Historical Perspectives on the Federal Income Tax
"IN THE PRESENT CASE THERE IS NO LACK OF UNIFORMITY AS BETWEEN CORPORATIONS AND INDIVIDUALS. THE EXEMPTION OF $4,000 IN THE CASE OF THE INDIVIDUAL OR FAMILIES, AS WILL BE SHOWN, IS INTENDED AS A COMPENSATION FOR THE NECESSARILY EXCESSIVE BURDEN OF CONSUMPTION TAXES UPON SMALL AND MODERATE INCOMES.
THERE IS NO SUCH SITUATION IN THE CASE OF A BUSINESS CORPORATION. EVERY CENT WHICH IT EXPENDS IS ALLOWED IT. IT IS TAXED ONLY ON ITS NET PROFITS, DEDUCTING THE WAGES ACCOUNT; WHICH CORRESPONDS TO THE LIVING EXPENSES OF THE INDIVIDUAL." (Attorney General Olney, in the 1895 Pollock Cases at 157 US 427, page 778)
(Note: The $4,000 exemption allowed to offset personal living and family expenses in 1895 is now $3,500 in 2008)
In the end, all of the taxes imposed by state, county, city, and or federal governments are collected from the people through the expenditure of their personal incomes. The exception being the poll tax charged by the early state and county governments to build and maintain roads, whereby they required the use of your labor, or the payment of money. These taxes have been classified as being either Direct or indirect depending upon the intent of the government charging them. Those taxes that operate directly upon the people without regard to any circumstances at all are considered to be Direct, because the intent of Government is to extract tribute from the existence of the people. Those taxes that operate upon the people through the choices they make are called indirect, because the intent of Government is that the people should have a choice on how much money they contribute to the support and operation of that government.
The things we buy, manufacture, produce, or own all have some form or amount of tax attached to them and although we are aware of most of these taxes, other taxes are hidden in the costs we choose to pay for the goods and services we purchase. Try as we may, most of these taxes are not avoidable when it comes to the necessities of life. However, other taxes are avoidable through the choices we make, such as putting gasoline in the car we chose to purchase. Even the property taxes imposed by the state or county you live in are avoidable, if one chooses not to own property (although you will be paying that property owner’s tax through the rent you chose to pay). The exception to this rule is the federal "income tax" or "personal" tax now imposed upon us simply because we choose to earn money in order to support ourselves and pay those other taxes.
In the beginning, the federal income tax was intended to be an indirect tax, in that it was intended for the tax to be passed on to the consumer through the price that was charged for the product or service sold. The tax ultimately being a part of the cost of doing business, the recovery of which is regulated by the price the consumer was willing to pay. Although the income tax is not a deductible expense of the transaction, it is included in the price that is charged and, therefore, recovered from the consumer’s choice to purchase the product or service. The purpose of the income tax being to extract a portion of the profits (surplus) of business in order to reduce the other necessary taxes imposed upon the consumption of necessities. Thereby creating an economic balance in the collection of taxes supporting the government.
As such, the federal "income tax" was to be paid out of one’s surplus income, the net gain or profit derived from their commercial and financial (business) endeavors. If one was not successful in their business endeavors to acquire gains and profits they didn’t have a surplus income, therefore, no income tax was due. Their contribution to the support of their government was taken from the purchases they chose to make with the income they did have. Likewise, those that were very successful were required to pay a proportionate amount of their gains and profits (income) to the government in the form of an income tax. The income tax, therefore, being measured by the ability to pay the additional tax, rather than taken from the necessities of life.
To this end, from 1913 to 1939 the Federal Income Tax was strictly imposed upon commercial net income and the personal exemption allowance did prevent the indirect tax from operating directly upon the life of the person receiving the income. However, that all changed in a matter of five years. The Revenue Acts of 1940 to 1944 not only created millions of new "individuals (single owner entities)," but also forever changed the intent of the income tax system. No longer would the tax fall strictly on commercial net income, nor would the personal exemption insulate the human person from the effects of the income tax operating directly upon their lives. No longer would the tax be upon "wealth, not want; accumulated possessions, not consumption" as envisioned by those that wrote the law. No longer would the tax be imposed strictly upon the surplus wealth of our country, for after all, even those of meager means owes something to their federal government, even if it takes away their ability to support themselves or their families.
