Tag Archives: Subpart F

Part 44 – The Moores, Unrealized Income And Exporting US Taxes, Forms And Penalties To Residents Of Other Countries

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Exporting U.S. taxes, forms and penalties to the residents of other countries

In the Moore appeal, the Supreme Court of the United States is charged with the task of determining whether “realization” is a necessary condition, for an “accession to wealth”, to qualify as “income” under the 16th Amendment. This broad question arises in the context of the Moores, who as “U.S. Shareholders” of a CFC, were subjected to the MRT which facilitated the double taxation of the Moores. The Moores, who reside in the United States, certainly have not and have no expectation of receiving a distribution from the India corporation. As problematic as the MRT was for the Moores, the MRT was far more devastating for Americans abroad, who were operating businesses that although “foreign to the United States”, were “local” to them. For the Moores their investment in the CFC represented an investment in a corporation that was “foreign” to both the Moores and the United States. Americans abroad were shareholders in CFCs (unlike the Moores and other resident Americans) that were “local” to them but foreign to the United States. In addition, for Americans abroad the CFC typically represents a pension/retirement planning vehicle. How can it be that the MRT could apply to individuals who live in other countries and are shareholders of corporations created in those countries? The answer is of course the extra-territorial application of the U.S. tax system to residents of other countries who happen to be U.S. citizens. In fact, the use of Canadian Controlled Private Corporations by dual US/Canada citizens living in Canada, demonstrates that it is possible for a U.S. citizen in Canada to be a shareholder in a Canadian corporation that would not qualify as CFCs if owned by U.S. residents.

The key takeaway is that the U.S. tax system, because of the extra-territorial tax regime (citizenship-based taxation) has a profoundly negative effect on individuals who are residents of other countries! U.S. tax law applies NOT only to U.S. residents but to residents of other countries who cannot demonstrate they are nonresident aliens. Therefore, a decision that the 16th Amendment does NOT require “realization” means that the U.S. will export the taxation of “unrealized income” to residents of other countries. The U.S. would tax the “unrealized income” of residents of other countries even when those other countries did not recognize the unrealized income as a taxable event!

In some circumstances the taxation of unrealized income would lead to double taxation. In other circumstances the taxation of unrealized income would frustrate the objectives of the tax policy of the other country. In many circumstances the taxation of “unrealized income” allows the United States to tax the wealth of other nations. It’s important to recognize that when the Supreme Court rules in the Moore appeal, it will also be deciding whether the U.S. can export the taxation of “unrealized income” to other countries! This has huge implications for both the residents and tax sovereignty of other countries.

Some EXISTING examples

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Part 42 – In Moore The Supreme Court Should Consider The Retroactive Nature Of The Transition Tax

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Prologue – Taxation, Fairness And “The Man On The Street”

Imagine asking an individual (who was not a tax academic, lawyer or accountant) the following two questions:

1. Do you think that people should be forced to pay taxes on income never received?

2. Do you think people should be forced to pay taxes on income from the previous 30 years that they had never received?

The average person would be shocked by the possibility of this.

It may be difficult for the average person to understand Subpart F’s attribution of the income of a corporation to a shareholder. The average person would not doubt the unfairness of attributing 30 years of untaxed earnings of the corporation to the shareholder (especially when the income was never received by the shareholder).

Moore and Retroactivity – The Readers Digest Version

This history of the Moore case is described by Professors Brooks and Gamage as follows:

The taxpayers brought suit challenging the MRT, arguing that it was an unapportioned direct tax and therefore in violation of the Constitution.25 (They also argued that its seeming retroactivity was in violation of the Due Process clause of the Fifth Amendment,26 though this was not the main focus of the case, nor did the dissenters address it, nor do the petitioners raise the issue in the cert petition, so we put that claim aside.27) The district court dismissed the claim, and a three-judge panel of the Ninth Circuit unanimously affirmed the dismissal.28 The taxpayers’ subsequent petition for rehearing and rehearing en banc was denied.29

The Chamber of Commerce’s amicus cert brief filed on March 27, 2023 included on page 18:

The Constitution imposes numerous safeguards that prevent the government from making rapid changes that would unsettle expectations. Such principles “find[] expression in several [constitutional] provisions,” Landgraf v. USI Film Prods., 511 U.S. 244, 265 (1994), and often implicate tax laws.

