Eisner v. Macomber

A nearly identical situation was addressed by the court in Towne v. Eisner . (Eisner was the person responsible for Internal Revenue Collection in both cases). However between the time the two cases were decided, the United States passed the Sixteenth Amendment to the United States Constitution, which allowed the Federal Government to levy a tax against income without regard to state population. The Sixteenth Amendment was passed due to decisions by the Supreme Court that ruled the Federal Government had no power to levy taxes on income unless they were proportioned by the population of the state. The Sixteenth Amendment effectively overruled the Supreme Court on the issue and allowed direct taxation of income without regard to a state's population. In addition, in the aftermath of Towne v. Eisner, the U.S. Congress, in its revenue collection statute, specifically stated that stock dividends were to be counted as income.

In the case before the bar, Macomber had been taxed on stock certificates received from Standard Oil of California, some of which represented cash held by the company that had been capitalized. The Internal Revenue Service taxed those certificates as if they had been cash received.

In the majority opinion, Justice Mahlon Pitney wrote that additional stock represented an distribution of a gain in a corporation's capital to its stockholders, rather than distribution of income. He essentially overruled the decision of Congress to treat stock dividends as income. He noted that in Towne v. Eisner, the court had said in no uncertain language that stock dividends were not income as nothing of value was received by Towne - the company was not worth any less than it was when the dividend was declared, and the total value of Towne's stock had not changed either, he just had more shares. Although Pitney acknowledged the power of the Federal Goverment to tax income under the Sixteenth Amendment, he essentially said this did not give Congress the power to tax anything other than income, and that Congress did not have the power to re-define the term income as it appeared in the amendment. The Court ordered that Macombe be reimbursed for the tax she paid.

In the dissent, Justice Louis Brandeis wrote that Sixteenth Amendment authorized Congress to tax “incomes, from whatever source derived”, and the authors of the amendment “intended to include thereby everything which by reasonable understanding can fairly be regarded as income”, and that “Congress possesses the power which it exercised to make dividends representing profits, taxable as income, whether the medium in which the dividend is paid be cash or stock, and that it may define, as it has done, what dividends representing profits shall be deemed income”. Brandeis took issue with the majority's interpretation of income. He noted that in business circles, cash dividends and stock dividends were treated absolutely identically. Prior to the passage of the income tax act in question, it was common for a dividend to be paid out in cash, and then those receiving the dividend would be allowed to buy company stock at a price well below market if they signed back the dividend. This transaction would clearly be taxable as income, and Brandeis saw no reason why two essentially identical transactions should be treated differently for tax purposes.

In any event, the success of investors in avoiding tax was short lived. The following year, the court ruled that capital gains were income, and that they accrued as income when the stock was sold. This put an end to any benefit stock dividends gave an investor, as such stock was essentially purchased at zero cost and the entire price of the stock became capital gains when it was sold. In addition, the exception for stock dividends was narrowed by the Court in such cases such United States v. Phellis, (shares in a subsidiary corporation issued to stockholders in the parent corporation were taxable as income); Rockefeller v. United States and Cullinan v. Walker (increase in capital accumulated by corporations over time were taxable when shares are distributed to stockholders in a successor corporations).

Anti-tax activists often use Eisner v. Macombe for its proposition that Congress cannot define what income is. This is a typical accurate, but misleading quote:

" In order, therefore, that the clauses cited from Article I of the Constitution may have proper force and effect save only as modified
by the Amendment, and that the latter also may have proper effect, it is essential to distinguish between what is and what is not 'income' as the term is there used; and to apply the distinction as cases arise according to truth and substance without regard to form. Congress by any definition it may adopt cannot conclude the matter, since it cannot by legislation alter the Constitution, from which it derives its power to legislate, and within whose limitations alone that power can be lawfully exercised" [emphasis added]

In fact, the Supreme Court did discuss what constituted income in Eisner v. Macombe, and quoted from Towne v. Eisner:

"Just as we deem the legislative intent manifest to tax the stockholder with respect to such accumulations only if and when, and to the extent that, his interest in them comes to fruition as income, that is, in dividends declared, so we can perceive no constitutional obstacle that stands in the way of carrying out this intent when dividends are declared out of a pre-existing surplus. ... Congress was at liberty under the amendment to tax as income, without apportionment, everything that became income, in the ordinary sense of the word, after the adoption of the amendment, including dividends received in the ordinary course by a stockholder from a corporation, even though they were extraordinary in amount and might appear upon analysis to be a mere realization in possession of an inchoate and contingent interest that the stockholder had in a surplus of corporate assets previously existing." [emphasis added]

Essentially, the only principal that can be taken from Eisner v. Macombe is that the word "income" in the Sixteenth Amendment has to be given its ordinary plain English meaning, and wealth and property that is not income may not be taxed directly by the Federal Goverment. However, the Court was clear that taxes on property and wealth could be levied freely by the states, and could be levied by the Federal Goverment if each state was required to pay a proportion of the tax relative to its population.

External Links

Unsuccessful attempts to use Macomber as justification for not paying taxes at quatloos.com [[2]" class="external">[1]