[Constitution of the United States of America:  Analysis, and Interpretation - 1992 Edition ]
[Amendments to the Constitution]
[Sixteenth Amendment - Income Tax]
[From the U.S. Government Printing Office, www.gpo.gov]



[[Page 1951]]


 
                           SIXTEENTH AMENDMENT

                               __________

                               INCOME TAX

                               __________

 
                                CONTENTS

                                                                    Page
        Income Tax................................................  1953
        History and Purpose of the Amendment......................  1953
        Income Subject to Taxation................................  1954
                Corporate Dividends: When Taxable.................  1955
                Corporate Earnings: When Taxable..................  1958
                Gains: When Taxable...............................  1960
                Income from Illicit Transactions..................  1962
                Deductions and Exemptions.........................  1962
                Diminution of Loss................................  1963



[[Page 1953]]

                           SIXTEENTH AMENDMENT
 
 
                               INCOME TAX

                               __________

  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 TAX

      History and Purpose of the Amendment

        The ratification of this Amendment was the direct consequence of 
the Court's decision in 1895 in Pollock v. Farmers' Loan & Trust Co.,\1\ 
whereby the attempt of Congress the previous year to tax incomes 
uniformly throughout the United States\2\ was held by a divided court to 
be unconstitutional. A tax on incomes derived from property,\3\ the 
Court declared, was a ``direct tax'' which Congress under the terms of 
Article I, Sec. 2, and Sec. 9, could impose only by the rule of 
apportionment according to population, although scarcely fifteen years 
prior the Justices had unanimously sustained\4\ the collection of a 
similar tax during the Civil War,\5\ the only other occasion preceding 
the Sixteenth Amendment in which Congress had ventured to utilize this 
method of raising revenue.\6\

        \1\157 U.S. 429 (1895); 158 U.S. 601 (1895).
        \2\Ch. 349, Sec. 27, 28 Stat. 509, 553.
        \3\The Court conceded that taxes on incomes from ``professions, 
trades, employments, or vocations'' levied by this act were excise taxes 
and therefore valid. The entire statute, however, was voided on the 
ground that Congress never intended to permit the entire ``burden of the 
tax to be borne by professions, trades, employments, or vocations'' 
after real estate and personal property had been exempted, 158 U.S. at 
635.
        \4\Springer v. United States, 102 U.S. 586 (1881).
        \5\Ch. 173, Sec. 116, 13 Stat. 223, 281 (1864).
        \6\For an account of the Pollock decision, see supra, pp. 352-
56.
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        During the interim between the Pollock decision in 1895 and the 
ratification of the Sixteenth Amendment in 1913, the Court gave evidence 
of a greater awareness of the dangerous consequences to national 
solvency which that holding threatened, and partially circumvented the 
threat, either by taking refuge in redefinitions of ``direct tax'' or, 
and more especially, by emphasizing, virtually to the exclusion of the 
former, the history of excise taxation. Thus, in a series of cases, 
notably Nicol v. Ames,\7\

[[Page 1954]]
Knowlton v. Moore,\8\ and Patton v. Brady,\9\ the Court held the 
following taxes to have been levied merely upon one of the ``incidents 
of ownership'' and hence to be excises: a tax which involved affixing 
revenue stamps to memoranda evidencing the sale of merchandise on 
commodity exchanges, an inheritance tax, and a war revenue tax upon 
tobacco on which the hitherto imposed excise tax had already been paid 
and which was held by the manufacturer for resale.

        \7\173 U.S. 509 (1899).
        \8\178 U.S. 41 (1900).
        \9\184 U.S. 608 (1902).
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        Because of such endeavors the Court thus found it possible to 
sustain a corporate income tax as an excise ``measured by income'' on 
the privilege of doing business in corporate form.\10\ The adoption of 
the Sixteenth Amendment, however, put an end to speculation whether the 
Court, unaided by constitutional amendment, would persist along these 
lines of construction until it had reversed its holding in the Pollock 
case. Indeed, in its initial appraisal\11\ of the Amendment it 
classified income taxes as being inherently ``indirect.'' ``[T]he 
command of the amendment that all income taxes shall not be subject to 
apportionment by a consideration of the sources from which the taxed 
income may be derived, forbids the application to such taxes of the rule 
applied in the Pollock case by which alone such taxes were removed from 
the great class of excises, duties, and imports subject to the rule of 
uniformity and were placed under the other or direct class.''\12\ 
``[T]he Sixteenth Amendment conferred no new power of taxation but 
simply prohibited the previous complete and plenary power of income 
taxation possessed by Congress from the beginning from being taken out 
of the category of indirect taxation to which it inherently 
belonged.''\13\

