Synaptic Sparks

The Income Tax Is An Excise Tax

What is an excise tax?

This case is in regard to the 1909 Corporate Excise Tax Act. It explains what an excise tax is.

Within the category of indirect taxation, as we shall have further occasion to show, is embraced a tax upon business done in a corporate capacity, which is the subject-matter of the tax imposed in the act under consideration. The Pollock Case construed the tax there levied as direct, because it was imposed upon property simply because of its ownership. In the present case the tax is not payable unless there be a carrying on or doing of business in the designated capacity, and this is made the occasion for the tax, measured by the standard prescribed. The difference between the acts is not merely nominal, but rests upon substantial differences between the mere ownership of property and the actual doing of business in a certain way.
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And in the same connection the chief justice, delivering the opinion of the court in Thomas v. United States, [...], in speaking of the words 'duties,' 'imposts,' and 'excises,' said:
'We think that they were used comprehensively, to cover customs and excise duties imposed on importation, consumption, manufacture, and sale of certain commodities, privileges, particular business transactions, vocations, occupations, and the like.'

Duties and imposts are terms commonly applied to levies made by governments on the importation or exportation of commodities. Excises are 'taxes laid upon the manufacture, sale, or consumption of commodities within the country, upon licenses to pursue certain occupations, and upon corporate privileges.' Cooley, Const. Lim. 7th ed. 680.
The tax under consideration, as we have construed the statute, may be described as an excise upon the particular privilege of doing business in a corporate capacity, i. e., with the advantages which arise from corporate or quasi corporate organization; or, when applied to insurance companies, for doing the business of such companies. As was said in the Thomas Case, 192 U. S. supra, the requirement to pay such taxes involves the exercise of privileges, and the element of absolute and unavoidable demand is lacking. If business is not done in the manner described in the statute, no tax is payable.

FLINT v. STONE TRACY CO., 220 U.S. 107 (1911)

The Court goes on to explain those corporate privileges.

In the case at bar we have already discussed the limitations which the Constitution imposes upon the right to levy excise taxes, and it could not be said, even if the principles of the 14th Amendment were applicable to the present case, that there is no substantial difference between the carrying on of business by the corporations taxed, and the same business when conducted by a private firm or individual. The thing taxed is not the mere dealing in merchandise, in which the actual transactions may be the same, whether conducted by individuals or corporations, but the tax is laid upon the privileges which exist in conducting business with the advantages which inhere in the corporate capacity of those taxed, and which are not enjoyed by private firms or individuals. These advantages are obvious, and have led to the formation of such companies in nearly all branches of trade. The continuity of the business, without interruption by death or dissolution, the transfer of property interests by the disposition of shares of stock, the advantages of business controlled and managed by corporate directors, the general absence of individual liability, these and other things inhere in the advantages of business thus conducted, which do not exist when the same business is conducted by private individuals or partnerships. It is this distinctive privilege which is the subject of taxation, not the mere buying or selling or handling of goods, which may be the same, whether done by corporations or individuals.

FLINT v. STONE TRACY CO., 220 U.S. 107 (1911)

This case is also in regard to the 1909 Corporate Excise Tax Act.

Evidently Congress adopted the income as the measure of the tax to be imposed with respect to the doing of business in corporate form because it desired that the excise should be imposed, approximately at least, with regard to the amount of benefit presumably derived by such corporations from the current operations of the government.

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

The income tax is, therefor, not a tax on income as such, It is an excise tax with respect to certain activities and privileges which is measured by reference to the income they produce.  The income is not the subject of the tax: it is the basis for determining the amount of tax.

Page 2580 House Congressional Record March 27, 1943

The income tax is still an excise (privilege) tax unless it is collected in the manner of a direct tax on property.

Moreover, in addition, the conclusion reached in the Pollock Case did not in any degree involve holding that income taxes generically and necessarily came within the class of direct taxes on property, but, on the contrary, recognized the fact that taxation on income was in its nature an excise entitled to be enforced as such unless and until it was concluded that to enforce it would amount to accomplishing the result which the requirement as to apportionment of direct taxation was adopted to prevent, in which case the duty would arise to disregard form and consider substance alone, and hence subject the tax to the regulation as to apportionment which otherwise as an excise would not apply to it.

BRUSHABER v. UNION PACIFIC R. CO., 240 U.S. 1 (1916)

In easier to understand English: 

The following four examples should help illustrate what the Supreme Court is addressing in the preceding citation.

Example 1:

Capital of $100 is invested in an interest bearing instrument like a CD for a time period that gives an ROI (return on investment) of 10%. The gain or profit is $10. A tax of 20% on the income is due. $2.00 in tax is deducted. The capital is undiminished and ready to be re-invested. The rule of apportionment does not apply, the tax is not unconstitutional as enforced.

  $110 gross receipts
-$100 less capital deposited
  $10 net receipts
x  20% tax rate
    $2 tax due

$110 gross receipts
 -  $2 minus tax
 $108 receipts after tax
-$100 less capital actually invested
     $8 income to be spent.
Example 2:

Capital of $100 is likewise invested for a time period that gives an ROI (return on investment) of 10%. The gain or profit is $10. A tax of 240% on the income is due. $24.00 in tax is deducted. The capital is diminished and can not be re-invested. The rule of apportionment does apply, the tax is unconstitutional as enforced.

  $110 gross receipts
-$100 less capital deposited
   $10 net receipts
x 220% tax rate
   $22 tax due

$110 gross receipts
- $22 minus tax
  $88 receipts after tax
-$100 less capital actually invested
  -$12 capital diminished
Example 3:

Capital of $100 is invested (expended) in material and labor. The product created by labor working the material is sold for $110. The rest of this example is exactly the same as example 1. Likewise, whether this scenario is constitutional or not, is based upon the tax rate applied in the same manner as in example 2.

  $110 gross receipts
-$100 less material & labor deductions
  $10 net receipts
x  20% tax rate
    $2 tax due

$110 gross receipts
 -  $2 minus tax
 $108 receipts after tax
-$100 less capital actually invested
     $8 income to be spent or reinvested.
Example 4:

The example is exactly like example 3, but the expenditure of the capital is not allowed to be deducted.

  $110 gross receipts
  -$0 less material & labor deductions
  $110 net receipts
x  20% tax rate
   $22 tax due

$110 gross receipts
- $22 minustax
  $88 receipts after tax
-$100 less capital actually invested
  -$12 capital diminished

Note how the same results happen in examples 2 and 4, arrived at by two different methods of enforcing the tax. When this happens, as the Supreme Court has said, "the duty would arise to disregard form and consider substance alone, and hence subject the tax to the regulation as to apportionment which otherwise as an excise would not apply to it."

From the previous examples it is clear to see that when capital is expended in the creation of gross receipts (revenue) the capital must be recouped and made whole or there is tax upon the capital.