US Supreme Court wary of upending tax on Americans’ foreign earnings

By Andrew Chung and John Kruzel

WASHINGTON (Reuters) -U.S. Supreme Court justices on Tuesday appeared hesitant to upend a tax on Americans who have invested in certain foreign corporations, as they pondered the meaning of “income” in a case that could undermine efforts by some Democratic lawmakers to impose a wealth tax on the very rich.

The justices heard arguments in an appeal by Charles and Kathleen Moore – a retired couple from Redmond, Washington – of a lower court’s decision rejecting their challenge to the tax on foreign company earnings, even though those profits have not been distributed to shareholders.

The case also has drawn attention because some Democratic lawmakers had urged Justice Samuel Alito to recuse himself because of his ties to one of the lawyers for the plaintiffs. Alito refused.

The one-time “mandatory repatriation tax” (MRT) is part of a Republican-backed tax law signed former President Donald Trump in 2017. It applies to owners of at least 10% of a foreign company controlled by Americans. At issue in the case was whether this tax on unrealized gains is allowed under the U.S. Constitution’s 16th Amendment, which enabled Congress to “collect taxes on incomes.”

The Moores, backed by the Competitive Enterprise Institute and other conservative and business groups, contend that “income” means only those gains that are realized through payment to the taxpayer, not a mere increase in the value of property.

Alito, a member of the court’s 6-3 conservative majority, pressed U.S. Solicitor General Elizabeth Prelogar, arguing on behalf of President Joe Biden’s administration, about the limits of congressional taxation power over wealth. Alito gave the example of a startup company founder who began a business in a garage and decades later is a billionaire.

“The appreciation in stock value over 20 or 30 years, could Congress say we want to reach back and tax all of that as the economic gain between two periods of time?” Alito asked.

The Moores are seeking a refund of nearly $14,729 in taxes that the law required them to pay as minority shareholders in a company in Bangalore, India, called KisanKraft that supplies equipment to farmers.

Some justices signaled the possibility of upholding the tax by attributing the income earned by the foreign company to its shareholders.

“Even assuming or leaving open whether realization is a constitutional requirement, there was realized income here to the entity that is attributed to the shareholders in a manner consistent with how Congress has done that and this court has allowed,” conservative Justice Brett Kavanaugh told Prelogar.

Some justices expressed concern that a ruling favoring the Moores could imperil a wider array of tax code provisions including those related to other business entities such as partnerships, limited liability companies and S-corporations.

“Your definition, I think, would affect the government’s ability to tax … those individual shareholders,” liberal Justice Sonia Sotomayor told Andrew Grossman, an attorney for the Moores.

The Justice Department has said that a ruling by the Supreme Court invalidating the mandatory repatriation tax could cost the U.S. government $340 billion over the next decade – and potentially far more if the decision invalidates other tax provisions as well.

Such a ruling also could thwart legislative proposals favored by some Democrats, including Senator Elizabeth Warren, for a tax on the net worth – meaning all assets and not just income – of super-rich Americans.

A ruling is expected by the end of June.

CALL FOR RECUSAL

The case became enmeshed in the ongoing debate over the ethical conduct of the justices amid revelations about issues including undisclosed luxury travel funded by wealthy benefactors.

Democratic senators urged Alito’s recusal because David Rivkin Jr., one of the lawyers for the Moores, co-authored Wall Street Journal articles in which Alito both defended the court and argued that Congress lacks power to regulate the Supreme Court. Senate Democrats have pursued ethics legislation that would apply to the court.

Rivkin attended Tuesday’s argument but did not take part. The senators argued that Rivkin’s access to Alito and his efforts to help him “air his personal grievances” cast doubt on the justice’s ability to fairly judge the case. Alito has said Rivkin’s role in the articles was “as a journalist, not an advocate.”

(Reporting by Andrew Chung; Editing by Will Dunham)

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