Judge Patrick Bumatay has a dissent from denial of rehearing en banc in Moore v. United States (9th Cir. 2022) (holding that the Sixteenth Amendment allows a tax on undistributed earnings of a foreign corporation owned in part by a U.S. taxpayer). From the introduction to Judge Bumatay's dissent:
… In 1913, the people created a limited exception to the [original Constitution's] apportionment requirement. By ratifying the Sixteenth Amendment, the people gave Congress the authority to “lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States.” U.S. Const. amend. XVI. So, today, Congress may enact a direct tax on “incomes”—and only on “incomes”—without apportioning the tax. The Sixteenth Amendment thus struck a delicate balance for federal taxing power—freeing Congress from the unwieldy requirement of apportionment, but only for taxes on “incomes.” Nothing in the Sixteenth Amendment relieved Congress of its duty to apportion other forms of direct taxation, such as a tax on property interests.
Now, more than a century after its ratification, our court upsets the balance reached by the people. We become the first court in the country to state that an “income tax” doesn’t require that a “taxpayer has realized income” under the Sixteenth Amendment. Moore v. United States, 36 F.4th 930, 935 (9th Cir. 2022). Instead, we conclude that the Sixteenth Amendment authorizes an unapportioned tax on unrealized gains because the “realization of income is not a constitutional requirement.” Id. at 936. We thus endorse the constitutionality of a federal tax on the share of undistributed earnings of a foreign corporation owned by a U.S. taxpayer—despite (in this case) the U.S. taxpayer being a minority shareholder of the foreign corporation. In other words, we allow a direct tax on the ownership interest of a taxpayer—even when the taxpayer has yet to receive any economic gain from the interest and has no ability to direct distribution of gain from the interest.
Neither the text and history of the Sixteenth Amendment nor precedent support levying a direct tax on unrealized gains. Ratification-era sources confirm that the prevailing understanding of “income” entailed some form of realization. And a hundred years of precedent establishes that only realized gains are taxable as “income” under the Sixteenth Amendment. While the Supreme Court has allowed flexibility in identifying “incomes,” it has never abandoned the core requirement that income must be realized to be taxable without apportionment under the Sixteenth Amendment. Simply put, as a matter of ordinary meaning, history, and precedent, an income tax must be a tax on realized income. And our court is wrong to violate such a common-sense tautology.
And from later on:
Ratification-era dictionaries suggest that the ordinary meaning of “income” was confined to realized gains. One dictionary defined “income” as “that gain which proceeds from labor, business, property, or capital of any kind.” Webster’s Revised Unabridged Dictionary (1913) (emphasis added). According to another turn-of-the-century dictionary, “income” meant “[t]hat which comes in to a person as payment for labor or services rendered in some office, or as gain from lands, business, the investment of capital, etc.” The Century Dictionary and Cyclopedia (1901).
Ratification-era legal authorities made explicit what these dictionary definitions conveyed: only realized gains qualify as taxable income. The 1910 edition of Black’s Law Dictionary defined “income” to include “that which comes in or is received from any business or investment of capital.” Income, Black’s Law Dictionary (2d ed. 1910) (emphasis added). And Henry Campbell Black—of Black’s Law Dictionary fame—addressed the issue in a book-length commentary published within months of ratification. Black noted that an income tax “is not a tax upon accumulated wealth, but upon its periodical accretions.” Henry Campbell Black, A Treatise on the Law of Income Taxation 1 (1913). In his view, these accretions occurred only when gains were realized, not when an asset had merely increased in value:
When a bond which was purchased at a discount reaches par value in the market, the owner cannot be properly said to have made a profit; he is in a position where he can realize a profit if he sells the bond, but not otherwise. If he sells, then the sum gained may constitute a part of his income, but it cannot be so described while he continues to hold the security.
Id. at 76–77.
Black rejected the idea of taxing shareholders for undistributed corporate profits as being “contrary to all the
weight of authority,” explaining:
In several of the cases on the subject, it is said that the word “income” is not broad enough to include things not separated in some way from the principal. It is not synonymous with “increase.” The value of corporate stock may be increased by good management, prospects of business, and the like, but such increase is not income. It may also be increased by the accumulation of a surplus fund. But so long as that surplus is retained by the corporation, either as a surplus or as increased stock, it can in no proper sense be called income. It may become income producing, but it is not income.
Id. at 120.
Black concluded that the Sixteenth Amendment “does not . . . enlarge the power of taxation previously possessed by Congress, but merely repeals certain parts of the existing Constitution which imposed a limitation upon the levying of . . . an income tax.” Id. at 11. Other early commentators shared Black’s assessment. In 1919, a well-known authority on income tax and accounting explained that the Sixteenth Amendment only covered taxes on realized gains:
In the circumstances, no apology is needed for a close inquiry into the right of Congress or the Treasury Department to extend the taxation of income—which is permitted under the sixteenth amendment—to the taxation of capital—which is not permitted. And the inquiry naturally extends itself into the right to tax any transaction unless there is an actual realization of income, as distinguished from the apparent income which may be and often is due to the temporary fluctuations in values.”
Robert H. Montgomery, Income Tax Procedure 198 (1919).
Taken collectively, these sources reinforce the commonsense notion that “income” refers to the receipt of some economic benefit. And because this “commonly understood meaning” was “in the minds of the people when they adopted the Sixteenth Amendment,” Smietanka, 255 U.S. at 519, neither Congress nor our court may redefine income to include unrealized gains. See Burk-Waggoner Oil Ass’n v. Hopkins, 269 U.S. 110, 114 (1925) (“Congress cannot make a thing income which is not so in fact.”).
Sounds right to me.
(Via How Appealing, which also points to this Wall Street Journal op-ed by and The Ninth Circuit Upholds a Wealth Tax – The Supreme Court should review the ruling, which ignores constitutional limits on the taxing power.)
Posted at 6:06 AM