§ 61 Residual Gross Income

Author:Deborah A. Geier
Pages:150-183
 
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Chapter 6: § 61 Residual Gross Income
Section 61(a) provides that “Gross Income means all income from whatever source derived,
including (but not limited to) the following items ….” (Emphasis added.) Because of that
parenthetical, we know that items of Gross Income exist in the world that are not found among the
15 listed items, but what are they? How should that vague residual clause be interpreted by both
courts and the administrators of the statute? That issue is what this chapter is all about.
In the early days of the income tax, interpreters often turned to the meaning of the term
“income” in other disciplines and contexts for help. Thus, for example, readers of 19th century
English novels (confession: Jane Austen fan here) often read that Lord Wembley has “30,000
pounds a year” in income on which to live. This “income” would come typically from land, such
as rent from the tenants on his estate. Under the social conventions of the time, Lord Wembley
would never dream of invading his “capital”—the landto spend on personal consumption,
invading his “capital” to live. Rather, it was understood that Lord Wembley would live only on
the income produced by his capital so that the capital, itself, could be passed intact to his first-born
son. If a plot of land proved to be inconveniently situated and he sold it, he would not view the
cash sales proceeds (or any profit from the sale) as available for consumption. Rather, he would
use the sales proceeds to purchase other land or other capital, which would, in turn, produce
“income” that he could legitimately consume under the social conventions of the time.
Notice that rent and interest tend to be paid periodically, i.e., from time to time or with
regularity, such as monthly or quarterly. Similarly, returns on human capital in the form of wages
are also paid periodically. Thus, some early interpreters concluded that “income” meant only the
periodic payments from invested capital (such as interest, dividends, rents, and royalties) and the
periodic return to human capital in the form of wages. Under this view, one-time, lump-sum
payments were not considered “income” but rather “capital” receipts that, when invested, would
produce future “income.” Thus, the “gain” realized on the sale of land was not considered
“income” under the early English income tax but rather the entire proceeds (including any gain)
were considered a tax-free “capital” receipt. If profit from one-time sales of land were considered
“income” and thus taxed, the wealth of the landed gentry might diminish over time when that
wealth needed to remain intact to be handed down to the first-born son.
Similarly, let’s return to an earlier example, under which Father died in the 19th century and,
under his will, instructed that the title to all of his land and other investment property be transferred
to a trust, with “income” from the trust to be paid to surviving Wife for the rest of her life. Upon
her death, his will instructed that the trust should be dissolved, with the trust “capital” or “corpus”
distributed to the first-born son. If the trustee of that trust sells land or another investment asset
held in the trust at a profit during Wife’s life, that profit (what we would call § 1001 “gain” today)
would not be distributed to Wife as “income” but rather would be considered a “capital” receipt
that belongs to the trust corpus and which would, when invested again by the trustee, produce
future “income” to be distributed to Wife. Because the profit was not a periodic return but rather
a lump sum, it was not considered to be “income” (available to spend on consumption) but rather
a capital receipt that would eventually be distributed to the first-born son on Wife’s death.
This all sounds quite odd to our 21st-century ears. Today, we do not view one-time, lump-sum
receipts as out of bounds for spending on personal consumption under any social convention
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(lottery winnings anyone?). And the term “capital” receipt would, to our ears, mean only a tax-
free return of basisnot the entire “amount realized.” Gain realized on the sale of an asset (the
excess of amount realized over basis) is similarly available to spend on personal consumption
under 21st-century mores. In the early 20th century, however, when the modern income tax was
first enacted, debate swirled regarding whether “income” under the residual clause was limited to
the periodic receipts from invested financial or human capital so that “gain” or profit on the sale
of an investment (capital gain) would not be considered “income,” just as under the English income
tax.1
In the 1920 Supreme Court decision in Eisner v. Macomber,2 the Court said—when interpreting
the meaning of that vague residual clausethat “income may be defined as the gain derived from
capital, from labor, or from both combined, provided it to be understood to include profit gained
through a sale or conversion of capital assets.” If that last clause had not been added, we still might
have been unsure after Macomber whether § 1001 “gain” realized on the sale of an asset could
legitimately be considered “income” for tax purposes.3
