Income in the United States Tax Law

Debate

According to the Liability Memorandum:

“Meaning of the word “income” causes confusion but the Supreme Court has more or less reduced the legal meaning of the troublesome term to “gain”. If there is no gain, there is no income at least so far as the term is used in the Sixteenth Amendment. Coming to grips with the distinction between capital and pay or compensation for labor verses profit or gain is essential to determining what is or isn’t treated as gross income. A reasonably decent exposition of the term and its application was provided by the Supreme Court in Bowers v. Kerbaugh-Empire Company 271 U.S. 170; 46 S. Ct. 449; 70 L. Ed. 88 (1926):
“The Sixteenth Amendment declares that Congress shall have power to levy and collect taxes on income, “from  whatever source derived” without apportionment among the several States, and without regard to any census or enumeration. It was not the purpose or effect of that Amendment to bring any new subject within the taxing power. Congress already had power to tax all incomes. But taxes on incomes from some sources had been held to be “direct taxes” within the meaning of the constitutional requirement as to apportionment. Art. I, § 2, cl. 3, § 9, cl. 4; Pollock v. Farmers’ Loan and Trust Co., 158 U.S. 601. The Amendment relieved from that requirement and obliterated the distinction in that respect between taxes on income that are direct taxes and those that are not, and so put on the same basis all incomes “from whatever source derived.” Brushaber v. Union Pac. R. R., 240 U.S. 1, 17. “Income” has been taken to mean the same thing as used in the Corporation Excise Tax Act of 1909, in the Sixteenth Amendment and in the various revenue acts subsequently passed. Southern Pacific Co. v. Lowe, 247 U.S. 330, 335;  Merchants L. & T. Co. v. Smietanka, 255 U.S. 509, 519. After full consideration, this Court declared that income may be defined as gain derived from capital, from labor, or from both combined, including profit gained through sale or conversion of capital. Stratton’s Independence v. Howbert, 231 U.S. 399, 415; Doyle v. Mitchell Brothers Co., 247 U.S. 179, 185; Eisner v. Macomber, 252 U.S. 189, 207. And that definition has been adhered to and applied repeatedly. See e. g. Merchants L. & T. Co. v. Smietanka, supra, 518; Goodrich v. Edwards, 255 U.S. 527, 535; United States v. Phellis, 257 U.S. 156, 169; Miles v. Safe Deposit Co., 259 U.S. 247, 252-253; United States v. Supplee-Biddle Co., 265 U.S. 189, 194; Irwin v. Gavit, 268 U.S. 161, 167; Edwards v. Cuba Railroad, 268 U.S. 628, 633. In determining what constitutes income substance rather than form is  to be given controlling weight. Eisner v. Macomber, supra, 206.
Gain derived from capital, from labor, or from both removes capital and labor as objects of the normal tax imposed by 26 U.S.C. § 1. The income at issue is “derived from”. This explains why the wage even of government personnel (26 CFR §§ 3401 et seq.) is not the object of taxation. Labor is equivalent to a capital asset. The return for labor, which is necessary for living and enjoying life, attends unalienable rights proclaimed in the Declaration of Independence: All people are endowed with rights to life, liberty and pursuit of happiness (property). The Fifth Amendment protects these rights by the substantive right to due process in the course of the common law. Direct tax on capital and/or labor are what they are and do not fall within the province of the Sixteenth Amendment tax on “income” as the term is applied by law.
The matter was treated somewhat more extensively in Conner v. Unites States of America 303 F. Supp. 1187 (USDC, S.D. Tex, 1969):

The issue to be resolved here is whether or not plaintiffs improperly excluded from their gross income, as that phrase appears in section 61(a) of the Internal Revenue Code of 1954, $4,200.00 received from the insurance company as reimbursement for the rental payments paid by plaintiffs plus $465.82 for reimbursement for other out-of-pocket living expenses resulting from the fire. n1 The parties agree that this is an issue which is solely one of law to be decided by the Court.

Section 61(a), Internal Revenue Code of 1954, defines gross income in the following terms:
“Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items: (1) Compensation for services, including fees, commissions, and similar items; (2) Gross income derived from business; (3) Gains derived from dealings in property; (4) Interest; (5) Rents; (6) Royalties; (7) Dividends; (8) Alimony and separate maintenance payments; (9) Annuities; (10) Income from life insurance and endowment contracts; (11) Pensions; (12) Income from discharge of indebtedness; (13) Distributive share of partnership gross income; (14) Income in respect of a decedent; and (15) Income from an interest in an estate or trust.”
How really broad is section 61(a)? Does it include within its scope the type of receipt paid to plaintiffs in this instance? The answers to these questions can be determined only by a careful investigation of the concept of income for tax purposes and the various stages through which it has evolved.