        \10\Flint v. Stone Tracy Co., 220 U.S. 107 (1911).
        \11\Brushaber v. Union Pac. R.R., 240 U.S. 1 (1916); Stanton v. 
Baltic Mining Co., 240 U.S. 103 (1916); Tyee Realty Co. v. Anderson, 240 
U.S. 115 (1916).
        \12\Brushaber v. Union Pac. R.R., 240 U.S. 1, 18-19 (1916).
        \13\Stanton v. Baltic Mining Co., 240 U.S. 103, 112 (1916).
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      Income Subject to Taxation

        Building upon definitions formulated in cases construing the 
Corporation Tax Act of 1909,\14\ the Court initially described income as 
the ``gain derived from capital, from labor, or from both combined,'' 
inclusive of the ``profit gained through a sale or conversion of capital 
assets'';\15\ in the following array of factual situations it

[[Page 1955]]
subsequently applied this definition to achieve results that have been 
productive of extended controversy.

        \14\Stratton's Independence v. Howbert, 231 U.S. 399 (1913); 
Doyle v. Mitchell Bros. Co., 247 U.S. 179 (1918).
        \15\Eisner v. Macomber, 252 U.S. 189 (1920); Bowers v. Kerbaugh-
Empire Co., 271 U.S. 170 (1926).
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        Corporate Dividends: When Taxable.--Rendered in conformity with 
the belief that all income ``in the ordinary sense of the word'' became 
taxable under the Sixteenth Amendment, the earliest decisions of the 
Court on the taxability of corporate dividends occasioned little 
comment. Emphasizing that in all such cases the stockholder is to be 
viewed as ``a different entity from the corporation,'' the Court in 
Lynch v. Hornby,\16\ held that a cash dividend equal to 24 percent of 
the par value of the outstanding stock and made possible largely by the 
conversion into money of assets earned prior to the adoption of the 
Amendment, was income taxable to the stockholder for the year in which 
he received it, notwithstanding that such an extraordinary payment might 
appear ``to be a mere realization in possession of an inchoate and 
contingent interest . . . [of] the stockholder . . . in a surplus of 
corporate assets previously existing.'' In Peabody v. Eisner,\17\ 
decided on the same day and deemed to have been controlled by the 
preceding case, the Court ruled that a dividend paid in the stock of 
another corporation, although representing earnings that had accrued 
before ratification of the Amendment, was also taxable to the 
shareholder as income. The dividend was likened to a distribution in 
specie.

        \16\247 U.S. 339, 344 (1918). On the other hand, in Lynch v. 
Turrish, 247 U.S. 221 (1918), the single and final dividend distributed 
upon liquidation of the entire assets of a corporation, although 
equaling twice the par value of the capital stock, was declared to 
represent only the intrinsic value of the latter earned prior to the 
effective date of the Amendment, and hence was not taxable as income to 
the shareholder in the year in which actually received. Similarly, in 
Southern Pacific Co. v. Lowe, 247 U.S. 330 (1918), dividends paid out of 
surplus accumulated before the effective date of the Amendment by a 
railway company whose entire capital stock was owned by another railway 
company and whose physical assets were leased to and used by the latter 
was declared to be a nontaxable bookkeeping transaction between 
virtually identical corporations.
        \17\247 U.S. 347 (1918).
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        Two years later the Court decided Eisner v. Macomber,\18\ and 
the controversy which that decision precipitated still endures. 
Departing from the interpretation placed upon the Sixteenth Amendment in 
the earlier cases, i.e., that the purpose of the Amendment was to 
correct the ``error'' committed in the Pollock case and to restore 
income taxation to ``the category of indirect taxation to which it 
inherently belonged,'' Justice Pitney, who delivered the opinion in the 
Eisner case, indicated that the sole purpose of the Sixteenth Amendment 
was merely to ``remove the necessity which otherwise might exist for an 
apportionment among the States of taxes laid on

[[Page 1956]]
income.'' He thereupon undertook to demonstrate how what was not income, 
but an increment of capital when received, could later be transmitted 
into income upon sale or conversion and could be taxed as such without 
the necessity of apportionment. In short, the term ``income'' acquired 
to some indefinite extent a restrictive significance.

