(originally launched into cyberspace on 03/26/2007)Dear Subscriber,
Within the "tax honesty" movement, there have been many
incarnations of the claim that the word "income" does not include
payments received as compensation for services (a.k.a. wages).
While the claims vary regarding what exactly DOES constitute
"income" (e.g., corporate profit, pay from government employment,
etc.), the common theme is that payment for work done by the
average person does not constitute "income." This conclusion,
however, is the result of misreading certain court decisions and
outright ignoring of other rulings, as well as decades of federal
tax statutes and regulations.
A recent version of this claim comes from the book "Cracking the
Code," by Peter Hendrickson. The title is a bit of a misnomer,
since the book barely addresses the tax code at all, instead
focusing on (and misunderstands) various court rulings having to do
with the meaning of "income."
Those arguing that wages are not "income" often harp on the fact
that the current law does not specifically define the term
"income." That is quite true, but by itself proves nothing. There
is no requirement that the law define every term used in the law--
which in reality would be impossible, as every definition would
simply use other words that would in turn need defining. If a law
DOES specifically define a term, then the common usage of that term
becomes irrelevant. However, if a term is NOT defined in the law
itself, then the word is presumed to have the meaning it has in
common usage (at the time the law was passed).
Obviously one's salary or paycheck constitutes "income" in the
common, everyday usage of the term. So what reason is there to
believe that the term "income" in the tax laws would exclude such
payments? The lack of a definition in the law itself is a reason to
defer to the common usage, not a reason to ignore the common usage.
Compare the way various cases are characterized by the "wages
aren't income" advocates (abbreviated below as "WAIA") and what
those cases actually said:
1) Merchants' Loan & Trust v. Smietanka, 255 U.S. 509 (1921)
This case is cited by the WAIA as being important because it said
that the term "income" in the 1913 income tax act had the same
meaning as it did in the 1909 corporate income tax act. That is
quite true, but the WAIA then erroneously conclude that the term
"income" itself refers only to corporate profits, which is simply
bad logic.
The 1909 tax gave a broad definition of the term "income" and then
taxed only income from corporate activity. The definition of
"income" itself, however, was NOT limited to corporate profits. On
the contrary, as the Supreme Court explained, while the 1909
corporate excise tax "was not an income tax law, a definition of
the word 'income' was so necessary in its administration that in an
early case it was formulated as 'A gain derived from capital, from
labor, or from both combined.'" Obviously the term "income," in and
of itself, was not confined to corporate profits, though only
income from corporate profits was subject to the 1909 tax.
The case had nothing to do with whether wages are "income." The
case was brought by the trustee of an estate concerning inherited
stocks, whose value increased between the time they were received
by the trustee and the time they were sold. The argument was that
the increase in value of the capital assets of the estate was not
"income." The Court ruled that it was, since the stocks had been
sold for a price higher than the market price of the stocks when
inherited.
A similar question has come up in other cases: is an increase in
the value of something always "income"? As a simple example,
suppose you own a house which is appraised at a value of $100,000
one year, and a few years later it is appraised at $150,000. Did
you receive $50,000 of income? Both logic and the courts give an
answer of "no." If you SELL something after its value has
increased, your "income" is what you received for it minus what you
paid for it (or its market value when you received it), but before
you sell it, its increased value does not constitute "income."
In its ruling on the case, the Court did not even hint that
"income" might have some unusual or artificially limited meaning
for tax purposes, but said just the opposite: "In determining the
definition of the word 'income' thus arrived at, this Court has
consistently refused to enter into the refinements of
lexicographers or economists, and has approved, in the definitions
quoted, what it believed to be the COMMONLY UNDERSTOOD MEANING OF
THE TERM which must have been in the minds of the people when they
adopted the Sixteenth Amendment to the Constitution."
How does that translate into "wages are not income"? Logically, it
doesn't at all. Quite the opposite.