Income has been the subject of federal taxation since as long ago as the Civil War and continuously since 1913. Rapp, Some Recent Developments in the Concept of Taxable Income, 11 Tax L. Rev. 329 (1956). In that year, the sixteenth amendment [**7] to the United States Constitution was proclaimed as having been ratified. It provided then, as now, that:
“The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”

Plainly, the amendment was not a grant of power to Congress to tax incomes, for such a power is one which Congress always had. It was adopted to meet the decision of the United States Supreme Court in Pollock v. Farmers’ Loan & Trust Co., 157 U.S. 429, 39 L. Ed. 759, 15 S. Ct. 673 (1895) which declared the Income Tax Act of 1894 unconstitutional on the ground that it was an unapportioned direct tax. See Bowers v. Kerbaugh-Empire Co., 271 U.S. 170, 173-4, 70 L. Ed. 886, 46 S. Ct. 449 (1926).

No attempt has ever been made by Congress to define with specificity the term “income” as it is used in the sixteenth amendment. In earlier taxing acts, it instead provided that “gross income” includes “gains, profits, and income” from various designated sources “or from any source whatsoever,” leaving to administrative and judicial determination the inclusion or exclusion of [**8] certain items. See Rapp, supra.

The judiciary accepted this responsibility and in Eisner v. Macomber, 252 U.S. 189, 207, 64 L. Ed. 521, 40 S. Ct. 189 (1919), the Supreme Court, referring to two cases n2 arising under the Corporation Tax Act of 1909, endorsed the following definition of income:
“Income may be defined as the gain derived from capital, from labor, or from both combined,’ provided it be understood to include profit gained through the sale or conversion of capital assets.”

With the growth of tax jurisprudence and the increasing store of experience with income tax problems, this “all-inclusive” formulation to test the presence of income was found to be impractical. The Supreme Court gradually abandoned its earlier pronouncements as universal criteria, instead approaching particular situations on an ad [**9] hoc basis, and throughout underscoring the “all-inclusive” scope of the income which Congress is permitted constitutionally to tax. n3.
Final abandonment of the “all-inclusive” approach to this definition of income came with the case of Commissioner v. Glenshaw Glass Co., supra. There, it was held that exemplary damages recovered for fraud or as the punitive two-thirds portion of a treble damage antitrust recovery must be reported by a taxpayer as gross income under section 22(a) of the Internal Revenue Code of 1939. That provision is as follows:

“Gross income’ includes  gains, profits, and income derived from salaries, wages, or compensation for personal service … of whatever kind  and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits from any source whatever.”
The Court said that the Eisner definition of “income” was useful in the context of the decision there, i.e., distinguishing gain from capital, but that:
” … it was not meant to provide a touchstone to all future gross income questions …
“Here we have instances of undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion….”
The language of section 61(a) of the Internal Revenue Code of 1954, set forth above, might at first glance appear to have broadened the definition of gross income by the omission of any reference to gain. n4 This, however, is not so, because the Supreme Court had before [**11] it the then recently enacted 1954 Code of Internal Revenue when it decided Commissioner v. Glenshaw Glass Co., supra. It noted that, although the definition of gross income had been simplified, “no effect on its present broad scope was intended.” 348 U.S. at 432. n5 In addition, the Court in General American Investors Co. v. Commissioner, 348 U.S. 434, 99 L. Ed. 504, 75 S. Ct. 478 (1955), decided the same day as Glenshaw Glass Company, supra, held that “insider profits” under the Securities and Exchange Act of 1934 were includable in therecipient corporation’s gross income.
“In accordance with the legislative design to reach all gain constitutionally taxable unless specifically excluded, we conclude that the petitioner is liable for the tax ….” 348 U.S. at 436.
The opinion in Glenshaw Glass Company, supra, regardless of what it said about Eisner v. McComber, supra, did not repudiate the concept that there must be gain before there is income within the meaning of the sixteenth amendment. 1 Mertens, section 5.02, p. 4. This is verified by the fact that in Commissioner v. Lo Bue, 351 U.S. 243, 100 L. Ed. 1142, 76 S. Ct. 800 (1956), a year after the decisions in Glenshaw Glass Company, supra, and General American Investors v. Commissioner, supra, it was said:

