moments in tax history | Eisner v. macombe | Income, an origin story | law of the free man
Eisner v. Macomber, 252 US 189 (1920)
Summary: In Eisner v. Macomberthe U.S. Supreme Court has ruled that for the purposes of the Sixteenth Amendment, “income” is “a gain, profit, anything of exchangeable value from property, separate from capital, however investment or employment, and incoming, being ‘derived’, i.e. received or drawn by the recipient (the taxpayer) for its separate use, benefit and disposal. macomber introduced the achievement requirement to federal income tax, and the decision continues to be cited in contexts such as cryptocurrency hard forks and the constitutionality of provisions disallowing deductions for cannabis businesses.
Background: The US Constitution prohibits Congress from imposing an undistributed direct tax.[1] In 1895, the United States Supreme Court ruled that an attempt by Congress to tax income uniformly across the United States was unconstitutional because of this constitutional prohibition.[2]
On February 3, 1913, the Sixteenth Amendment to the United States Constitution was ratified. According to the Sixteenth Amendment, “Congress shall have power to establish and collect taxes on income from whatever source, without apportionment among the several states, and without regard to any census or enumeration.”[3] That same year, Congress passed the Revenue Act of 1913, ushering in the modern federal personal income tax.[4]
The Revenue Act of 1916 further amended personal income tax. In relevant part, the Revenue Act 1916 provided that a stock dividend would be treated as income up to its cash value.[5]
On January 1, 1916, the Standard Oil Company of California had surplus and retained earnings of approximately $45,000,000, of which approximately $20,000,000 was earned before March 1, 1913.[6] That month, the company issued a stock dividend of 50% of its outstanding shares, transferring an amount equivalent to that issue from its surplus account to its capital stock account.[7]
Prior to the stock dividend, Myrtle H. Macomber owned 2,200 shares of the company and she received an additional 1,100 shares as a result. Approximately 18.07%, or 198.77 shares with a face value of $19,877, were treated as representing surplus earned between March 1, 1913 and January 1, 1916.[8] The Bureau of Internal Revenue (the name at the time of the Internal Revenue Service) demanded that Ms. Macomber pay federal income tax on the value of this portion of the stock dividend, which she did under Reserve.[9]
Holding: The Court has ruled that a shareholder does not realize income when receiving a pro rata stock dividend. Accordingly, an act of Congress that taxed such stock dividends was unconstitutional.
Reason for detention: The Court determined that the Sixteenth Amendment must be interpreted in light of the tax clauses of the Constitution before the amendment was passed.[10] The Court noted that before the amendment was passed, it had ruled that Congress could not impose taxes on real estate rents and profits and on income from personal property investments without apportioning those taxes. between the States according to the population, because these taxes were in fact direct taxes on the goods giving rise to these incomes.[11] The passage of the Sixteenth Amendment simply removed the requirement that income taxes be apportioned among the states—it did not “extend the power of taxation to new subjects”. . . .”[12]
Thus, the Court determined that the Sixteenth Amendment should be interpreted so as to preserve the apportionment requirement found elsewhere in the Constitution.[13] To do this, the Court had to decipher the meaning of the word “income”.[14]
The Court began by discussing the relationship between “capital” and “income”, observing that “the old [had been] assimilated to the tree or the earth, the latter to the fruit or the harvest; the first represented as a reservoir fed by sources, the second as the output current, to be measured by its flow rate over a period of time.[15] Extrapolating from this, the Court concluded that “‘[i]Income may be defined as the gain from capital, labor, or both combined, provided it is understood to include profit made by the sale or conversion of capital assets. . . .”[16]
The Court then observed that with a stock dividend,
no part of the company’s assets are separated from the common fund, nothing is distributed except paper certificates which attest to a previous increase in the value of the shareholder’s capital interest resulting from an accumulation of profits by the company, but profits hitherto absorbed in the so that it is impossible to separate them for withdrawal and distribution. . . . [I]t does not alter a shareholder’s pre-existing proportionate interest or increase the intrinsic value of his interest or the aggregate interests of other shareholders as they previously existed. The new certificates simply increase the number of shares, thereby diluting the value of each share.[17]
The Court concluded that, in such circumstances,
the shareholder has not received any of the company’s assets for his separate use and benefit; on the contrary, each dollar of its initial investment, as well as the accretions and accumulations resulting from the employment of its money and that of the other shareholders in the business of the company, remains the property of the company and is subject to the risks which may result in the cancellation of the entire investment. In view of the truth of the matter, in substance and not in form, he received nothing that met the definition of income under the Sixteenth Amendment.[18]
Thus, the test adopted by the Court for determining “income” under the Sixteenth Amendment was “a gain, profit, anything of exchangeable value proceeding from the property, Cup of the capital invested or employed, and frombeing “derived”, i.e. received Where drawn by the beneficiary (taxpayer) for its separate use, benefit and disposal. . . .”[19]
Reactions to the decision: The macomber decision was the only time in the last century that the Supreme Court ruled on a federal income tax case on constitutional grounds.[20] Although macomber was never explicitly overturned, some have argued that it was in fact overturned by the Court by Commissioner v Glenshaw Glass Co., 348 US 426, 431 (1955)who considered that the term “income” included “undeniable increases in wealth, clearly realized, and over which the taxpayers have full control”.[21] Specifically, the Court held that the definition of “income” in macomber “was not meant to be a touchstone for all future gross income questions.”[22]
The macomber decision had its dissents. Justice Oliver Wendell Holmes held that the term “income” “should be read in the sense most obvious to common understanding at the time of its adoption”.[23] Holmes felt that “[t]he knew the purpose of [the Sixteenth] The amendment was intended to eliminate the nice questions about what direct taxes might be, and I have no doubt that most non-lawyer people would assume, when voting for, that they were asking a question like this.[24]
Judge Louis D. Brandeis, for his part, argued that issuing cash and stock dividends were equivalent mechanisms for distributing corporate wealth and should also be subject to federal income tax.[25] Holding otherwise would empower “owners of America’s most successful businesses.” . . to escape taxation on much of what is really their income.[26]
Continued relevance: The macomber decision continues to be invoked in various contexts.
