What is the Repatriation Tax in the US?

The “Repatriation Tax” is typically used to refer to a specific tax policy or provision that applies to the repatriation of foreign earnings by U.S. multinational corporations. This tax has reached news headlines recently, due to the U.S. Supreme Court reviewing a constitutional challenge to its foundational legislation (aka. The Tax Cuts and Jobs Act of 2017). 

Repatriation, in this context, means bringing back profits and income earned by a U.S. company’s foreign subsidiaries to the United States. The repatriation tax has undergone significant changes in recent years, so it’s essential to understand its historical and current context.

Historical background

In the past, U.S. corporations often held significant amounts of earnings abroad to avoid paying U.S. corporate income tax, which had one of the highest rates among developed countries (the top corporate rate was ~35% prior to 2017). 

To put this into perspective, 2017 estimates assessed nearly $2.8 Trillion in untaxed profits by U.S. corporations held in foreign subsidiaries. Specifically, the Board of Governs of the Federal Reserve System estimated that ~$1 trillion in cash was being held overseas by multinational enterprises (MNEs). 

Typically, these earnings would only be taxed if they were paid to the U.S. parent company as a dividend (this is generally referred to as ‘repatriating earnings’). Determining a way to incentivize these earnings to be repatriated is where the Tax Cuts and Jobs Act comes into play. 

Tax Cuts and Jobs Act (TCJA) of 2017

The most significant change to the repatriation tax came with the passage of the Tax Cuts and Jobs Act (TCJA) in 2017. This tax reform legislation reduced the top statutory corporate tax rate from 35% to 21%; and it included a one-time “deemed repatriation” tax on previously untaxed foreign earnings, which imposed a 15.5% tax on cash/cash equivalents, and an 8% tax on other earnings over a period of 8 years. This tax was designed to encourage U.S. companies to bring back their offshore cash and invest it domestically. 

Key points about the TCJA’s repatriation tax:

• It imposed a one-time tax on accumulated foreign earnings held offshore.
• The tax rate was lower than the standard corporate tax rate, which incentivized companies to repatriate their foreign earnings.
• It allowed companies to pay the tax liability over a span of several years.

Current status

The TCJA’s repatriation tax was a one-time measure, and it mainly impacted the transition of foreign earnings held overseas at that time. After the TCJA, the United States transitioned to a “territorial tax system,” which generally exempts foreign income from U.S. taxation. However, some anti-abuse provisions and other tax rules still apply to foreign earnings, and these can affect the taxation of repatriated profits.

The U.S. Supreme Court Case of Moore v. United States (currently pending)

The TCJA also established the mandatory repatriation tax (MRT, aka. “the transition tax”). MRT applies to individuals who own 10% or more of a controlled foreign corporation (CFC) as of December 31^st, 2017. U.S. Taxpayers who fall into this category were required to pay a pro-rata share of the CFC’s earnings (15.5% on cash/cash equivalents and 8% on non-liquid assets).

The taxpayers in this case of Moore v. United States argue that they are being taxed on a dividend they never received since the company, for which they own a minority stake of ~13%, reinvested the earnings into the business. 

Nevertheless, the Moores were required to pay the MRT due to the TCJA treating untaxed foreign earnings as if those earnings had been repatriated, and they are now suing for a refund. The primary issue before the U.S. Supreme Court is whether the 16^th Amendment is violated by the enforcement of the MRT, as a tax on unrealized income.

The implications of this case

Prior to reaching the U.S. Supreme Court (SCOTUS), the issues posed by Mr. and Mrs. Moore were reviewed by the 9^th Circuit whereby the majority ruled against them stating:

• “Whether the taxpayer has realized income does not determine whether a tax is constitutional…” 
• “…there is no constitutional prohibition against Congress attributing a corporation’s income pro-rata to its shareholders” (see 9th Circuit Court Opinion)

However, in dissent, Judge Patrick Bumatay stated the following:

• “Without the guardrails of a realized component, the federal government has unfettered latitude to redefine ‘income’ and redraw the boundaries of its power to tax without apportionment…” 
• “…the Moores have received no return on their investment…they have no power to direct a dividend payment or otherwise realize a gain. Thus, the Moores had no ‘control over’ the company nor any ‘readily realizable economic value from it’.” (see Casetext: Moore v. United States )

While the TCJA has provided many incentives for repatriating funds, this new SCOTUS case will have an impact on U.S. taxpayers beyond those who own(ed) a qualifying interest in CFCs. This case raises implications for how Congress can define and tax income when it comes to future legislation.  Only time will tell what kind of ramifications will stem from this new case as oral arguments are scheduled for December 5th, 2023. 

The outcome of this case has the potential to not only affect individuals but also multinational corporations and their foreign subsidiaries. It could potentially shape how future tax policy is written, and it may even create new challenges for enforcing tax laws in regards to international income.

To learn more about how these tax laws could affect your individual circumstances, schedule a conversation with the fiduciary advisors from Avidian Wealth Solutions.

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