The SALT Implications of Moore v. United States

On June 26, the U.S. Supreme Court agreed to review a challenge to the constitutionality of the repatriation tax in Internal Revenue Code Section 965, a one-time mandatory transition tax imposed on U.S. shareholders of some foreign corporations measured by the corporations’ untaxed foreign earnings.

The question presented to the Court in Moore v. United States , No. 22-800, is whether the mandatory repatriation tax imposed on the deemed repatriation is constitutional. The taxpayers argue, unsuccessfully so far, that the mandatory repatriation tax imposes a tax on unrealized income in violation of the 16th Amendment to the U.S. Constitution. (See a related BDO Tax Strategist Insight.)

That the Court agreed to review a case won by the government in the lower federal courts and in the absence of a split among federal appellate courts is notable. Thus, in addition to its potential far-reaching federal tax implications, a decision in favor of the taxpayers could have state and local tax (SALT) consequences for corporations and individuals.

SALT Overview 

While Moore could have wide-ranging federal income tax results, its potential state income tax consequences for corporate and individual taxpayers should not be ignored. Should the Court rule in favor of the taxpayers, there could be unique state income tax ramifications. However, those ramifications will differ across states and the type of taxpayer, corporate or individual.  

As with the potential federal implications, a taxpayer-favorable decision in Moore could affect 2017 (and some 2018) returns. Not all states that taxed Section 965(a) income allowed installment payments of the state income tax on the repatriation. 

Protective Refund Claims

A protective refund claim preserves a taxpayer’s right to claim a tax refund when the right to the refund is contingent on future events – such as a court decision – that might not occur until after the limitations period expires. State protective refund claims and procedures are established by state statute or administrative guidance, policy, or practice.  

Taxpayers who may be eligible for refunds of state corporate or personal income taxes paid on Section 965(a) income could be affected if the Court rules that the Section 965 tax is unconstitutional.

Limitations Periods

Because state taxes were likely paid with 2017 or 2018 returns reporting the Section 965(a) income, state limitations periods on refunds have expired for most taxpayers. Different limitations rules might also be relevant for taxpayers that elected to pay the Section 965 tax in annual installments.

States may have special limitations periods applicable to refunds of unconstitutional taxes. For example, under the New York State Tax Law, no limitations period applies to illegally collected taxes, erroneously collected taxes, or taxes “paid under mistake of fact.” 

Corporate Taxpayers

After Section 965 was enacted as part of the Tax Cuts and Jobs Act, most states eventually responded by allowing a full or partial subtraction of, or dividends received deduction for, Section 965(a) income from federal taxable income starting points for calculating taxable income subject to a state’s corporate income tax. Nonetheless, Nebraska and Vermont conformed to the federal tax treatment of Section 965(a) income (and allowed the Section 965(c) deduction). Another group of states’ partial subtractions or DRDs ranged from 50% (Utah) to 80% or less (Maine, Montana, North Dakota), which left a significant chunk of Section 965(a) income subject to apportionment and taxation by those states. And in Colorado, Mississippi, New Hampshire, and Oklahoma, Section 965(a) income could have gotten caught up in the state’s foreign-source income inclusion rule, allocation provisions, or other unique state income inclusion or apportionment rules. As a result, at least some portion of Section 965(a) income could have been subjected to corporation taxation in those states. 

If the U.S. Supreme Court holds that Section 965 is unconstitutional under the 16th Amendment, then a state income tax imposed on that income should also be unconstitutional. Subject to limitations periods, taxpayers might consider filing protective refund claims for the 2017 (and possibly 2018) tax year in states reporting Section 965(a) income.

Taxpayers in New York State (and City) might also consider filing protective refund claims. While Section 965(a) income was, at least superficially, fully subtracted as exempt controlled foreign corporation income, the subtraction was net of direct and indirect interest expenses attributable to the Section 965(a) income. In lieu of tracing interest expenses, taxpayers may have elected the safe harbor 40% expense attribution without realizing that under the safe harbor, 40% of Section 965(a) income will be indirectly subject to New York State and City corporate income taxes.      

Individual Taxpayers

The treatment of Section 965(a) income for state personal income tax purposes was largely the reverse of the state corporate income tax treatment. Of the 43 states that impose a personal income tax, only 10 either allowed a deduction or subtraction of Section 965(a) income for personal income tax purposes or never conformed to Section 965. For example, California conforms to the IRC as enacted on January 1, 2015, which predates the TCJA’s enactment of Section 965; thus, it never conformed to Section 965. Other states that do not impose personal income tax on Section 965(a) income are Alabama, Arkansas, Hawaii, Iowa, Kentucky, Minnesota, Pennsylvania, South Carolina, and Wisconsin. (Although Alabama provided a specific exclusion of Section 965(a) income for individuals who owned stock directly in a CFC, the exclusion did not apply to partners or S corporation shareholders whose pass-through entities owned the stock.)  

Depending on their individual situations, taxpayers who were resident (or filed nonresident returns or composite returns) in up to 33 states might consider filing protective refund claims to protect potential refunds should the Court hold in favor of the taxpayers in Moore.