        \18\252 U.S. 189, 206-08 (1920).
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        Specifically, the Justice held that a stock dividend was capital 
when received by a stockholder of the issuing corporation and did not 
become taxable without apportionment, that is, as ``income,'' until sold 
or converted, and then only to the extent that a gain was realized upon 
the proportion of the original investment which such stock represented. 
``A stock dividend,'' Justice Pitney maintained, ``far from being a 
realization of profits to the stockholder, . . . tends rather to 
postpone such realization, in that the fund represented by the new stock 
has been transferred from surplus to capital, and no longer is available 
for actual distribution . . . not only does a stock dividend really take 
nothing from . . . the corporation and add nothing to that of the 
shareholder, but . . . the antecedent accumulation of profits evidenced 
thereby, while indicating that the shareholder is richer because of an 
increase of his capital, at the same time shows [that] he has not 
realized or received any income in'' what is no more than a 
``bookkeeping transaction.'' But conceding that a stock dividend 
represented a gain, the Justice concluded that the only gain taxable as 
``income'' under the Amendment was ``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; . . . .'' Only the latter in his 
opinion, answered the description of income ``derived'' from property, 
whereas ``a gain accruing to a capital, not a growth or an increment of 
value in the investment'' did not.\19\ Although steadfastly refusing to 
depart from the principle\20\ which it asserted in Eisner v. Macomber, 
the Court

[[Page 1957]]
in subsequent decisions has, however, slightly narrowed the application 
thereof. Thus, the distribution, as a dividend, to stockholders of an 
existing corporation of the stock of a new corporation to which the 
former corporation, under a reorganization, had transferred all its 
assets, including a surplus of accumulated profits, was treated as 
taxable income. The fact that a comparison of the market value of the 
shares in the older corporation immediately before, with the aggregate 
market value of those shares plus the dividend shares immediately after, 
the dividend showed that the stockholders experienced no increase in 
aggregate wealth was declared not to be a proper test for determining 
whether taxable income had been received by these stockholders.\21\ On 
the other hand, no taxable income was held to have been produced by the 
mere receipt by a stockholder of rights to subscribe for shares in a new 
issue of capital stock, the intrinsic value of which was assumed to be 
in excess of the issuing price. The right to subscribe was declared to 
be analogous to a stock divided, and ``only so much of the proceeds 
obtained upon the sale of such rights as represents a realized profit 
over cost'' to the stockholders was deemed to be taxable income.\22\ 
Similarly, on grounds of consistency with Eisner v. Macomber, the Court 
has ruled that inasmuch as it gave the stockholder an interest different 
from that represented by his former holdings, a dividend in common stock 
to holders of preferred stock,\23\ or a dividend

[[Page 1958]]
in preferred stock accepted by a holder of common stock\24\ was income 
taxable under the Sixteenth Amendment.

