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The American Income Tax

Chapter 15

Gross Income — Arguing With the Camel

Written by Darrell Anderson.

“When I use a word,” Humpty Dumpty said, in a rather scornful tone, “it means just what I choose it to mean — neither more nor less.”

Humpty Dumpty, from Through the Looking-Glass, by Lewis Carroll

The history of the 16th Amendment is clear, as is the history that a tax on incomes is a direct tax as opposed to an indirect tax measured by incomes. Much like the confusion with the “derived from . . . labor” issue, at least one author has recommended that the 16th Amendment should be read in context of the early 20th century:[1]

The Congress shall have the power to lay and collect indirect taxes on unearned incomes and annual profits, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.

Yet notice the inherent problem with this mental adjustment. Income is personal property and taxes on incomes have always been seen as a direct tax. The original legislative intent of the 16th Amendment was to create a new method of collecting taxes with respect to the specific property of income. Those early legislators recognized that a tax on incomes is a direct tax — they simply wanted to avoid the rule of apportionment.

Revenue agents today generally embrace the Brushaber decision where through some magnificent twistifications the Supreme Court justices alleged that the income tax is an indirect tax in the nature of an excise. Thus, adding the word indirect to the 16th Amendment would accomplish little with respect to those revenue agents and their actions. The zero basis nonsense allows those same people to create an illusion of profits and gains with respect to wages and salaries. The suggested changes resolve little.

To avoid the issue of the zero basis nonsense, consider replacing the word on with the phrase with respect to. Also consider ensuring that any taxable profits and gains are limited to incorporated and registered businesses (limited liability companies, partnerships, and registered Doing Business As entities). This latter mental image then would allow independent workers, tradespeople, and artisans to avoid the problem of being accused of being “engaged in a trade or business.” Currently, revenue agents classify all people as either employed or engaged in a trade or business (independent contractor). The difference between an “independent contractor” and an “employee” is merely one of degree. Regardless of how a worker is classified the result remains the same with respect to the basic exchange process.

With those modifications the 16th Amendment would read like this:

The Congress shall have the power to lay and collect taxes with respect to unearned incomes and the profits derived from incorporated and registered businesses, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.

The tax remains a direct tax no longer subject to apportionment. This was the original intent of those early legislators as well as the common worker of that day. Those people wanted to tax the unearned income of the wealthy as well as organized business profits. Taxing wages and salaries never was the intent of that social movement. Removing the infamous “from whatever source derived” clause eliminates the open-ended fishing trips.

So how is the trap laid today?

Most people discover section 1 of the Internal Revenue Code, which imposes a tax on “taxable income.” Taxable income is defined at section 63 and generally means gross income minus allowed statutory deductions and exemptions. Gross income is defined at section 61 and means, generally, all income derived from whatever source but not limited to the various items identified in that section. Income has been defined numerous times by the Supreme Court justices and means profits and gains with respect to business operations and certain passive transactions in which the gains are unearned, such as various investments.

To determine profits and gains in those various transactions requires establishing a cost basis from which the profits and gains might be derived. A key component to interpreting section 61 are the words derived from. Those words in section 61 are copied directly from the 16th Amendment. The source is not taxed but only the profit or gain derived from that source is taxed. Identifying the source is necessary to establish a cost basis. Cost basis is a question of fact and not a question of law. The remaining unknown is whether a person experiences or realizes income in the nature of profits or gains.

Many people have noticed that the 1916 Supreme Court cases categorized income taxes as an indirect tax in the nature of an excise. Worded differently, all income taxes are excise taxes. Many people have noticed that the Supreme Court justices defined excises as “taxes laid upon the manufacture, sale, or consumption of commodities within the country, upon licenses to pursue certain occupations, and upon corporate privileges.”

What seems apparent by such research is that one pays a tax on incomes only if participating in certain statutorily defined activities. If legislators fail to define an activity as a portal toward realizing income in the nature of profits or gain, then any increase or gain is irrelevant with respect to taxation.

Because the Supreme Court justices declared the income tax an indirect tax in the nature of an excise, many people look in the Internal Revenue Code in an effort to discover the statute that imposes a tax on them for the manufacture, sale, or consumption of commodities; upon licenses to pursue certain occupations; or upon corporate privileges. After a thorough investigation, many people believe no such statute exists.

However, an excise tax is a tool used by crafty legislators. When discussing the topic of an excise tax with respect to the income tax debate, many people look only for a licensed or privileged activity. A few people remember to look for the manufacture, sale, or consumption of commodities, but often they limit themselves to looking only in the nature of a retail sales tax. However, the concept of a commodity covers a wide spectrum of exchangeable tangible objects. Exactly what is a commodity?

The English word commodity is derived from the French word commodité, which means comfort or convenience; which is derived from the Latin word commoditas, which means fitness and adaptation.[2] In modern usage the word commodity means any tangible object that people believe is useful and renders life easier or more enjoyable. Commodities are movable tangible objects, as opposed to fixed tangible objects.