First, “a retroactive tax provision [can be] so harsh and oppressive as to transgress the constitutional limitation” of due process. Carlton, 512 U.S. at 30. When “Congress act[s] promptly and establishe[s] only a modest period of retroactivity,” like “only slightly greater than one year,” a tax law’s retroactive effect has been deemed permissible. Id. at 32–33. But a tax law that deals with a “novel development” regarding “a transfer that occurred 12 years earlier” has been held unconstitutional. Id. at 34 (discussing Nichols v. Coolidge, 274 U.S. 531 (1927)). Here, of course, the Ninth Circuit called the MRT a “novel concept,” and it reached back—not one, not twelve—but more than thirty years into the past, long after companies made decisions about where to locate their long-term as- sets.2 App 6. The MRT’s aggressive retroactivity showcases the danger of unmooring income from its defining principle of realization. Erasing the realization requirement upends taxpayer expectations—leaving them looking over their shoulders for what unrealized gain Congress might next call “income.”

How “retroactivity” was considered by the District Court and the 9th Circuit

The District court specifically found that the transition tax was a retroactive tax, but ruled that the retroactivity did NOT violate the 5th Amendment. The 9th Circuit “assumed” (without considering) the retroactivity of the tax and like the District Court ruled that the retroactivity did NOT violate the 5th Amendment.

The Supreme Court granted the cert petition based only on the question of whether the 16th amendment requires income to be “realized”. The issue in Moore is whether 30 years of income realized by a CFC, never distributed to the US shareholder, and never previously taxable to the U.S. shareholder (under Subpart F) in that 30 year period, can be deemed to be “income” and taxed directly to the U.S. citizen shareholder in 2017.

Can a current attribution to a shareholder, of income earned by a corporation 30 years ago, meet the constitutional requirement of “income” under the 16th Amendment?

A ruling that 30 years of retroactive income could not qualify as 16th Amendment income might allow the court to:

1. Provide relief to the Moores (and other individual shareholders of CFCs); and

2. Avoid ruling on the broader and more general issue of realization.

Arguably a finding of “retroactivity” could mean that (whether realized or not), income earned by the CFC in the past 30 years cannot be considered to be current “income” under the 16th Amendment.

The purpose of this post is to focus on the issue of retroactivity. I do not believe that “retroactivity” was properly analyzed by either the District Court or 9th Circuit.

This post is divided into the following parts:

Part A – Introduction – Thinking about taxation of income
Part B – What is it about the “transition tax” that raises the question of retroactivity?
Part C – Retroactivity and the “Carlton” standard
Part D – Discussion of retroactivity: District Court Decision Moore
Part E – Discussion of retroactivity – 9th Circuit – Moore
Part F – Concluding thoughts …
Appendixes – Excerpts from relevant cases and articles
Appendix A – Excerpt from Hank Adler interview discussing the retroactive nature of the MRT
Appendix B – Moore District Court
Appendix C – Moore the 9th Circuit
Appendix D – Quarty
Appendix E – Justice Blackmun’s majority decision in Carlton
Appendix F – Justice O’Connor concurrence in Carlton
Appendix G – Justice Scalia and Justice Thomas in Carlton

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Part 41 – The Six Faces Of The 965 Transition Tax – The Ugliest Face Applies To Americans Abroad

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Part I: Introduction – What Is The Transition Tax?

“Tell me who you are. Then I’ll tell you how the law applies to you!” I’ll also tell you whether you are a “winner” or a “loser” under this law.

At the end of 2017, Congress was enacting the TCJA. A major purpose of the TCJA was to lower U.S. corporate tax rates from 35% to 21%. This was a huge benefit to U.S. multinationals. One Congressional concern was how to find additional tax revenue in order to compensate the Treasury Department for the reduction in tax revenue which would result in lower receipts from corporations. Congress needed to find some additional tax revenue. They found this additional tax revenue by creating “new income” from the past and taxing that newly created income in the present. In fact, Congress said:

“Let there be income! And there was income …“

Significantly, Congress didn’t create any real income. No taxpayer actually received any income. The income created by Congress was not “real income”. Rather it was “deemed income”. But, this “deemed income” was intended to appear on tax returns. Real tax was payable on this “deemed” income.