Perhaps the most influential macomber introduces the federal income tax fulfillment requirement. Under the realization requirement, federal income tax can generally only be assessed when there is a change in a taxpayer’s relationship to the property.[27] While debate continues over whether the requirement of achievement is a constitutional requirement (as macomber alluded to) or a matter of administrative convenience, it remains an important aspect of federal income tax to this day.[28]
Recently, the ruling was cited as authoritative for the idea that cryptocurrency hard forks should not be taxed.[29] macomber has also been used in challenges to the constitutionality of Section 280Edenial of credits and deductions for cannabis businesses[30] and Section 965repatriation tax.[31]
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[1] See const. art. I, § 9, cl. 4.
[2] Pollock v. Farmers’ Loan & Trust Co.157 US 429 (1895).
[4] Revenue Act of 1913, Pub. L. No. 63-16, 38 Stat. 166 (1913).
[5] Revenue Act of 1916, Pub. L. no. 64-271, § 2(a), 39 Stat. 756, 757 (1916).
[6] Eisner v. Macomber252 US 189, 200 (1920).
[7] macomber252 US to 200.
[8] macomber252 United States at 200-01.
[9] ID. at 201.
[10] Identifier. at 205.
[11] ID. (citing Pollock18. US 601).
[12] macomber252 United States to 206.
[13] Identifier.
[14] Identifier. Notably, the Court held that Congress’s definition of income did not settle the case, because Congress could not change the Constitution by mere legislation. Identifier.
[15] Identifier.
[16] Identifier. at 206-07 (citing Independence of Stratton v. Howbert231 US 399, 415 (1913) and Doyle v. Mitchell Bros. Co.247 US 179, 185 (1918)).
[17] macomber252 United States at 210-11.
[18] Identifier. at 211.
[19] Identifier. at 209.
[20] Reuven Avi-Yonah, Should US tax law be constitutionalized? Centennial Reflections on Eisner c. Macomber (1920), 16 Duke J. Const. L. & Pub. Poly 65, 66 (1921).
[21] Reuven Avi-Yonah, Should US tax law be constitutionalized? Centennial Reflections on Eisner c. Macomber (1920), 16 Duke J. Const. L. & Pub. Poly 65, 67 (1921).
[22] Glenshaw glass348 United States to 431.
[23] macomber252 US at 219 (Holmes, J., dissent).
[24] Identifier. at 220 (Holmes, J., dissent).
[25] Identifier. at 221, 237-238 (Brandeis, J., dissent).
[26] Identifier. at 237 (1920) (Brandeis, J., dissenting).
[27] Alice G. Abreu and Richard K. Greenstein, Define income11 Fla. Tax Rev. 295, 336 (2011).
[28] For cases implying that the fulfillment requirement is unconstitutional, see Helvering v. Horst, 311 US 112, 116 (1940) (“[T[he rule that income is not taxable until realized . . . [is] based on administrative convenience. . . .” and Helvering v. Griffiths, 318 US 371, 393-94 (1943)(indicating that Horst “further undermined the original theoretical basis of the decision to Eisner v. Macomber.”).
[29] David G. Chamberlain, Forking Belief in Cryptocurrency: A Tax Non-Realization Event, 24 Fla. Tax. Rev.651 (2021).
[30] Beckett Cantley and Geoffrey Dietrich, The Cannabis Conundrum: Constitutional and Political Concerns in Marijuana Industry Taxationy, 10 Legis. & Pol’y Brief 39, 57-58 (2021).
[31] See Moore v. 20-36122 (9th Cir. June 7, 2022) (writing here).
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