Over those five years the Democratic Congress of FDR managed to change not only the intent of the federal income tax system, but its application as well. That is, it is still an indirect tax imposed upon commercial net income, although the personal exemption no longer insulates the human person from the effects of the tax operating directly upon their life. The major change is the inclusion of the massive labor force i.e., the common laborer, where the same indirect tax is measured by their wages, i.e., their gross receipts for the year (income). The bottom line is, we now have a dual basis (income/income) tax system, whereby the intent of Congress is to tax the people Directly, through their different definitions of income.
The following is a short synopsis of the five Revenue Acts, and the slight changes they each made to the character and application of the 16th Amendment Federal Income Tax system. These changes were deliberate and specifically worded to fool the court and the laborer into believing the tax, under the 16th Amendment, was to be imposed upon everyone alike, without regard to any circumstances or restraints. The basis for "taxable income" is now statistical in nature, being based on the amount of money one receives throughout the year; which has nothing whatsoever to do with the Sixteenth Amendment definition of income. It was imposed upon the people as a restraint to the monetary inflation brought on by the recovery programs instituted by F.D.R., and our entry into WWII. The people would simply have too much money to spend, unless government took it away from them first.
The Revenue Act of 1940 (HR10039) changed the measurement of the "personal exemption" allowance from that of commercial net income, to that of commercial gross income. Gross income being defined as the receipts (income) minus the return of capital (property, or cost of goods sold). In other words, the gross amount of gain (16th Amendment income) before the deduction of the expenses incurred to produce it (Statutory income). The purpose being so that the deductions for business related expenses could be more readily verified as to the actual net income subject to tax. This legislation was designed to increase the number of "taxpayers," in order to increase the yield of the tax, without changing the character or intent of the law.
The Revenue Act of 1941 (HR 5417) implemented the "voluntary (optional)" tax tables (Supplement T), applicable to specified items of "gross income" only. Congress made a specific point that the use of this table was VOLUNTARY, yet once used must be used forever! This is the first of the "simplification" changes made necessary by the increased number of new "individual taxpayers" drawn into the system by the change in the basis of the personal exemption and its lowered amount. These tables allowed the small business investors, landlords, and sole-proprietor service providers, to choose between using their actual expenses for the year, or accepting the Treasury Departments computed average expenses, to determine their "commercial net income," for the purpose of filing tax returns. However, the tables only applied to "salaries, wages, compensation for services, dividends, interest, annuities, royalties, and rents" of $5000 gross income (receipts minus cost basis) or less. Although this Act did not materially change the character of the federal income tax, it did set the stage for the 1942 "Victory Tax" and the changes that followed.
The Revenue Act of 1942 (HR7373) created, in addition to and separate from the existing commercial net income tax system, a new "Income Tax" based upon a new definition of net income Congress called "Victory Tax Net Income". This new definition of net income however, followed that of the Statistical Abstract of the United States in their report of the National "Per Capita Income" information gathered by the Census Bureau, not the 16th Amendment. As such, this definition of net income was based on the Oxford English Dictionary meaning of income (all that comes in), not the court’s 16th Amendment definition as "the gain derived from". The effect of this change in definition made the common laborer’s wages equivalent to rent, interest, dividends, and annuities derived from the investment of money for gain and profit. It also came with its own report card (withholding at the source) and a "personal exemption" allowance of $624 per person. This exemption allowance was higher than that allowed under the existing "commercial net income" tax provisions, specifically recognizing the cost of living at that time as indicated by the statistics. This Act did change the character of the federal income tax. It was even called a "Gross Income Tax by Congress; yet it was repealed in 1944. Why? If it was legal (Constitutional) to tax the gross receipts of the common laborer in 1942, why repeal the separate tax in 1944? This is the point at which Congress changes the intent of the 16th Amendment from a class tax (excise) to a mass tax (Direct), without the courts or the people, ever knowing it.
The Current Tax Payment Act of 1943 (HR2570) Established our current
"withholding at the source" provisions applied to remuneration for services, "IF paid as compensation for services" (commercial gross income). Remuneration for services being defined as "salary," "wages," "fees," "commissions," and other forms of payments for commercial services (labor), thereby, implying that the common laborer’s "wages" fell within the grasp of the Code. It then clarified that definition by inserting the words "IF paid as compensation for services," i.e., if reportable in the gross net income of the "individual *" business owner. This wording was actually designed to exclude the common laborer’s (non-commercial) wages (income) from the operation of the Tax Code, while at the same time prevented the "individual" business owner from claiming their compensation (income) to be "wages," therefore exempt from tax. It also provided for the "honest mistakes" that were likely to be made in the application of the withholding and tax provisions associated with this new Victory Tax system. (1)
*(single owner entity as opposed to multi owner entities)
THE INDIVIDUAL INCOME TAX BILL of 1944 (HR4646) sealed the doom of the common labor employee, yet it repealed the 1942 Victory Tax by which their "wages" were made taxable under a "gross income" tax.
