to an open debate of statutory ambiguity.

Expect a waive of challenges to existing federal regulations.

Connelly

In Connelly, as Executor of the Estate of Connelly v. United States, 144 S. Ct. 1406, 1414 (2024), SCOTUS assessed the value (for estate tax purposes) of corporate-owned life insurance proceeds. The issue is whether the value of insurance proceeds (held to fund a mandatory shareholder redemption) may be offset by the corporation’s obligation to purchase the decedent’s shares. In other words, does the corporate obligation to redeem reduce the value of shares held by the selling estate?

The litigants agreed that the value of stock held by a decedent shareholder in a closely held U.S. company includes the value of life insurance held by the company (on the life of the deceased). Prior caselaw allowed the estate of a deceased owner to offset the value of corporate life insurance (from share value), if used to fund the mandatory redemption of the deceased shareholder. SCOTUS ruled that a corporate obligation to redeem corporate shares (funded by the life insurance) does not reduce (offset) the corporation’s value (by the insurance proceeds) for U.S. estate tax purposes. This unanimous decision illustrates the Court’s practical and direct methodology in altering prior caselaw when the issue under consideration is unrelated to the federal balance of power.

• Facts of the Case — Michael and Thomas Connelly together owned Crowne Supply, Inc., a building supply company. Michael held about 77% of the stock outstanding and Thomas 23%. The brothers signed a buy-sell agreement, affording the surviving brother the option to purchase the deceased brother’s shares. Under the buy-sell arrangement, price-per-share was governed by an annual certificate of agreed value, to be executed by the brothers or through appraisal. If the surviving brother opted out of purchasing the deceased’s equity, based on an annual shareholder certificate of value, the corporation must then redeem any remaining shares of the deceased. The redemption price is the appraised fair market value of the shares.

The corporation purchased life insurance to fund the redemption of a deceased brother. Each policy offered coverage of $3.5 million to ensure sufficient cash to cover a death buyout.

Upon Michael’s death in 2013, Thomas did not elect to purchase his shares, triggering the corporation’s obligation to redeem the shares (using $3 million of the $3.5 million life insurance proceeds). Michael’s estate, therefore, valued the company at just under $4 million (and Michael’s shares at $3 million). Michael’s son and Thomas agreed that the value of Michael’s shares was $3 million. Crown paid the agreed redemption price, which was the value reported on Michael’s estate tax return. Michael and Thomas failed to ever obtain a professional appraisal and never executed the annual certificate of agreed value, as contemplated in the buy-sell agreement. No post-death appraisal of the corporation was performed.

During the IRS audit, Thomas (the executor of Michael’s estate) hired an accounting firm to value Michael’s shares at death. The accounting firm determined that Crown was worth $3.86 million. That amount excluded the $3 million in insurance proceeds (on the theory that insurance value was offset by the redemption obligation). The accounting firm’s exclusion of insurance value was based on Estate of Blount v. Commissioner, 428 F.3d 1338 (2005). Blount is a 2005 11th Circuit Court of Appeals ruling that the value of life insurance proceeds owned by a corporation may be offset by the corporation’s obligation to redeem the decedent’s shares. For two decades, taxpayers have relied on the Blount ruling to shelter the value of insurance.

Thomas submitted (during the audit) to the IRS the CPA valuation report. The valuation included $500,000 of life insurance proceeds (not used for the redemption), but excluded the $3 million used to purchase Michael’s stock.

The IRS took the position that Michael’s equity in Crown (part of his taxable estate) must be determined by valuing Crown to include corporate life insurance proceeds (used for the stock redemption). The IRS argued that the redemption obligation did not offset the value of the insurance proceeds from the value of the company. The IRS adjusted the estate tax return to include the value of the life insurance proceeds in the valuation of the company. The addition of life insurance to the company value increased the value of the company to $6.8 million (with an increase in value of Michael’s shares to approximately $5.3 million). Thomas claimed that the corporation’s obligation to redeem Michael’s shares was a liability that offset the value of the life insurance proceeds. Under the IRS assessment, the estate owed an additional $889,914 in estate taxes. Thomas, for the estate, paid the estate tax and sued for a refund.

• Rulings — The district court held that the $3 million in life insurance proceeds must be included in valuing Crown^[9]and that the buy-sell agreement did not govern corporate valuation. The IRS often ignores valuation language in buy-sell agreements, in determining stock value for estate tax purposes. In this case, the circuit court found that the Crown buy-sell agreement was a bona fide business arrangement, but did not conclusively establish the value of shares because 1) no professional valuation was performed and 2) the agreement did not set a fixed and determinable price for the shares. The court granted summary judgment to the IRS. The Eighth Circuit Court of Appeals affirmed.