        \19\Id. at 207, 211-12 (1920). This decision has been severely 
criticized, chiefly on the ground that gains accruing to capital over a 
period of years are not income and are not transformed into income by 
being dissevered from capital through sale or conversion. Critics have 
also experienced difficulty in understanding how a tax on income which 
has been severed from capital can continue to be labeled a ``direct'' 
tax on the capital from which the severance has thus been made. Finally, 
the contention has been made that in stressing the separate identities 
of a corporation and its stockholders, the Court overlooked the fact 
that when a surplus has been accumulated, the stockholders are thereby 
enriched, and that a stock dividend may therefore be appropriately 
viewed simply as a device whereby the corporation reinvests money earned 
in their behalf. See also Merchants' L. & T. Co. v. Smietanka, 255 U.S. 
509 (1921).
        \20\Reconsideration was refused in Helvering v. Griffths, 318 
U.S. 371 (1943).
        \21\United States v. Phellis, 257 U.S. 156 (1921); Rockefeller 
v. United States, 257 U.S. 176 (1921). See also Cullinan v. Walker, 262 
U.S. 134 (1923).
        In Marr v. United States, 268 U.S. 536, 540-41 (1925), it was 
held that the increased market value of stock issued by a new 
corporation in exchange for stock of an older corporation, the assets of 
which it was organized to absorb, was subject to taxation as income to 
the holder, notwithstanding that the income represented profits of the 
older corporation and that the capital remained invested in the same 
general enterprise. Weiss v. Stearn, 265 U.S. 242 (1924), in which the 
additional value in new securities was held not taxable, was likened to 
Eisner v. Macomber, and distinguished from the aforementioned cases on 
the ground of preservation of corporate identity. Although the ``new 
corporation had . . . been organized to take over the assets and 
business of the old . . . , the corporate identity was deemed to have 
been substantially maintained because the new corporation was organized 
under the laws of the same State with presumably the same powers as the 
old. There was also no change in the character of the securities 
issued,'' with the result that ``the proportional interest of the 
stockholder after the distribution of the new securities was deemed to 
be exactly the same.''
        Under existing law, however, when a taxpayer exchanges all of 
the outstanding stock for a minor percentage of the total shares of a 
larger corporation, plus cash, the gain to be recognized in full is not 
limited to the cash but embraces the excess of the sum of the market 
value of the stock acquired plus the cash over the cost of the original 
stock plus the expenses of the sale. Turnbow v. Commissioner, 368 U.S. 
337 (1961).
        \22\Miles v. Safe Deposit Co., 259 U.S. 247 (1922).
        \23\Koshland v. Helvering, 298 U.S. 441 (1936).
        \24\Helvering v. Gowran, 302 U.S. 238 (1937).
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        Corporate Earnings: When Taxable.--On at least two occasions the 
Court has rejected as untenable the contention that a tax on 
undistributed corporate profits is essentially a penalty rather than a 
tax or that it is a direct tax on capital and hence is not exempt from 
the requirement of apportionment. Inasmuch as the exaction was 
permissible as a tax, its validity was held not to be impaired by its 
penal objective, namely, ``to force corporations to distribute earnings 
in order to create a basis for taxation against the stockholders.'' As 
to the added contention that, because liabilty was assessed upon a mere 
purpose to evade imposition of surtaxes against stockholders, the tax 
was a direct tax on a state of mind, the Court replied that while ``the 
existence of the defined purpose was a condition precedent to the 
imposition of the tax liability, . . . [did] not prevent it from being a 
true income tax within the meaning of the Sixteenth Amendment.''\25\ 
Subsequently, in Helvering v. Northwest Steel Mills,\26\ this appraisal 
of the constitutionality of the undistributed profits tax was buttressed 
by the following observation: ``It is true that the surtax is imposed 
upon the annual income only if it is not distributed, but this does not 
serve to make it anything other than a true tax on income within the 
meaning of the Sixteenth Amendment. Nor is it true . . . that because 
there might be an impairment of the capital stock, the tax on the 
current annual profit would be the equivalent of a tax upon capital. 
Whether there was an impairment of the capital stock or not, the tax 
. . . was imposed on profits earned during . . .--a tax year--and 
therefore on profits constituting income within the meaning of the 
Sixteenth Amendment.''\27\

        \25\Helvering v. National Grocery Co., 304 U.S. 282, 288-89 
(1938). In Helvering v. Mitchell, 303 U.S. 391 (1938), the defendant 
contended the collection of fifty per cent of any deficiency in addition 
to the deficiency alleged to have resulted from a fraudulent intent to 
evade the income tax amounted to the imposition of a criminal penalty. 
The Court, however, described the additional sum as a civil and not a 
criminal sanction, and one whch could be constitutionally employed to 
safeguard the Government against loss of revenue. In contrast, the 
exaction upheld in Helvering v. National Grocery Co., though conceded to 
possess the attributes of a civil sanction, was declared to be 
sustainable as a tax.
        \26\311 U.S. 46 (1940). See also Crane-Johnson Co. v. Helvering, 
311 U.S. 54 (1940).
        \27\311 U.S. 53.
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        Likening a cooperative to a corporation, federal courts have 
also declared to be taxable income the net earnings of a farmers' 
cooperative, a portion of which was used to pay dividends on capital 
stock without reference to patronage. The argument that such