This is the beginning of "Adjusted Gross Income" and the "Standard Deduction." The place where Congress actually defined the common laborer’s "wages" to be "gains and profits" produced by commercial activities, for purposes of the 16th Amendment and the Statutes imposing a tax upon the "entire net income" of every citizen. Everything else is history; old and forgotten.
Professors Stanley Surrey and William Warren, in the text book titled "Federal Income Taxation Cases and Materials" (1953 Edition, page 293) explains this transition:
"Here a difficulty arose. The blanket deduction was to be in lieu of personal expenses, and to be expressed as a percentage of taxable income. To afford equality among taxpayers, it would, therefore, necessarily have to be based on a percentage of taxable income before such personal expenses. BUT THE EXISTING STRUCTURE [Tax Code] DID NOT PROVIDE A MEASURE OF THAT TYPE OF TAXABLE INCOME. In effect what was needed was a measure of net income from business and other profit seeking activities plus gross income (receipts) from other sources, so as to arrive at taxable income prior to the allowance of any personal expenses.
This measure was therefore provided by the adoption of the concept of adjusted gross income, which with a few exceptions is gross income (gross gain) less expenses incurred in business and profit-seeking activities. …
An exception must be noted as to wage and salary earners. … As a result however, there is a discrimination between employees and individual entrepreneurs in favor of the latter who can deduct all business expenses." … Whereas in the other situations since such business expenses are deducted "above the line," i.e., to reach adjusted gross income, both the benefits of such expenses and of the standard deduction may be obtained. …
If the standard deduction is not utilized, the concept of adjusted gross income plays no part in the tax computation, except to serve in the calculation of the maximum amount allowable for charitable contributions and the minimum floor for medical expenses."
I would say that the revision of the Tax Code in 1954 was the beginning of the terms "taxable income (Section 63)," and "adjusted gross income (Section 62)," but I would be wrong. The term "taxable income" existed and was in use before 1917, as reflected in the 1918 Treasury Regulations and other historical texts. This term was used to identify that portion of income (gains and profits) Congress chose by Statute to tax, prior to the allowance of the "personal exemption" or other credits against the tax. It was referred to as "taxable net income" in compliance with the wording of the Statute imposing the tax on "the entire net income" of the citizen. The underlying bases of the income tax being the gains and profits (income) derived from the receipts (income) of the business transactions. Thus the receipts (income) were first reduced to gross income, meaning the capital or cost basis of the property being sold was subtracted from the receipts (income) to identify the gross gain (income) derived from the transaction. This prevented the tax from operating directly upon the property involved and complied with the Court’s definition of income under the 16th Amendment. Then further reduced to commercial net income (profit), meaning the expenses of selling or providing goods and services were subtracted from the gross gain, before the tax could be applied. This is the statutory application of the tax and once applied Congress could further reduce the amount being taxed by whatever it chose to allow.
However, as stated in the Pollock Cases of 1895, Congress must allow some form of reduction to the taxable net income of the business, when transferred to the owner, in order to prevent the tax from becoming a Direct or capitation tax upon them. Thus, the reason behind the "no cost basis" applicable to the "owner’s" labor when calculating the net profit of the business. Their labor (property) is compensated for by the allowance of the "personal exemption" when paying the tax. Accordingly, the "personal exemption" up to 1943 was set at or above the basic cost of living for the majority of people, thereby, en essence removing the property "labor" from the operation of the excise tax.
In contrast, 26CFR63 "Taxable Income" is now a reference to the amount of money made "taxable," after the deduction of the personal exemption and other credits. This change, en essence, implied that the excise tax was imposed upon gross income, without changing the net income basis of the Statute. This deception was necessary in order to include the employee’s (labor for hire) wages (income) within the net income provisions of the Statute, so that the court would not perceive the double standard created by Section 62 "Adjusted Gross Income". That term simply combined the business net income of the "individual" with the gross income (wages) of the common laborer so that the amount of money being taxed looked the same for both. In other words, it changed the character of the federal income tax from an indirect excise tax, measured by gains and profits (income), to a direct tax upon people, measured by the amount of money they earn each year.
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