Such, is the beginning of the story of the IRC 965 Transition Tax. The Transition Tax was a benefit to U.S. multinationals and destroyed the lives of individual U.S. citizens living outside the United States who organized their businesses, lives and retirement planning (as did their neighbours) through small business corporations.

This post identifies different groups impacted by the Transition Tax and the “winners” and “losers”.

Introducing the IRC 965 U.S. Transition Tax

26 U.S. Code § 965 – Treatment of deferred foreign income upon transition to participation exemption system of taxation

(a) Treatment of deferred foreign income as subpart F income

In the case of the last taxable year of a deferred foreign income corporation which begins before January 1, 2018, the subpart F income of such foreign corporation (as otherwise determined for such taxable year under section 952) shall be increased by the greater of—

(1) the accumulated post-1986 deferred foreign income of such corporation determined as of November 2, 2017, or
(2) the accumulated post-1986 deferred foreign income of such corporation determined as of December 31, 2017.

https://www.law.cornell.edu/uscode/text/26/965

Part II: The Reader’s Digest Version – The Six Faces Of The Transition Tax

The six “faces” of the 965 transition tax include the faces of five different kinds of “U.S. Persons”. The sixth face is the country where a U.S. citizen was living. Some are winners and some are losers. A list of winners and losers includes:

Three Winners

1. Winner: A U.S. C corp: Typically a U.S. multinational – Received value in return for being subjected to the transition tax

2. Winner: The individual shareholder of a U.S. S corp: Can opt to have the “deemed income inclusion” of 965 to NOT apply – Escaped the application of the transition tax

3. Winner: Green Card holder who is a “treaty nonresident”: Can escape U.S. taxation on “foreign source income – Escaped the application of the transition tax

Three Losers:

4. Loser: A U.S. resident individual (U.S. citizen or resident): The Moores – Subject to the transition tax, received nothing in return and likely subject to double taxation

5. Biggest Loser: A U.S. citizen living outside the United States who is a tax resident of another country: More of a loser than the Moore’s – what if the Moores had lived in British Columbia Canada? – Subject to the transition tax, received nothing in return, likely subject to double taxation on business income earned and retained by their “foreign corporation”. But unlike the Moore’s they live outside the United States as “tax residents” of another country. Unlike the Moore’s their CFC was likely not a simple investment in the shares of another company. Rather their CFC was likely the equivalent of a pension, created and encouraged by the tax laws of their country of residence. While the Moore’s experienced “double taxation” on an investment, the U.S. citizen abroad experienced the confiscation of their retirement pension. Individual shareholders of a CFC who live in the United States were affected quite differently from individual shareholders who live outside the United States.

6. Indirect Loser: The countries where overseas Americans are resident were also damaged by the transition tax: Many countries (example Canada) incentivize the creation of private pension plans through the use of private corporations. The effect of the transition tax was effectively to “loot” the retained earnings of those private corporations that were intended to be pension plans for residents of other countries. This is a particularly ugly manifestations of U.S. citizenship taxation and is a graphic example of how US citizenship taxation operates to extract working capital from other sovereign countries.

Significantly the biggest losers in the application of the 965 transition tax are Americans living outside the United States!

The transition tax confiscated the retained earnings of their local business corporations. Because they are tax residents of other countries, there was no prospect of the corporation’s earnings being repatriated to the United States. The corporation’s earnings were the pension/retirement plans for those individuals.

To put it simply:

The Treasury Department – via IRC 965 – effectively “looted” the retained earnings of small business corporations located outside the United States. The justification for the “looting” was that more than 50% of the shares were “owned” by U.S. citizens. The 2017 US Transition Tax was the ugliest face of the Transition Tax and a particularly ugly manifestation of U.S. citizenship taxation!