[[Page 1959]]
earnings were in reality accumulated savings of its patrons which the 
cooperative held as their bailee was rejected as unsound for the reason 
that ``while those who might be entitled to patronage dividends have 
. . . an interest in such earnings, such interest never ripens into an 
individual ownership . . . until and if a patronage dividend be 
declared.'' Had such net earnings been apportioned to all of the patrons 
during the year, ``there might be . . . a more serious question as to 
whether such earnings constituted `income' [of the cooperative] within 
the Amendment.''\28\ Similarly, the power of Congress to tax the income 
of an unincorporated joint stock association has been held to be 
unaffected by the fact that under state law the association is not a 
legal entity and cannot hold title to property, or by the fact that the 
shareholders are liable for its debts as partners.\29\

        \28\Farmers Union Co-op v. Commissioner, 90 F.2d 488, 491, 492 
(8th Cir. 1937).
        \29\Burk-Waggoner Ass'n v. Hopkins, 269 U.S. 110 (1925).
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        Whether subsidies paid to corporations in money or in the form 
of grants of land or other physical property constitute taxable income 
has also concerned the Court. In Edwards v. Cuba Railroad,\30\ it ruled 
that subsidies of lands, equipment, and money paid by Cuba for the 
construction of a railroad were not taxable income but were to be viewed 
as having been received by the railroad as a reimbursement for capital 
expenditures in completing such project. On the other hand, sums paid 
out by the Federal Government to fulfill its guarantee of minimum 
operating revenue to railroads during the six months following 
relinquishment of their control by that government were found to be 
taxable income. Such payments were distinguished from those excluded 
from computation of income in the preceding case in that the former were 
neither bonuses, nor gifts, nor subsidies, ``that is, contributions to 
capital.''\31\ Other corporate receipts deemed to be taxable as income 
include the following: (1) ``insiders profits'' realized by a director 
and stockholder of a corporation from transaction in its stock, which, 
as required by the Securities and Exchange Act,\32\ are paid over to the 
corporation;\33\ (2) money received as exemplary damages for fraud or as 
the punitive two-thirds portion of a treble damage antitrust 
recovery;\34\ and (3) compensation awarded for the fair rental value of 
trucking facilities operated by the taxpayer under control and 
possession of the Government during World War II, for in the last

[[Page 1960]]
instance the Government never acquired title to the property and had not 
damaged it beyond ordinary wear.\35\

        \30\268 U.S. 628 (1925).
        \31\Texas & Pacific Ry. Co. v. United States, 286, U.S. 285, 289 
(1932); Continental Tie & L. Co. v. United States, 286 U.S. 290 (1932).
        \32\15 U.S.C. Sec. 78p.
        \33\General American Investors Co. v. Commissioner, 348 U.S. 434 
(1955).
        \34\Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955).
        \35\Commissioner v. Gillette Motor Co., 364 U.S. 130 (1960).
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        Gains: When Taxable.--When through forfeiture of a lease in 
1933, a landlord became possessed of a new building erected on his land 
by the outgoing tenant, the resulting gain to the former was taxable to 
him in that year. Although ``economic gain is not always taxable as 
income, it is settled that the realization of gain need not be in cash 
derived from the sale of an asset. . . . The fact that the gain is a 
portion of the value of the property received by the . . . [landlord] 
does not negative its realization. . . . [Nor is it necessary] to 
recognition of taxable gain that . . . [the landlord] should be able to 
sever the improvement begetting the gain from his original capital.'' 
Hence, the taxpayer was incorrect in contending that the Amendment 
``does not permit the taxation of such [a] gain without apportionment 
amongst the states.\36\ Consistent with this holding the Court has also 
ruled that when an apartment house was acquired by bequest subject to an 
unassumed mortgage and several years thereafter was sold for a price 
slightly in excess of the mortgage, the basis for determining the gain 
from that sale was the difference between the selling price, 
undiminished by the amount of the mortgage, and the value of the 
property at the time of the acquisition, less deductions for 
depreciation during the years the building was held by the taxpayer. The 
latter's contention that the Revenue Act, as thus applied, taxed 
something which was not revenue was declared to be unfounded.\37\

        \36\Helvering v. Brumn, 309 U.S. 461, 468-69 (1940).
        \37\Crane v. Commissioner, 331 U.S. 1, 15-16 (1947).
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        As against the argument of a donee that a gift of stock became a 
capital asset when received and that therefore, when disposed of, no 
part of that value could be treated as taxable income to said donee, the 
Court has declared that it was within the power of Congress to require a 
donee of stock, who sells it at a profit, to pay income tax on the 
difference between the selling price and the value when the donor 
acquired it.\38\ Moreover, ``the receipt in cash or property . . . not 
[being] the only characteristic of realization of

