What Is Gross Income: Section 61 and the Sixteenth Amendment

• Author: William Kratzke
• Pages: 38-135

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Chapter 2: What Is Gross Income: Section 61 and the Sixteenth

Amendment

We now take up various elements of the tax formula. You should place whatever

we are studying at the moment (the “trees”) within that formula (the “forest”). This

chapter introduces you to the concept of “gross income,” the very first item in the

tax formula. We also consider the constitutional underpinning of the federal income

tax. The constitutional basis of the income tax has been intertwined with the

concept of gross income itself.

You will notice that after adding up

all of the items encompassed by the

phrase “gross income,” every

succeeding arithmetical operation is a

subtraction. If an item is not

encompassed by the phrase “gross

income,” it will not be subject to

federal income tax. The materials that

follow consider various aspects of

gross income: its definition, whether

certain items that taxpayer has

received constitute “gross income,”

the timing of “gross income,” and

valuation.

Do the CALI lesson, Basic Income Taxation: Gross Income: Realization Concepts

in Gross Income.

Do the CALI lesson, Basic Income Taxation: Gross Income: Indirect Transfers for

Services.

I. The Constitutional and Statutory Definitions of “Gross Income”

Article I of the Constitution, which grants legislative powers to the Congress,

The Tax Formula:

 (g ro ss inco m e )

MINUS deductions named in § 62

EQUALS (adjusted gross income (AGI))

MINUS (standard deduction or itemized

deductions)

MINUS (personal exemptions)

EQUALS (taxable income)

Compute income tax liability from tables

in § 1 (indexed for inflation)

MINUS (credits against tax)

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contains several provisions concerning federal taxes.

Article I, § 2, clause 3: Representatives and direct Taxes shall be

apportioned among the several States which may be included within this

Union, according to their respective Numbers, which shall be determined

by adding to the whole Number of free Persons, including those bound to

Service for a Term of Years, and excluding Indians not taxed, three fifths

of all other Persons. The actual Enumeration shall be made within three

Years after the first Meeting of the Congress of the United States, and within

every subsequent Term of ten Years, in such Manner as they shall by Law

direct. ...

Article I, § 7, clause 1: All Bills for raising Revenue shall originate in the

House of Representatives; but the Senate may propose or concur with

Amendments as on other Bills.

Article I, § 8, clause 1: The Congress shall have Power To lay and collect

Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the

common Defence and general Welfare of the United States; but all Duties,

Imposts and Excises shall be uniform throughout the United States[.]

Article I, § 9, clause 4: No Capitation, or other direct, Tax shall be laid,

unless in Proportion to the Census or Enumeration herein before directed to

be taken.

The Constitution does not delegate to any other branch of the government any

authority to impose taxes. In Article I, § 9, cl. 4, the Constitution refers to “direct”

taxes, and restricts them to impositions upon states according to their population.

The founding fathers regarded consumption taxes as “indirect taxes” and regarded

them as superior to “direct taxes” in terms of fairness and for purposes of raising

revenue. See Alexander Hamilton, FEDERALIST NO. 21.

An income tax is a “direct tax.” Pollock v. Farmers’ Loan & Trust Co., 158 U.S.

601, 630 (1895) (tax on income from property). Congress has never tried to assess

an income tax state by state in proportion to their respective populations. Hence,

imposition of an income tax required an amendment to the Constitution. That came

in 1913:

Amendment 16: The Congress shall have power to lay and collect taxes on

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incomes, from whatever source derived, without apportionment among the

several States, and without regard to any census or enumeration.

Read § 61(a) of the Code. Notice that “gross income” encompasses “all” income

“from whatever source derived.” The language of the Code tracks that of the

Sixteenth Amendment, and it has been noted many times that in taxing income,

Congress exercised all of the constitutional power that it has to do so. However,

that point left open the question of what exactly is “income[], from whatever source

derived.” Taxpayers have argued many times that the “income” that Congress

wants to tax is beyond the scope of “income” as the term is used in the Sixteenth

Amendment. See Ann K. Wooster, Annot., Application of 16th Amendment to U.S.

Constitution – Taxation of Specific Types of Income, 40 A.L.R. FED.2d 301 (2010).

We consider here two cases in which the Supreme Court undertook to provide a

definition of “gross income,” the phrase that Congress used in § 61(a). We then

consider a case in which the United States Court of Appeals for the Seventh Circuit

more recently considered the scope of congressional authority to impose an income

tax. In Macomber, notice the justices’ differing views on the internal accounting

of a corporation.

•What does the Court mean by “capitalization?”

•What does the Court mean by “surplus?”

•By way of review: a demurrer is a creature of code pleading and is the

equivalent of a motion to dismiss for failure to state a claim. In Macomber,

taxpayer sued for a refund. The Commissioner (Eisner) demurred. The

federal district court overruled the demurrer, so taxpayer-plaintiff prevailed.

The Supreme Court affirmed.

Eisner v. Macomber, 252 U.S. 189 (1920).

MR. JUSTICE PITNEY delivered the opinion of the Court.

This case presents the question whether, by virtue of the Sixteenth Amendment,

Congress has the power to tax, as income of the stockholder and without

apportionment, a stock dividend made lawfully and in good faith against profits

accumulated by the corporation since March 1, 1913.

It arises under the Revenue Act of September 8, 1916, 39 Stat. 756 et seq., which,

in our opinion (notwithstanding a contention of the government that will be