Supreme Court Upholds Tax on Foreign Profits, Upends Deference to Government Agencies

By Leo Parmegiani, CPA, MST, Partner; Chris Migliaccio, JD, Partner; and Thomas Kinder, JD, LLM, Director

The Supreme Court recently issued decisions in two key cases with big impacts for the tax landscape in the U.S. – Loper Bright Enterprises v. Raimondo and Moore v. United States. One case overturns long-standing precedent and the other provides a challenge to a key international tax provision – with potential implications for the fundamental right of the U.S. government to tax certain income. Read on for more details on each case.

Loper Bright Enterprises v. Raimondo

The recent Supreme Court case Loper Bright Enterprises v. Raimondo focused on a dispute over environmental regulations. The case questioned whether the company had properly complied with federal environmental standards as laid out by the regulations related to emissions and waste disposal and whether those regulations themselves were valid.

Previously under the Chevron Doctrine (from the case Chevron v. Natural Resources Defense Council), courts were required to defer to permissible agency interpretations of statutes (e.g., the Environmental Protection Agency). The Chevron Doctrine was a two-part test. First, did the statute Congress enacted directly speak to the question at issue? If upon reviewing the language of the statute, the court determined there was only one reading for the statute and Congressional intent was clear, that was the end of the matter. However, if they determined there was room for interpretation, the second part of the test under Chevron was to review whether the agency constructing a regulation was a reasonable interpretation of the statute. If so, then the courts would defer to the regulation. For example, if the statute on air emissions was not clear and the EPA released regulations as guidance for the statute, the courts would have been required to defer to the regulatory guidance if the guidance was a reasonable interpretation of the statute.

In the Loper Bright case, however, the Court held that the courts must exercise their independent judgment to determine whether an agency has acted within its statutory authority and are not required to defer to regulations where the statutes are unclear. This overturned Chevron creating the potential for less deferential judicial review of agency regulations – including those of the IRS and Treasury.

PKFOD Observation: Given the complexity of the Internal Revenue Code, often a statute is not specific enough to apply to every fact pattern. IRS and Treasury guidance in the form of regulations aid in the interpretation of the statutes. Loper Bright seems to throw a wrench in the idea that these regulations must be relied upon and thus, consequently, could lead to more tax litigation in the future. This new doctrine will be a key point to track going forward, especially as recent court cases have shown that courts are already giving less deference to tax regulations.

Moore v. United States

In Moore, the petitioners argued that the tax on deemed repatriation of the earnings of controlled foreign corporations under IRC Section 965 as part of the Tax Cuts and Jobs Act violated the Direct Tax Clause of the Constitution, because it was an unapportioned direct tax on their shares of stock. (Read more about 965 here.) Under the Constitution, direct taxes must be distributed among the states in proportion to their population. However, income taxes have been considered an “indirect tax” and, therefore, are not required to be apportioned according to the population of every state. The sixteenth amendment authorized unapportioned taxes on income realized from any source. The plaintiffs argued that they did not realize income since there was no actual payment of a dividend and, thus, the tax is on property and, therefore, should be an apportioned direct tax.

The case was one to watch because of the far-reaching potential implications. Overturning the Section 965 tax would have created a monumental issue after taxpayers had paid billions in tax as a result. Further, many other areas of the tax law operate similarly – both in the international space (such as Subpart F and GILTI income) and the domestic (arguably, the same logic could be used as it relates to S Corporation income being taxed at the shareholder level). The petitioner attempted to distinguish Section 965 and other regimes such as Subpart F and pass-through entities but did concede that Subpart F and pass-through entity taxes were constitutional.

The Court sided with the government and upheld Section 965 of the tax code, holding that taxes on undistributed income through “pass-through entities” (including controlled foreign corporations under Subpart F, GILTI and Section 965) are constitutional. Importantly, the Court did not conclude whether realization of income is a constitutional requirement to taxation, stating this would be an issue for another day.

PKFOD Observation: In Moore, the petitioner tried to thread the needle and treat the Mandatory Repatriation Tax as something different than pass-through tax and Subpart F. They were not successful, but the questions they asked were not all answered in the opinion. For example, as mentioned above, the majority refused to answer whether a realization of the income was required for income to be taxable. So, while the decision maintained the status quo, we will continue to monitor court cases if a similar issue makes its way through the courts again.

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As demonstrated above, PKF O’Connor Davies is constantly monitoring new legislation, as well as game-changing court cases at the federal, state and international tax levels. Our goal is to offer our clients, friends and contacts cutting edge tax planning consultation in an ever-changing tax world. We are available as needed.

If you have any questions on these developments, please contact your PKFOD tax advisor or one of the authors :

Leo Parmegiani, CPA, MST

Christopher Migliaccio, JD

Thomas Kinder, JD, LLM