[[Page 1961]]
income to a taxpayer on the cash receipt basis,'' it follows that one 
who is normally taxable only on the receipt of interest payments cannot 
escape taxation thereon by giving away his right to such income in 
advance of payment. When ``the taxpayer does not receive payment of 
income in money or property, realization may occur when the last step is 
taken by which he obtains the fruition of the economic gain which has 
already accrued to him.'' Hence an owner of bonds, reporting on the cash 
receipts basis, who clipped interest coupons therefrom before their due 
date and gave them to his son, was held to have realized taxable income 
in the amount of said coupons, notwithstanding that his son had 
collected them upon maturity later in the year.\39\

        \38\The donor could not, ``by mere gift, enable another to hold 
this stock free from . . . [the] right . . . [of] the sovereign to take 
part of any increase in its value when separated through sale or 
conversion and reduced to possession.'' Taft v. Bowers, 278 U.S. 470, 
482, 484 (1929). However, when a husband, as part of a divorce 
settlement, transfers his own corporate stock to his wife, he is deemed 
to have exchanged the stock for the release of his wife's inchoate, 
marital rights, the value of which are presumed to be equal to the 
current, market value of the stock, and, accordingly, he incurs a 
taxable gain measured by the difference between the initial purchase 
price of the stock and said market value upon transfer. United States v. 
Davis, 370 U.S. 65 (1962).
        \39\Helvering v. Horst, 311 U.S. 112, 115-16 (1940).
        With a frequency that for obvious reasons is progressively 
diminishing, the Court also has been called upon to resolve questions as 
to whether gains, realized after 1913, on transactions consummated prior 
to ratification of the Sixteenth Amendment are taxable, and if so, how 
such tax is to be determined. The Court's answer generally has been that 
if the gain to the person whose income is under consideration became 
such subsequently to the date at which the amendment went into effect, 
namely, March 1, 1913, and is a real, and not merely an apparent, gain, 
said gain is taxable. Thus, one who purchased stock in 1912 for $500 
could not limit his taxable gain to the difference, $695, the value of 
the stock on March 1, 1913 and $13,931, the price obtained on the sale 
thereof, in 1916; but was obliged to pay tax on the entire gain, that is 
the difference between the original purchase price and the proceeds of 
the sale, Goodrich v. Edwards, 255 U.S. 527 (1921). Conversely, one who 
acquired stock in 1912 for $291,600 and who sold the same in 1916 for 
only $269,346, incurred a loss and could not be taxed at all, 
notwithstanding the fact that on March 1, 1913, his stock had 
depreciated to $148,635. Walsh v. Brewster, 255 U.S. 536 (1921). On the 
other hand, although the difference between the amount of life insurance 
premiums paid as of 1908, and the amount distributed in 1919, when the 
insured received the amount of his policy plus cash dividends 
apportioned thereto since 1908, constituted a gain, that portion of the 
latter which accrued between 1908 and 1913 was deemed to be an accretion 
of capital and hence not taxable. Lucas v. Alexander, 279 U.S. 473 
(1929).
        However, a litigant who, in 1915, reduced to judgment a suit 
pending on February 26, 1913, for an accounting under a patent 
infringement, was unable to have treated as capital, and excluded from 
the taxable income produced by such settlement, that portion of his 
claim which had accrued prior to March 1, 1913. Income within the 
meaning of the Amendment was interpreted to be the fruit that is born of 
capital, not the potency of fruition. All that the taxpayer possessed in 
1913 was a contingent chose in action which was inchoate, uncertain, and 
contested. United States v. Safety Car Heating Co., 297 U.S. 88 (1936).
        Similarly, purchasers of coal lands subject to mining leases 
executed before adoption of the Amendment could not successfully contend 
that royalties received during 1920-1926 were payments for capital 
assets sold before March 1, 1913, and hence not taxable. Such an 
exemption, these purchasers argued, would have been in harmony with 
applicable local law whereunder title to coal passes immediately to the 
lessee on execution of such leases. To the Court, on the other hand, 
such leases were not to be viewed ``as a `sale' of the mineral content 
of the soil'' inasmuch as minerals ``may or may not be present in the 
leased premises, and may or may not be found [therein]. . . . If found, 
their abstraction . . . is a time consuming operation and the payments 
made by the lessee . . . do not normally become payable as the result of 
a single transaction. . . .'' The result for tax purposes would have 
been the same even had the lease provided that title to the minerals 
would pass only ``on severance by the lessee.'' Bankers Coal Co. v. 
Burnet, 287 U.S. 308 (1932); Burnet v. Harmel, 287 U.S. 103, 106-107, 
111 (1932).