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Part 40 – The Moore @USTransitionTax Appeal: Unrealized Income And Attacking The “Wealth Of OTHER Nations”

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Introduction

The Moore’s are U.S. residents who happen to be the U.S. shareholders of a CFC (“Controlled Foreign Corporation”). In basic terms, the Moore’s transition tax appeal is based on the fact that (1) although the Moore’s received no distribution from the CFC, they (2) were deemed to have received a distribution and required to treat the “deemed distribution” as U.S. taxable income. In other words, they paid “real tax” on “pretend income”. In a previous post I demonstrated how the “transition tax” AKA “repatriation tax” (taxation of “unrealized gains”) resulted in pure double taxation.

The double taxation caused by the transition tax was the result of:

1. The creation of a fictitious realization event which generated a U.S. tax before an actual realization event in India; coupled with

2. A later, ACTUAL realization event in India which generated an additional tax in India.

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Part 37 – 2023: US Supreme Court To Hear Moore Appeal In Lawsuit Against @USTransitionTax – Great News!

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June 26, 2023 – Great News! – The US Supreme Court Agrees To Hear Moore 965 Transition Tax Case!

A direct link to the Supreme Court site which will track the progress and filings of all briefs (including what are expected to be a large number of amicus briefs) is here.

The brief from the CATO Institute frames the question addressed to the Supreme Court as follows:

QUESTION PRESENTED

Whether Congress may levy income tax on a tax-payer who has not realized income.

What follows is a twitter thread (which I will continually update) which includes commentary, resources and general information about the appeal.

Litigation against the 965 Mandatory AKA transition tax has come from two sources.

The first source was from U.S. tax lawyer Monte Silver. His challenge to the tax was based generally on procedural grounds and specifically on the failure of U.S. Treasury to comply with the provisions of the Regulatory Flexibility Act. Despite a heroic, valiant and determined effort the Supreme Court refused to hear his cert petition. As a result, in May 2023, his challenge came to an end. Monte Silver’s challenge focused on the legality of the Treasury Regulations insofar as they applied to US citizens living outside the United States.

The second source is the Charles Moore case. This case is arguing that the tax is unconstitutional. Although brought on behalf of an individual shareholder of a CFC, the case makes no mention of the application of the tax to Americans abroad. On June 26, 2023 (about a month after denying the cert petition in the Silver case) the U.S. Supreme Court agreed to hear the Moore case. To be clear, this case is attacking the constitutionality of the tax (not the procedural aspects) head on. Much will be written about this issue and the case.

On September of 2019 I wrote a post describing the Moore lawsuit arguing that the Section 965 Transition Tax AKA Mandatory Repatriation Tax is unconstitutional. Although the Moore’s were not successful in the District Court and Appeals court, the Supreme Court of the United States has agreed to hear the case!

The Cert Petition

The Cert petition was based on an appeal from the 9th Circuit and a dissenting judgment from the plaintiff’s application to rehear the case in the 9th Circuit.

The original 9th Circuit decision is here.

The decision of the 9th Circuit denying the request (with the dissent) to rehear the Moore case is here.

An excellent article discussing the history of the Moore “Transition Tax” ligation is here.

The cert petition in CHARLES G. MOORE and KATHLEEN F. MOORE, Petitioners, v. UNITED STATES OF AMERICA,Respondent, includes:
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Extradition Is One Way That Changes In Another Country’s Tax Laws May Change Your Tax Relationship With The US

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Prologue

As long as the US continues to employ citizenship taxation any changes in US tax law will continue to have unintended consequences on Americans abroad. In March of 2022 I outlined how some of the tax changes proposed in the 2023 Biden Green book would impact US citizens who live outside the United States. As important as US tax changes are, Americans abroad must be aware of how changes in the laws of their country of residence may also impact their “tax relationship” with the United States.

The purpose of this post is provide five simple examples. Some of the examples are based on Canada’s tax laws and others are of a more general nature.

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To punish 100 #GILTI Corporations is to punish millions more individuals

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Introduction: As Goes Tax Reform For US Multinationals, So Escalates The Harm To Individual Americans Abroad

The Problem: The proposed changes in International Tax (mostly in relation to corporations) will affect numerically more individuals than corporations. The effects on Americans abroad, who run small businesses outside the United States, will be absolutely devastating.

