December 4th 2023.
I want to talk about the Moore v. United States tax case. This week, the U.S. Supreme Court hears oral arguments, however, the current media coverage of the case has been largely political and has missed the significant impact it has on small businesses and entrepreneurs. To understand the case better and its implications, let's take a look at the details.
The Moores’ case brings up three issues related to a tax that appeared in 2017, the Section 965 transition tax. One of the easiest to understand is the “Due Process” clause in the U.S. Constitution. To illustrate it clearly, let's take the example of savings in a 401 account or a traditional or Roth Individual Retirement Account. You have saved money in this account for years, and the tax law says you don't pay income taxes on your profits until you withdraw the money.
However, the Section 965 transition tax retroactively changed the tax law and rules, making previously earned income from earlier years and decades taxable in 2017. This situation is unfair and unjust, as the Moores explain in their petition. The Moores invested $40,000 in a friend's small business in India. When President Trump signed the new law, they had to pay income taxes on the money earned in the 1990s or the 2000s, amounting to $14,729. This raises the question whether the retroactive tax law is a violation of due process.
The second issue the Moore v. United States case examines is the measurement of income. Historically, income was measured by transactions summarized in income statements. For investors, they don't owe taxes on the money the corporation shows on their income statements. Instead, they only owe taxes on dividend income or capital gain from selling shares. However, the Section 965 transition tax and the Section 951A “global intangible low-taxed income” tax make a taxpayer pay taxes on a chunk of the income earned by a foreign corporation they've invested in, even if they haven't realized any income.
This raises the issue of compliance costs of the Section 965 and 951A taxes. Some critics of the Moores’ petition say Subchapter S corporations already force shareholders to report and pay income taxes on corporation income, thus, Sections 965 and 951A aren't really a new way of doing the tax accounting. However, with an S corporation, shareholders unanimously consent to the tax accounting treatment before it occurs. The compliance costs of the Section 965 and 951A taxes may be more complex to figure out, as the Court will consider a bunch of issues as they look closely at how the mechanics need to work.
I want to talk about the Moore v. United States tax case that will be heard by the U.S. Supreme Court this week. The media coverage of the pending case has been mostly political, but what they've missed is the giant impact the case’s issues have on small businesses and entrepreneurs. Let's take a look at a few of the issues that will be discussed.
The Moores’ case brings up three issues related to a tax that appeared in 2017, the Section 965 transition tax. The most easily understandable one is the “Due Process” clause in the U.S. Constitution. To explain it more simply, let's use an analogy.
Imagine you've been saving money in a 401 account or a traditional or Roth Individual Retirement Account for years. According to the tax law, you don't pay income taxes on your profits until you withdraw the money. But what if Congress retroactively changed the rules and said you need to pay income taxes on the money earned inside your IRA or 401 account in the 1990s or the 2000s using a new tax law? That's exactly what the Section 965 transition tax did. It made previously earned income from earlier years and decades taxable in 2017. And the Moores ended up paying a tax of $14,729.
The second issue the Moore v. United States case examines is when and how a taxpayer measures income. This is where it gets more complicated. Common-sense income measurement has been used for centuries, and it looks at transactions summarized in income statements. To illustrate how this works for investors, let's use the example of owning stock in some U.S. corporation. You don't owe taxes on the money the corporation shows on their income statements and pays taxes on - you only owe taxes on dividend income you receive from the corporation or on capital gain you enjoy if you sell shares. However, the Section 965 transition tax and the Section 951A “global intangible low-taxed income” tax say you pay taxes on a chunk of the income earned by a foreign corporation you’ve invested in, even though you haven’t received or realized any income.
The last issue discussed in this case is the compliance costs of the Section 965 and 951A taxes. This issue raises more unanswered questions than casual analysis might predict. Furthermore, there are a few technical points to consider. For instance, GILTI and other sections of Subpart F work similarly to how U.S. partnership accounting works, but there is a difference between typical partnership accounting and the Section 965 transition tax. With an S corporation, shareholders unanimously consent to this tax accounting treatment before it occurs, which simplifies accounting and saves tax.
All in all, the Moore v. United States tax case will be an important one to watch - not only because it's groundbreaking, but also because it produces actionable insights both for small business owners and individual taxpayers.
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