From Noah Webster’s 1828 American Dictionary of the English Language:

Commodity: That which affords ease, convenience or advantage; any thing that is useful, but particularly in commerce, including every thing movable that is bought and sold, goods, wares, merchandize, produce of land and manufactures. Unless perhaps animals be excepted, the word includes all the movables which are objects of commerce.

Any excise tax imposed on the manufacture, sale, or consumption of commodities is a property transaction tax. Legislators often impose an excise tax in a manner whereby a certain property transaction is explicitly declared by statute as taxable. Examples not only include various retail sales taxes, but also gasoline taxes, tire taxes, alcoholic beverage taxes, tobacco taxes, etc. Such taxes almost always are passed to the end consumer. As consumers, people may avoid paying such taxes by not buying such commodities at retail. People can avoid being directly liable for collecting and paying such taxes by not selling those commodities at retail.

From Noah Webster’s 1828 American Dictionary of the English Language:

Excise: Cut off. An inland duty or impost, laid on commodities consumed, or on the retail, which is the last stage before consumption . . . But many articles are excised at the manufactories . . . .

A gray area in this income tax debate is whether other property transactions in which one might realize a gain is subject to being taxed as a taxable transaction. This is the territory of the infamous “from whatever source derived” clause. Such transactions are not statutorily defined as are those previously mentioned excise taxes. Legislators might not explicitly define such transactions as a gain, but identify potential gains through indirect means. An example is the sale of a house. Comparing the original purchase price and the recent selling price might reveal a gain. Under the guise of an income tax, legislators argue that such a gain is taxable as income. If any gain exits, the gain certainly is unearned.

Could such a taxable transaction also include labor or the products derived from labor? In the Pollock decision the justices observed that taxes on business, privileges, or employments have assumed the guise of an excise tax and have been sustained as such. The justices implied they knew that a tax imposed on wages and salaries was a direct tax, but under the guise of an excise tax legislators have nonetheless taxed wages and salaries. Through their court decisions the very justices themselves had sustained that deception. Everybody understands such a tax to be a direct tax, but with mere toying of words the tax is labeled an excise tax and escapes the apportionment argument.

For at least 140 years the definition of a commodity seems little changed since Noah Webster first penned his definition in 1828. To be a commodity a key element seems to be any tangible object that is movable in commerce. From Black’s Law Dictionary, fourth edition:

Commodities: Those things which are useful or serviceable, particularly articles of merchandise movable in trade . . . Goods, wares, and merchandise of any kind; movables; articles of trade or commerce . . . Movable articles of value; things that are bought and sold.

Yet, in that same 1968 text, labor was recognized as not being a commodity:

Labor has been held not to be a commodity. Rohlf v. Kasemeier, 140 Iowa 182, 118 N. W. 276, 23 L. R. A., N. S. 1285. But it has been held that the supplying of telephone service is the supplying of a commodity of commerce; McKinley Telephone Co. v. Cumberland Telephone Co., 152 Wis. 359, 140 N. W. 38, 39; and it has also been thought that the privilege of receiving property by will or intestate succession is a commodity subject to the Massachusetts excise law; Dana v. Dana, 226 Mass. 297, 115 N. E. 418, 419.

Interestingly, in Black’s Law Dictionary, sixth edition, these court case references no longer are available. Still, the key seems to remain limited to tangible objects. The question remains then, is labor or the products we humans derive from the process of laboring a commodity? If so, then where is the statute that explicitly identifies those commodities as being subject to an income tax in the nature of an excise? If the trick instead is to merely discover a gain “from whatever source derived,” then where is the gain involved that any such exchange produces?

Income tax proponents understand these questions. Through the years as more people became informed about the nature and history of the income tax, and began to grasp and appreciate the meaning and effect of those early foundational Supreme Court decisions, proponents therefore derived an esoteric theory to justify a direct tax on wages and salaries but masquerading as an excise. Proponents therefore had to create an illusion of gain through their zero basis nonsense.

A seemingly insignificant Supreme Court case opened the door to this nonsensical zero basis theory. Along with the changes made to the Internal Revenue Code by legislators in 1954, in 1955 the Supreme Court justices rendered the issue moot. In Commissioner v. Glenshaw,[3] the straightforward issue at bar was whether money received from punitive damages awarded through litigation was gross income subject to taxation. The broader question was whether “windfall gains” were taxable. The legislators and early proponents of the income tax probably would have answered that question rather easily by identifying the payments as unearned gain. Unearned gains was one of the targets of the original income tax effort. Such a seemingly simple case, but years later tax experts would grow to realize that Glenshaw was a watershed moment with income tax issues.[4]

Prior to this case, judges, attorneys, and legislators tended to view the topic of income from within the context of generally accepted accounting principles. Practically all of the cases that appeared in court had to do with focusing on what was income with respect to deductions and the “ordinary and necessary” expenses of doing business. That popular definition of income produced from Eisner v. Macomber with respect to the gain derived from capital or hired labor was within the limited context of doing business. Because a stock dividend was not derived from employing capital or labor, the justices decided that stock dividends were not income. Within that environment, income was perceived as being distinct from the capital and labor that created income.