Two Solutions: Suggestions for how to protect individuals (including Americans abroad) would be to make changes to the Subpart F regime – GILTI, etc. There are at least two ways this change can be achieved:

1. To NOT apply Subpart F to INDIVIDUALS who are shareholders of CFCs.

2. If Subpart F is to apply to individual shareholders of CFCs, it should NOT apply to those individual Americans abroad who meet the residence requirements to use the S. 911 Foreign Earned Income Exclusion. (I.e. people who are almost certainly tax residents of other countries.)

March 25, 2021 – The Senate Finance Committee Held A Hearing Described As:

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US Senate Finance Hearing Affects Americans Abroad AKA Mini-Multinationals – Action Needed!

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Introduction

The background: The US Senate Finance Committee has begun hearings for the purpose of discussing further reform of the rules of International Tax. These reforms would appear to include raising the GILTI tax and raising US corporate tax rates in general. Each of these would have a massive negative effect on Americans abroad. The reasons are detailed in the rest of this post.

Bottom line: Americans abroad need to send their views (presumably objections) to the Committee. The rest of this post provides the background, SEAT’s understanding of the issue and templates individuals can use to email Senate Finance.

Please forward this post to anybody who you believe would be affected by this (anybody who runs a small business through a corporation.)

Okay ….

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Seriously now, who’s GILTI? Senators Wyden and Brown attempt to reinforce the punishment of GILTI Americans abroad

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Introduction and July 2021 update …

There is wide agreement that the United States needs to improve its infrastructure. This will require massive spending. All spending necessitates a discussion of taxation. Since March 25, 2021 the Senate Finance Committee, Ways and Means Committee and the Biden administration have been exploring ways to increase taxation to pay for this. A series of SEAT submissions to the Senate Finance Committee is available here.

The community of Americans abroad has also recognized that any major tax reform creates an opportunity for a consideration of the United States transitioning to residence-based taxation. Although everybody claims to want residence-based taxation, the devil is in the details. As I have previously explained the words “residence-based taxation” mean different things to different people. The shared objective (of residence based taxation) is that the United States would cease imposing taxation on the non-US source income received by Americans abroad. That said, there are two broad ways that goal can be achieved. One way completely severs Americans abroad from US tax jurisdiction. The other leaves Americans abroad subject to US tax jurisdiction (forcing them to live in fear of every legislative change).

1. Pure residence-based taxation: Ending US tax jurisdiction over individuals who do NOT live in the United States. This would mean that Americans abroad would simply NOT be part of the US tax base. This is what residence-based taxation means in every other country of the world. In other words: you are not subject to US worldwide taxation because you don’t live in the United States. This is what I call “pure residence based taxation”. It is the only form of residence-based taxation that will solve the problems of Americans abroad. (This is what is advocated by SEAT.)

2. Citizenship-based taxation with a carve out: Continuing US tax jurisdiction over individuals who do NOT live in the United States, but relaxing the requirements that would apply to them. This proposal is what I call citizenship-based taxation with a carve out for certain people. Under this proposal, ALL Americans abroad would continue to be subject to US tax jurisdiction, but their non-US source income would (presumably) not be taxed by the United States. (This citizenship-based taxation with a carve out was the basis of the 2018 Holding bill and appears to what is being proposed by various groups. Further discussion of the Holding bill is here. It is essential that whenever a group announces that it is working toward residence based taxation that you ask them to clarify what they mean. Under the proposal, will Americans abroad remain subject to US tax jurisdiction? Will they still be defined as tax residents of the United States?)

(A more complete discussion about the difference between pure residence taxation and citizenship taxation with a carve out is here. A proposal for changes in the Internal Revenue Code that would result in pure residence-based taxation is here.)

Why completely ending US tax jurisdiction over Americans abroad (moving to pure residency-based taxation) is essential!!

The US tax code is incredibly complicated. The existence of citizenship-based taxation means that many changes in the tax code can impact Americans abroad even when the legislators are not considering the impact on Americans abroad. Since March of 2021 the Senate Finance Committee has been conducing hearings discussing tax reform for US corporations. The truth is that these proposals will affect many more individuals than corporations. Yet, Senate Finance never discusses the impact on individuals generally and individual Americans abroad in particular.

It is impossible for Americans abroad to survive when any change in the tax code could impact them without the legislators remembering that they even exist.