2) Eisner v. Macomber, 252 US 189 (1920)
This is another case often cited, and often misunderstood, by the
WAIA ("Wages Aren't Income" Advocates). Again, the case was not
about wages at all, but about whether a stock dividend constituted
"income." The Court stated, and rightly so, that Congress cannot by
legislation change the meaning of "income" as used in the Sixteenth
Amendment, and then set out "to distinguish between what is and
what is not 'income.'"
So, did the Court come up with some new definition, which excludes
wages? No, the case wasn't about wages at all; it was about capital
versus income derived from capital. The Court explained the concept
as follows:
"The fundamental relation of 'capital' to 'income' has been much
discussed by economists, the former being likened to the tree or
the land, the latter to the fruit or the crop; the former depicted
as a reservoir supplied from springs, the latter as the outlet
stream, to be measured by its flow during a period of time."
Then the Court said this:
"For the present purpose we require only a clear definition of the
term 'income,' AS USED IN COMMON SPEECH, in order to determine its
meaning in the amendment."
The court then said that it could "find little to add to the
succinct definition" of "income" used in prior cases: "the gain
derived from capital, from labor, or from both combined." So how
does this case support the idea that getting paid for doing labor
is NOT "income"? It doesn't. It was about the difference between
the value of one's CAPITAL going up, and separate income coming
FROM capital. So the Court concluded, concerning the dividends in
question: "The essential and controlling fact is that the
stockholder has received nothing out of the company's assets for
his separate use and benefit ... Having regard to the very truth of
the matter, to substance and not to form, he has received nothing
that answers the definition of income within the meaning of the
Sixteenth Amendment."
If he were to SELL the dividends, however, the proceeds would
constitute "income." So you can see, in THAT context, why the Court
emphasized the concept of "gain" when determining what constitutes
"income." The entire discussion had NO bearing on whether "getting
paid for doing work" is income, and the same holds true of most of
the cases cited by the WAIA: they deal with a certain KIND of
income, and in THAT context seek to distinguish between increase in
value of capital versus actual income separated from the capital--
an issue which doesn't come into play at all when someone gets a
paycheck for performing services.
3) Lucas v. Earl, 281 US 111 (1930)
This case, the ruling in which is extremely short, involved the
question of whether an attorney should be taxed on ALL of his
salary, or only half, because by contract he had to give half to
his wife (and so he claimed that half to be HER income, not his).
The court ruled that one could not, "by anticipatory arrangements
and contracts," make the payments not constitute income to the
attorney, even if he afterwards had to give half to his wife.
Frankly, I'm not entirely sure why the WAIA cite this case at all,
since it is talking about SALARIES being taxed, so there's not much
more to say about that one. Apparently someone fabricated a
"quote," which does not appear in the actual ruling, to the effect
that salaries and wages are not necessarily taxable, or not
necessarily "income." But the court said nothing of the sort.
4) South Pacific v. Lowe, 247 US 330 (1918)
Once again, this is a case which involved the taxability as income
of "certain dividends upon stock." The Court rejected the idea that
"all receipts--everything that comes in--are income within the
proper definition of the term 'gross income.'" And that, not
surprisingly, is the part the WAIA quote. However, here is the
court's statement in context:
"We must reject in this case, as we have rejected in cases arising
under the Corporation Excise Tax Act of 1909 [citations omitted],
the broad contention submitted in behalf of the government that all
receipts--everything that comes in--are income within the proper
definition of the term 'gross income,' and that the entire proceeds
of a conversion of capital assets, in whatever form and under
whatever circumstances accomplished, should be treated as gross
income."
Again, the question had nothing to do with wages; it was about
capital versus gain from capital (income), and in that case, the
Court decided that it was "bound to consider accumulations that
accrued to a corporation prior to January 1, 1913, as being
capital, not income, for the purposes of the act." (The Court also
said that "the term 'income' has no broader meaning in the 1913 act
than in that of 1909," which again does NOT mean that "income"
means only corporate profit, even though the 1909 tax taxed only
income FROM corporate profits.)
That ought to give you something to chew on for now. We will
continue this discussion in my next message.
(To be continued.)
Sincerely,
Larken Rose
www.larkenrose.com