Decided the same day, in General American Investors Company v. Commissioner,[5] the justices discussed “the legislative design to reach all gain constitutionally taxable.” The justices refused to eliminate the element of gain from their understanding of the term income. Once the legislators revised the Internal Revenue Code in 1954, and purposely or accidentally disassociated the term income from the terms profits and gains, the door opened to a more liberal interpretation of income — in the nature of “everything that comes in” rather than in the nature of profits and gains. In Glenshaw the Supreme Court justices established two doctrines with respect to deciding whether an exchange constituted income:

  1. That the Internal Revenue Code and not language in judicial opinions is the ultimate source of tax law.
  2. The term gross income in the Code is a catch-all phrase that reaches all accessions to wealth, regardless of source and not explicitly excluded in the Code.

These rules establish the alpha and omega of federal tax issues, that the Internal Revenue Code is the ultimate source of all federal tax law, the common law is not an element in those disputes, and that because the Code is completely a statutory creation, judicial opinions and definitions are secondary to the Code.[6] In other words, all of those individual judicial attempts to define income were no longer holding, except within the narrow context of the issue at bar.

This case was a turning point where the definition of income was no longer a question of law but a question of fact. After Glenshaw the only element that remained standing was the concept of gain. Realization of that gain, as affirmed in Eisner v. Macomber, was no longer an important element. The Supreme Court justices had previously rendered ineffective the severability test established in Eisner in 1940.[7] They had previously established that judicial definitions within any particular case were irrelevant as precedent.[8] They had decided that receiving money from uncontrolled third party sources was irrelevant.[9] They eventually rejected their own maxim established in Gould v. Gould[10] that taxing statutes ought to be construed in favor of the taxpayer.[11] With this subtle and slow erosion, the constitutional meaning of the term income no longer was relevant. Was the 16th Amendment dead? No, but the “from whatever source derived” clause had prevailed completely. Those simple words had transformed the entire concept of explicitly identifying a taxable activity into an implied bottomless pit. Through the years the justices had not overturned Eisner v. Macomber, and legislators learned their lessons from each subsequent decision by learning to tweak the Code to their satisfaction.[12] IRS bureaucrats no longer had to identify an activity as taxable, but merely had to claim that something was income. Court judges complied.

In Glenshaw the issue at bar depended upon the 1939 Code, but the justices emphasized the “from whatever source derived” clause that was embedded in the newer 1954 Code — linked to the 16th Amendment. Any gain, derived from whatever source, was income. Although the Supreme Court justices never have addressed the singular question of deriving income from wages and salaries, the IRS bureaucrats grabbed the opportunity from this judicial climate to establish their zero basis theory. All everybody had to do was ignore the key words “derived from.” That the term “compensation for services” found in section 61(a) of the Internal Revenue Code is rooted in the concept of how businesses calculate net income, along with the legislative shifts of World War II, those same words are now easily misconstrued to mean all wages and salaries. That clause was indeed a bottomless pit. With legislators failing to maintain exemptions and standard deductions that cover the ordinary and necessary expenses of life, magically, with the zero basis theory, all wages and salaries automatically became taxable net income rather than income in the nature of gross receipts. Much to the frustration of many people, court judges have sustained this approach.

Finis.

Terms of Use

Next: Chapter 16: Presumptions — Kissing the Camel

Table of Contents

Bibliography

Endnotes

[1] Hart, Constitutional Income, pp. 235–236.

[2] Webster’s New Universal Unabridged Dictionary, second edition, 1983.

[3] 348 U.S. 426 (1955).

[4] Dodge, “The Story of Glenshaw Glass: Toward a Modern Concept of Gross Income,” Tax Stories, p. 15.

[5] 348 U.S. 434 (1955), at pages 436 and 479.

[6] Dodge, “The Story of Glenshaw Glass: Toward a Modern Concept of Gross Income,” Tax Stories, p. 30.

[7] Helvering v. Bruun, 309 U.S. 461 (1940).

[8] United States v. Kirby Lumber Co., 284 U.S. 1 (1931).

[9] Irwin v. Gavit, 268 U.S. 161 (1925), in which the justices decided that trust income was not exempt; Robertson v. United States, 343 U.S. 711 (1952), in which the justices decided a cash prize received from winning a musical contest was gross income subject to taxation.

[10] 245 U.S. 151 (1917).

[11] White v. United States, 305 U.S. 281 (1938).

[12] Caron, Tax Stories, p. 4.