But when you think about that Eisner v. Macomber definition of income for more than a
moment, you realize that some receipts would still escape the “income” label if the receipt could
not be traced back to a capital investment or to labor. What about lottery winnings, prizes, punitive
damages, and other windfalls? They are not compensation for services rendered (a return to labor),
and they are not a return on invested capital (§ 1001 “gain” on the sale of an asset, interest,
dividends, rents, or royalties). Does that mean that they are not “income” within the meaning of
the residual clause?
It seems odd that the facts in the following case had to be litigated all the way up to the Supreme
Court, as the outcome seems so intuitive today. But you can see why the issue arose when you
appreciate the background described above.
COMMISSIONER V. GLENSHAW GLASS
348 U.S. 426, reh’g denied, 349 U.S. 925 (1955)
MR. CHIEF JUSTICE WARREN delivered the opinion of the Court.
This litigation involves two cases with independent factual backgrounds yet presenting the
identical issue. The two cases were consolidated for argument before the Court of Appeals for the
Third Circuit and were heard en banc. The common question is whether money received as
exemplary damages 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 § 22(a) of the Internal Revenue
Code of 1939 [the predecessor to current § 61(a)]. In a single opinion, the Court of Appeals
affirmed the Tax Court’s separate rulings in favor of the taxpayers. Because of the frequent
recurrence of the question and differing interpretations by the lower courts of this Court’s decisions
bearing upon the problem, we granted the Commissioner of Internal Revenue’s ensuing petition
for certiorari.
1 Capital gains have bee n regularly taxed under the English inc ome tax only since 1965.
2 252 U.S. 189 (1920).
3 In case we were not sure of this result, the Court confirmed in the following year that even “occasional” capital gains
on the disposition of property constitute “income.” See Merchants’ Loan & Trust Co. v. Smietanka, 255 U.S. 509
(1921).
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The facts of the cases were largely stipulated and are not in dispute. So far as pertinent they are
as follows:
The Glenshaw Glass Company, a Pennsylvania corporation, manufactures glass bottles and
containers. It was engaged in protracted litigation with the Hartford-Empire Company, which
manufactures machinery of a character used by Glenshaw. Among the claims advanced by
Glenshaw were demands for exemplary damages for fraud and treble damages for injury to its
business by reason of Hartford’s violation of the Federal antitrust laws. In December, 1947, the
parties concluded a settlement of all pending litigation, by which Hartford paid Glenshaw
approximately $800,000. Through a method of allocation which was approved by the Tax Court,
and which is no longer in issue, it was ultimately determined that, of the total settlement,
$324,529.94 represented payment of punitive damages for fraud and antitrust violations. Glenshaw
did not report this portion of the settlement as income for the tax year involved. The Commissioner
determined a deficiency. As previously noted, the Tax Court and the Court of Appeals upheld the
taxpayer.
William Goldman Theatres, Inc., a Delaware corporation operating motion picture houses in
Pennsylvania, sued Loew’s, Inc., alleging a violation of the Federal antitrust laws and seeking
treble damages. After a holding that a violation had occurred, the case was remanded to the trial
court for a determination of damages. It was found that Goldman had suffered a loss of profits
equal to $25,000 and was entitled to treble damages in the sum of $375,000. Goldman reported
only $125,000 of the recovery as Gross Income and claimed that the balance constituted punitive
damages and as such was not taxable. The Tax Court agreed, and the Court of Appeals, hearing
this with the Glenshaw case, affirmed.
It is conceded by the respondents that there is no constitutional barrier to the imposition of a
tax on punitive damages. Our question is one of statutory construction: are these payments
comprehended by § 22(a) [predecessor to current § 61(a)]?
The sweeping scope of the controverted statute is readily apparent:
SEC. 22. GROSS INCOME.
(a) GENERAL DEFINITION.‘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 and income derived from any source whatever….
This Court has frequently stated that this language was used by Congress to exert in this field
the full measure of its taxing power.” Helvering v. Clifford, 309 U.S. 331, 334; Helvering v.
Midland Mutual Life Ins. Co., 300 U.S. 216, 223; Douglas v. Willcuts, 296 U.S. 1, 9; Irwin v.
Gavit, 268 U.S. 161, 166. Respondents contend that punitive damages, characterized as
windfalls” flowing from the culpable conduct of third parties, are not within the scope of the
section. But Congress applied no limitations as to the source of taxable receipts, nor restrictive
labels as to their nature. And the Court has given a liberal construction to this broad phraseology
in recognition of the intention of Congress to tax all gains except those specifically exempted.
Comm’r v. Jacobson, 336 U.S. 28, 49; Helvering v. Stockholms Enskilda Bank, 293 U.S. 84, 87-

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