The Taxing Question of Income: Historical Insights on the Meaning of “Income” May Preserve the Income Tax

Donald B. Tobin and Ellen P. Aprill

In Through the Looking Glass, Humpty Dumpty explains, “When I use a word . . . it means just what I choose it to mean—neither more nor less.” As Alice explores this interpretive method, Alice gives up; “[s]he was too much puzzled to make any other remark.”

Many tax lawyers felt similarly confused by recent efforts by the petitioners in Moore v. United States to define the word “incomes” within the Sixteenth Amendment to include only  “realized income.” The narrow definition of income proposed by the Moores would tax only a small subset of what economists, accountants, and tax lawyers consider to be income. This limited definition would significantly constrain Congress’s taxing power set out in Article I, Section 8 of the Constitution and reaffirmed in the Sixteenth Amendment.

The Sixteenth Amendment provides Congress with the power to “lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States.” Despite this clear statement, some 100 years after the passage of the Sixteenth Amendment, Moore asks the Supreme Court to examine whether the meaning of “incomes” within the Sixteenth Amendment includes only a specific type of income.

The taxpayers in Moore argue that an international tax provision in the Tax Cuts and Jobs Act (TCJA) is unconstitutional because it taxed unrealized gains. Although no constitutional or statutory provision defines “realization,” the concept is generally understood as the moment when taxpayers have sufficient control over income to make taxation appropriate. For example, a taxpayer realizes income when the taxpayer sells property for a gain, or receives wages, rents, interest, etc. In several cases, the Supreme Court has determined that realization is not a constitutional requirement for the taxation of income, but instead is a helpful concept often used by Congress for administration of the income tax.

 The Moores base their argument on the following facts. They were shareholders in a foreign controlled corporation. Under the provision introduced by TCJA, the Moores were liable for tax on income realized by the corporation. The Moores, however, argue that although the corporation realized the income, the Moores had not received the income from the corporation and thus there was not a realization event as to them.

The Moores then assert that unrealized gains are not “income” within the meaning of the Sixteenth Amendment. The Mooresrely principally on Eisner v. Macomber for the notion that income includes only income that is realized. In fact, the Moores argue that the phrase unrealized income is an “oxymoron.”

Central to the Moores’ argument is the Supreme Court’s 1895 decision, Pollock v. Farmers’ Home Loan & Trust Co. The decision in Pollock found the income tax in the Wilson-Gorman Tariff Act of 1894 to be unconstitutional because it was a direct tax not apportioned among the States. Contrary to almost one hundred years of precedent, the Court in Pollock determined that a direct tax included not only a tax on property, but also the tax on income derived from that property. Then and now, requiring apportionment of a tax was thought to immediately defeat its implementation. The Court’s determination that the income tax was a direct tax invalidated the income tax at issue.

The Sixteenth Amendment was ratified to address the ramifications of the Supreme Court’s decision in Pollock. The Sixteenth Amendment explicitly provides that Congress has the power to tax income, whether or not it is a direct tax. Because the taxation of incomes is explicitly permitted in the Constitution, the Moores needed to argue that the money the Government sought to tax here did not constitute income within the meaning of the Sixteenth Amendment.

A number of tax scholars have argued that the Court’s current jurisprudence, including the proper application of originalism, should doom the petitioners in Moore and confirm a broad view of Congress’s power to tax income. We reach the same conclusion as many of these scholars but take a slightly different approach by examining how economists, accountants, and legal scholars viewed the word “income” at the turn of the century. Our examination includes both the scholarship and theory of the time. It also includes the practice of accountants as they established a more formal system of accounting. Importantly, economists and accountants grappled with the complexities of “what is income” well before the debate surrounding the constitutionality of the income tax.