Let’s be clear! When it comes to Americans abroad:

It’s not that Congress doesn’t care about them. It’s that they don’t care that they don’t care!

This is why it is essential that ALL Americans abroad support and only support a movement toward “pure residence based taxation” which will ensure that nonresidents are NOT part of the US tax base.

If Americans abroad are left subject to the US tax based (citizenship-based taxation with a carve out) they will always be subject to being affected by any and all changes in US tax law.

A particularly egregious example of this in the following post. What follows is long, comprehensive and technical. Most will NOT want to read it.

But, the following post (written in 2020) is proof that ONLY pure residence-based taxation will solve the problems of Americans Abroad!

________________________________________________________________________________________

Prologue

Americans abroad who are individual shareholders of small business corporations in their country of residence have been very negatively impacted by the Section 951A GILTI and Section 965 TCJA amendments. In June of 2019, by regulation, Treasury interpreted the 951A GILTI rules to NOT apply to active business income when the effective foreign corporate tax rate was at a rate of 18.9% or higher. Treasury’s interpretation was reasonable, consistent with the history of Subpart F and consistent with the purpose of the GILTI rules.

Now, Senators Wyden and Brown are attempting to reverse Treasury’s regulation through legislation. This is a direct attack on Americans abroad. Senators Wyden and Brown are living proof of the principle that:

When it comes to Americans abroad:

It’s not that Congress doesn’t care. It’s that they don’t care that they don’t care!

Introduction

As many readers will know the 2017 US Tax Reform, referred to as the Tax Cuts and Jobs Act (TCJA), contained provisions which have made it difficult for Americans abroad to run small businesses outside the United States. In the common law world a corporation is treated as a separate legal entity for tax purposes. In other words the corporation and the shareholders are separate for tax purposes, file separate tax returns and pay tax on different streams of income. The 2017 TCJA contained two provisions that basically ended the separation of the company and the individual for U.S. tax purposes. In other words: there is now a presumption (at least how the Internal Revenue Code applies to small business owners) that active business income earned by the corporation will be deemed to have been earned by the individual “U.S. Shareholders”. To put it another way: individual shareholders are now presumptively taxed on income earned by the corporation, whether the income is paid out to the shareholders or not! The effect of this on individual Americans abroad has been discussed by Dr. Karen Alpert in her article: “Callous Neglect: The impact of United States tax reform on nonresident citizens“.

The expansion of the Subpart F Regime

The Subpart F rules were established in 1962. The principle behind them was that individual Americans should be prevented from, using foreign corporations to earn passive income, in jurisdictions with low tax regimes (or tax regimes that have lower taxes than those imposed by the United States). The Subpart F rules have (since 1986) included a provision to the effect that investment income (earned inside a foreign corporation) which was subject to foreign taxation at a rate of 90% or more of the U.S. corporate rate, would NOT be subject to taxation in the hands of the individual shareholder.

To put it another way (with respect to investment income):

1. It was mostly investment/passive income that was subject to inclusion in the incomes of individual shareholders as Subpart F income; and

2. Passive income that was subject to foreign taxation at a rate of 90% or more of the U.S. corporate tax rate (now 21%) would NOT be considered to be Subpart F income (and therefore not subject to inclusion in the hands of individual shareholders).

To coordinate my background discussion with the Arnold Porter submission described below, I will refer to exclusion of investment income subject to a 90% tax rate as “HTKO” (High Tax Kick Out).

The basic principle was (and continues to be):

If passive income earned in a foreign corporation is taxed at a rate of 90% or more of the U.S. corporate tax rate, that there was no attribution of that corporate income to the individual U.S. shareholder.

In its most simple terms, the Subpart F rules are found in Sections 951 – 965 of the Internal Revenue Code. They are designed to attribute income earned by the corporation directly to the U.S. shareholder, without regard to whether the corporate profits were paid to the shareholders as a dividend. Note that many developed countries have similar rules. Many developing (from a tax perspective) countries (for example Russia) are adopting Subpart F type rules. The U.S. rules are more complicated, more robust and (because of citizenship taxation) apply to the locally owned companies of individuals, who do not live in the United States.

Punishing them for their past and destroying their futures – The expansion of the Subpart F Regime to active business income

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