SCOTUS ruled that the obligation to redeem a deceased shareholder does not necessarily reduce a corporation’s value (for estate tax purposes). Interestingly, the fact that life insurance increases corporate value was not at issue. The sole issue addressed was whether the value may be diminished or eliminated by an offsetting obligation to use the proceeds for a redemption. Justice Thomas authored the opinion.

The ruling hinges on assessment of the fair market value of the equity sold to an unrelated third-party buyer. A buyer would pay the $5.3 million (including the value of life insurance) for the company. The mandatory redemption only consolidates ownership of less assets in fewer shares (leaving the per share value unchanged). An arms-length buyer of the shares subject to redemption would expect to receive the fair market value of those shares (including $3.5 million of life insurance proceeds). SCOTUS distinguished Blount as incorrectly assessing corporate value post redemption.

SCOTUS clarified that shareholders could alternatively use a cross-purchase agreement, to avoid the addition of life insurance to company value. A cross purchase arrangement permits the concentration of share value in the survivor, financed by shareholder cash (unrelated to the company).

The Supreme Court limited its review to whether the obligation to redeem the decedent’s shares constituted a liability that reduced the value of Crown for estate tax purposes. SCOTUS held that the obligation in the buy-sell agreement was not a liability reducing the value of Crown (by the amount of the life insurance used to purchase the shares). A corporation’s contractual obligation to redeem at fair market value does not reduce the value of shares held by a seller.

• Commentary — The ruling in Blountwas questionable because the obligation to redeem is not a financial expense. The redemption is accomplished with corporate cash made available by maturity of life insurance. The obligation is a mandatory recapitalization, where consideration is paid for equity redeemed. The redemption concentrates the remaining assets in the surviving shareholder, generally leaving the survivor with the same equity value.

On a balance sheet/net worth basis, payment of cash insurance proceeds is the same on a reduced asset basis as incurring debt to cover the redemption price. The note receivable augments the assets of the selling estate. The same would be true for a payment from corporate cash or other assets. The obligation to redeem is not an expense, reducing net worth. It’s an agreement to recapitalize, equity for cash.

The shareholder’s failure to appraise the value of Crown is mentioned several times in the ruling. The business should be appraised upon signing of the buy-sell agreement and periodically thereafter. At a minimum, the shareholders should agree in writing on an annual value.

Often, the cost of insurance is marginal, which makes the “cross-purchase” of life insurance by the shareholders, each on the other, a more prudent option. Cross-purchase agreements move the cost and coverage of life insurance to the owners. Each shareholder owns a life insurance policy on the other. Insurance proceeds are used to directly purchase the deceased shareholder’s equity, without using corporate assets. The cross-purchase agreement both 1) avoids the augmented estate tax value of the shares sold and 2) establishes a stepped-up basis for the individual buyer, by direct purchase of equity.

Life insurance may be maintained by each shareholder, on the other, in trust. Upon the death of a shareholder, the life insurance trustee distributes the stock of the deceased to the surviving shareholder(s) for the applicable purchase price. This avoids any doubts regarding the proper payment of insurance proceeds to the selling estate.

^[1] Moore v. U.S., 602 U.S. 572 (2024).

^[2] I.R.C. §951A (Global intangible low-tax income included in gross income of U.S. shareholders).

^[3] Poll tax as an example.

^[4] Justice Samuel Alito was interviewed for The Wall Street Journal by David B. Rivkin, an attorney in this case. Alito rejected Senator Durbin’s accusation that his verdict would be swayed by his contract with Rivkin, and he refused to recuse himself.

^[5] Relentless v. Department of Commerce, 144 S. Ct. 325 (2023), is a companion case from the First Circuit Court of Appeals.

^[6] Loper Bright Enterprises v. Raimondo, 603 U.S. 369 (2024).

^[7] “It is emphatically the province and duty of the judicial department to say what the law is,” Marbury v. Madison, 5 U.S. 137, 177 (1803).

^[8] See Mayo Foundation for Medical Ed & Research v. United States, 562 U.S. 44 (2011), in which the Court confirmed the applicability of Chevron to tax matters in a matter involving liability for employment taxes payable to medical residents.

^[9] Connelly v. Dep’t of Treasury, Internal Revenue Serv., 4:19-CV-01410-SRC, 2021 WL 4281288 (E.D. Mo. Sept. 21, 2021).