“We have repeatedly held that in defining ‘gross income’ as broadly as it did in section § 22(a) Congress intended to ‘ tax all gains except those specifically exempted.” 351 U.S. at 246.
To the same effect, see Commissioner v. Minzer, 279 F.2d 338 (5th Cir. 1960).
Accountants and economists may differ greatly as to what is or is not income. It is not, however, their theories that have guided the courts throughout the years. Instead, the courts have chosen to use the meaning given the term “income” by its everyday use in common speech. Helvering v. Edison Bros. Stores, 133 F.2d 575 (8th Cir. 1943); 1 Mertens, supra, n. 5, p. 2. And the meaning of income in its everyday sense is “a gain or recurrent benefit usually measured in money that derives from capital or labor; also: the amount of such gain recovered by an individual in a given period of time.” Webster’s Seventh New Collegiate Dictionary, p. 425 (1965). Income is nothing more nor less than realized gain. Shuster v. Helvering, 121 F.2d 643 (2nd Cir. 1941). It is not synonymous with receipts. 47 C.J.S., section § 98, p. 226.
Whatever may constitute income, therefore, must have the essential feature of gain to the recipient. This was true when the sixteenth amendment became effective, it was true at the time of the decision in Eisner v. McComber, supra, it was true under section 22(a) of the Internal Revenue Code of 1939, and it is likewise true under section 61(a) of the Internal Revenue Code of 1954. If there is no gain, there is no income.
It is apparent that plaintiffs in this case realized no gain in connection with the reimbursement by the insurance company of the rental payments in the total amount of $4,200.00. If there was any income in the ordinary and real sense of the word realized by anyone relating to these payments, it was the owner of the house that plaintiffs rented. With respect to the reimbursement by the  insurance company to plaintiffs of the $4,200.00, plaintiffs were no more than a conduit through which these funds passed.

If one of plaintiffs suffered a personal injury covered by insurance, the receipts of that insurance would be specifically excludable under section 104(a)(3) of the Internal Revenue Code of 1954. The same would hold true under section 104(a)(2) if plaintiffs had been compensated for personal injury not covered by insurance. While it is recognized that these statutory exclusions apply only to personal injuries, the same logic on which they are based would control the issue of the judicial exclusion from gross income of the payments made to the plaintiffs here. Congress has taxed income, not compensation.

Direct payment for labor is different from profit derived from labor. If a business contracted labor to another concern with the consequence of generating profit above the cost of labor, returns beyond direct payment to whoever actually provided the labor would be profit. If a worker, professional or whatever earned more from his labor than he needed to live, interest and other returns generated from investment of direct labor returns would potentially be subject to the Chapter 1 normal tax. In a manner of speaking, wages, salaries and the like are compensation, not income. This conclusion is reinforced by the 26 CFR § 31.3402(n)-1 exemption provision. Even for government personnel, the wage is not the object of the tax. But even this technicality appears to be qualified almost to the point of being moot by the necessity of determining the source of income in order to qualify what is gross and therefore taxable income to whom.”

Practical Information

Note: Some of this information was last updated in 1982

Income in Federal tax law

The return in money, property, or services from one’s business, labor, or invested capital. 1. Gross Income. To determine gross income, subtract from income the income that is exempt from taxes. Items of income that are exempt from federal income tax (in U.S. law) are called exclusions. Some examples of exclusions are gifts, inheritances, and interest on state bonds.

2. Adjusted Gross Income. Gross income less business expenses of the taxpayer. Adjusted gross income is computed by individuals only, not by corporations.

3. Taxable Income. Gross income less deductions allowed by law. For individuals, adjusted gross income less additional deductions for personal expenses and personal exemptions is the taxable income. Individuals may take a standard deduction in lieu of itemizing deductions for personal expenses. The standard deduction is in addition to deductions for adjusted gross income, but instead of deductions for personal expenses. In every case, the amount of the standard deduction depends on the amount of the taxpayer’s adjusted gross income.

For corporations, taxable income is gross income less deductions. Many expenses incurred by corporations are deductions.

4. Prepaid Income. Income that is received before it is earned. See also withholding (in U.S. law); capital (in U.S. law) (Gain and Loss).

(Revised by Ann De Vries)

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