Constitutionality of Grantor Trusts

In Moore v. United States, 602 U.S. ___, No. 22-800 (6/20/2024), the U.S. Supreme Court upheld the constitutionality of the “mandatory repatriation tax” (MRT), which was enacted as part of the Tax Cuts and Jobs Act in 2017 and required American taxpayers to pay a tax on income that had been accumulated in foreign corporations of which the taxpayer is a shareholder. In reaching that conclusion, the majority opinion (authored by Justice Kavanaugh and joined by four other justices) relied on the long-standing acceptance of Congressional power to tax shareholders and partners on the income of the businesses that they own.

Neither the majority opinion nor the concurring and dissenting opinions mentioned the provisions of the Internal Revenue Code that tax the grantors of certain kinds of trusts on the income of those “grantor trusts.” (See “Overview: Benefits/Costs of Grantor Trusts” and “Intentional Grantor Trusts is Pennsylvania” for additional information on grantor trusts.) But a limit of the ability of Congress to tax owners of business entities is mentioned. In footnote 4 of the majority opinion, it is noted that there may be limits on the attribution of income under the due process clause of the Fifth Amendment, such as “limits based on the taxpayer’s relationship to the income.” Viewed by that standard, the grantor trust rules are almost certainly constitutional because grantors are taxed only on the income earned by trusts that are revocable or over which the grantor has retained powers giving the grantor some level of control over the income of the trust or the investments of the trust.

Similar constitutional issues might apply to the so-called “kiddie tax” imposed by IRC section 1(g), which requires that the unearned income of a minor child to be taxed at the marginal tax rates of the parents. The constitutionality of that tax has been upheld by several district courts, even though the Supreme Court had previously held that it was an unconstitutional violation of due process for a state to impose tax rates on a married person based in part on the income of his her spouse, stating that “because of the fundamental conceptions which underlie our system, any attempt by a state to measure the tax on one person’s property or income by reference to the property or income of another is contrary to due process of law as guaranteed by the Fourteenth Amendment.” Hoeper v. Tax Commission of Wisconsin, 284 U.S. 206, 215 (1931).

In Moore, the majority opinion specifically expresses no opinion on whether Congress could require shareholders to pay an income tax on the undistributed income of widely held or domestic corporations, or whether Congress could impose a tax on unrealized capital gains or a tax on wealth generally, so those issues remain for another day.

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