What is
income?
Believe it
or not, there is a line of cases over decades developing the tax concept of
income.
Some
instances are clear-cut: if you receive wages or salary, for example, then you
have income.
Some
instances may not be so clear-cut.
For example,
let’s say that you receive a stock dividend. The company has a good year, and
you receive – as an example – 1 additional share for every 5 shares you own.
Do you have
income?
Let’s talk
this out. Let’s say that the company is worth $25 million before the stock
dividend and has 1 million shares outstanding. After the stock dividend it will
have 1.2 million shares outstanding. What are those extra 200,000 shares worth?
This is an
actual case – Eisner v Macomber - that the Supreme Court decided in
1920. Congress had changed the tax law to tax this stock dividend, and someone
(Myrtle Macomber) brought suit arguing that the law was unconstitutional.
Her
argument:
· The company was worth $25 million
before the dividend
· The company was worth $25 million after
the dividend
· She may have more shares, but her
shares represent the same proportional ownership of the company.
· She did not have any more money than
she had before.
She had a
point.
The Bureau
of Internal Revenue (that is, the IRS) came at it from a different angle:
There was income – the income generated by the company. The company was “distributing” said income by
means of a stock dividend.
The Court reasoned
that one could have income from labor or from capital. The first did not apply,
and it could find nothing to support the second had happened to Mrs Macomber.
The Court
decided that she did not have income.
Let’s continue.
The Glenshaw
Glass Company sued the Hartford-Empire Company for damages stemming from fraud
and for treble damages for business injury.
The two
companies settled, and Hartford was paid approximately $325 thousand in
punitive damages.
Glenshaw had
no intention of paying tax on that $325 grand. That money was not paid because
of labor or because of capital. It was paid because of injury to its business -
returning Glenshaw to where it should have been if not for the tortious behavior.
Not labor, not capital. Glenshaw was draped all over that earlier Eisner v Macomber decision.
But the IRS had
a point – in fact, 325 thousand points.
Here is the
Court:
Here we have instances of undeniable accessions to wealth, clearly realized, and over which taxpayers have complete dominion. The mere fact that the payments were extracted from the wrongdoers as punishment for unlawful conduct cannot detract from their character as taxable income.”
The Court levered
away from its earlier labor/capital impasse and clarified income to be:
· An increase in wealth
· Clearly realized, and
· Over which one has (temporary or
permanent) discretion or control
In time Glenshaw
has come to mean that everything is taxable unless Congress says that it is not
taxable. While not mathematically precise, it is precise enough for day-to-day
use.
I have a
question, though.
At a
conceptual level, what are the limits on the “clearly realized” requirement?
I get it
when someone receive a paycheck.
I also get
it when someone sells a mutual fund.
But what if
your IRA has gone up in value, but you haven’t taken a distribution?
Or the house
in which you raised your family has appreciated in value?
Do you have
an increase in wealth?
Do you have
discretion or control over said increase in wealth?
Do you have
“income” that Congress can tax under Glenshaw?
