Synaptic Sparks

Constitutional Income

U.S. Constitution, Sixteenth Amendment

The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration.

"Income" is now a Constitutional word. 

In order, therefore, that the clauses cited from article 1 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 becomes 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 cannot by any definition it may adopt conclude the matter, since it cannot by legislation alter the Constitution, from which alone it derives its power to legislate, and within whose limitations alone that power can be lawfully exercised.

EISNER v. MACOMBER ,
252 U.S. 189 (1920)

Because the word "income" is used in the Sixteenth Amendment, its definition has become a Constitutional meaning that Congress is required to obey. This definition of "income" now rules Congress, whereas before the Sixteenth Amendment Congress ruled the definition of "income". 

The Supreme Court drives the point home that Congress does NOT get to define the meaning of "income". The Supreme Court's duty is to clarify what the Constitution means and the Supreme Court addresses the clarification of the word "income" with these words:

The question is one of definition, and the answer to it may be found in recent decisions of this Court.  [...]

[T]here would seem to be no room to doubt that the word [income] must be given the same meaning in all of the Income Tax Acts of Congress that was given to it in the [1909] Corporation Excise Tax Act, and that what that meaning is has now become definitely settled by decisions of this Court.

MERCHANTS' LOAN & TRUST CO. v. SMIETANKA,
255 U.S. 509 (1921)

"That meaning has now become definitely settled by decisions of this Court." 

What then, is this definition of "income"?

This case was in regard to the 1909 corporate excise tax act.

And, however the operation shall be described, the transaction is indubitably 'business' within the fair meaning of the act of 1909; and the gains derived from it are properly and strictly the income from that business; for 'income' may be defined as the gain derived from capital, from labor, or from both combined, and here we have combined operations of capital and labor.

STRATTON'S INDEPENDENCE, LTD. v. HOWBERT,
231 U.S. 399 (1913)

This case was in regard to the 1909 tax act as well.

Whatever difficulty there may be about a precise and scientific definition of 'income,' it imports, as used here, something entirely distinct from principal or capital either as a subject of taxation or as a measure of the tax; conveying rather the idea of gain or increase arising from corporate activities. As was said in Stratton's Independence v. Howbert, 231 U.S. 399, 415 , 34 S. Sup. Ct. 136: 'Income may be defined as the gain derived from capital, from labor, or from both combined.'

DOYLE v. MITCHELL BROS. CO. ,
247 U.S. 179 (1918)

The tax act of 1916 and this case both arose after the Sixteenth Amendment was declared ratified. The outcome of this case was determined by the definition of "income in the constitutional sense", a phrase I found of interest in yet another case.

This case was in regard to an attempt to tax stock dividends in accordance with the revenue act of 1916. (The stock dividends were corporate dividends paid out as more shares of stock.) 

The fundamental relation of 'capital' to 'income' has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time. For the present purpose we require only a clear definition of the term 'income,' as used in common speech, in order to determine its meaning in the amendment, and, having formed also a correct judgment as to the nature of a stock dividend, we shall find it easy to decide the matter at issue.

After examining dictionaries in common use (Bouv. L. D.; Standard Dict.; Webster's Internat. Dict.; Century Dict.), we find little to add to the succinct definition adopted in two cases arising under the Corporation Tax Act of 1909 (Stratton's Independence v. Howbert; Doyle v. Mitchell Bros., 'Income may be defined as the gain derived from capital, from labor, or from both combined,' provided it be understood to include profit gained through a sale or conversion of capital assets, to which it was applied in the Doyle Case.

Brief as it is, it indicates the characteristic and distinguishing attribute of income essential for a correct solution of the present controversy. The government, although basing its argument upon the definition as quoted, placed chief emphasis upon the word 'gain,' which was extended to include a variety of meanings; while the significance of the next three words was either overlooked or misconceived. 'Derived-from-capital'; 'the gain-derived-from-capital,' etc. Here we have the essential matter: not a gain accruing to capital; not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value, proceeding from the property, severed from the capital, however invested or employed, and coming in, being 'derived'-that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal- that is income derived from property. Nothing else answers the description.

EISNER v. MACOMBER,
252 U.S. 189 (1920)

Observe the court's usage of the words expressed. 

This case goes right to the issue as to what is "income" within the meaning of the Sixteenth Amendment.

There remains the question, strenuously argued, whether this gain in four years of over $700,000 on an investment of about $500,000 is 'income' within the meaning of the Sixteenth Amendment to the Constitution of the United States.

The question is one of definition, and the answer to it may be found in recent decisions of this Court.

The Corporation Excise Tax Act of August 5, 1909, was not an income tax law, but a definition of the word 'income' was so necessary in its administration that in an early case it was formulated as 'A gain derived from capital, from labor, or from both combined.' Stratton's Independence v. Howbert.

This definition, frequently approved by this court, received an addition, in its latest income tax decision, which is especially significant in its application to such a case as we have here, so that it now reads:
'Income may be defined as a gain derived from capital, from labor, or from both combined, provided it be understood to include profit gained through sale or conversion of capital assets.' Eisner v. Macomber.
MERCHANTS' LOAN & TRUST CO. v. SMIETANKA,
255 U.S. 509 (1921)

Income is gain derived from capital or labor or both combined.

Reviewing this excerpt shows that the Supreme Court has also examined the property that income is derived from.

[A] gain, a profit, something of exchangeable value, proceeding from the property, severed from the capital, however invested or employed, and coming in, being 'derived'-that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal- that is income derived from property. Nothing else answers the description.

EISNER v. MACOMBER,
252 U.S. 189 (1920)

The court has clearly told us that income is gain or profit severed from the property (capital) that is invested, regardless of how the property is invested or employed.

The Constitutional requirements that "direct" taxes be apportioned is part of the reason why a clear line must be drawn between "income" and "property invested".

The sixteenth amendment authorizes the taxation of income "from whatever source derived" -- thus taking in investment income --"without apportionment among the several States."
[...]
So the 16th amendment made it possible to bring investment income within the scope of a general income-tax law, but did not change the character of the tax.  It is still fundamentally an excise or duty with respect to the privilege of carrying on any activity or owning any property which produces income.

Page 2580 House Congressional Record March 27, 1943