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[[Page 1962]]

        Income from Illicit Transactions.--In United States v. 
Sullivan,\40\ the Court, held that gains derived from illicit traffic 
were taxable income under the act of 1921.\41\ Said Justice Holmes for 
the unanimous Court: ``We see no reason . . . why the fact that a 
business is unlawful should exempt it from paying the taxes that if 
lawful it would have to pay.''\42\ Consistent therewith, although not 
without dissent, the Court ruled that Congress has the power to tax as 
income moneys received by an extortioner,\43\ and, more recently, that 
embezzled money is taxable income of an embezzler in the year of 
embezzlement. ``When the taxpayer acquires earnings, lawfully or 
unlawfully, without the consensual recognition, express or implied, of 
an obligation to repay and without restriction as to their disposition, 
`he has received income . . . , even though it may still be claimed that 
he is not entitled to retain the money, and even though he may still be 
adjudged liable to restore its equivalent.'''\44\

        \40\274 U.S. 259 (1927).
        \41\42 Stat. 227, 250, 268.
        \42\274 U.S. 259, 263. Profits from illegal undertakings being 
taxable as income, expenses in the form of salaries and rentals incurred 
by bookmakers are deductible. Commissioner v. Sullivan, 356 U.S. 27 
(1958).
        \43\Rutkin v. United States, 343 U.S. 130 (1952). Four Justices, 
Black, Reed, Frankfurter, and Douglas, dissented.
        \44\James v. United States, 366 U.S. 213, 219 (1961) (overruling 
Commissioner v. Wilcox, 327 U.S. 404 (1946)).
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        Deductions and Exemptions.--Notwithstanding the authorization 
contained in the Sixteenth Amendment to tax income ``from whatever 
source derived,'' Congress has been held not to be precluded thereby 
from granting exemptions.\45\ Thus, the fact that ``under the Revenue 
Acts of 1913, 1916, 1917, and 1918, stock fire insurance companies were 
taxed . . . upon gains realized from the sale . . . of property accruing 
subsequent to March 1, 1913,'' but were not so taxed by the Revenue Acts 
of 1921, 1924, and 1926, did not prevent Congress, under the terms of 
the Revenue Act of 1928, from taxing all the gain attributable to 
increase in value after March 1, 1913, which such a company realized 
from a sale of property in 1928. The constitutional power of Congress to 
tax a gain being well established, Congress was declared competent to 
choose ``the moment of its realization and the amount realized''; and 
``its failure to impose a tax upon the increase in value in the earlier 
years . . . [could not] preclude it from taxing the gain in the year 
when realized . . . .''\46\ Congress is equally well equipped with the 
``power to condition, limit, or deny deductions from gross in

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comes in order to arrive at the net that it chooses to tax.''\47\ 
Accordingly, even though the rental value of a building used by its 
owner does not constitute income within the meaning of the 
Amendment,\48\ Congress was competent to provide that an insurance 
company shall not be entitled to deductions for depreciation, 
maintenance, and property taxes on real estate owned and occupied by it 
unless it includes in its computation of gross income the rental value 
of the space thus used.\49\

        \45\Brushaber v. Union Pac. R.R., 240 U.S. 1 (1916).
        \46\MacLaughlin v. Alliance Ins. Co., 286 U.S. 244, 250 (1932).
        \47\Helvering v. Ind. L. Ins. Co., 292 U.S. 371, 381 (1934); 
Helvering v. Winmill, 305 U.S. 79, 84 (1938).
        \48\A tax on the rental value of property so occupied is a 
direct tax on the land and must be apportioned. Helvering v. Ind. L. 
Ins. Co., 291 U.S. 371, 378-79 (1934).
        \49\Id. at 381. Expenditures incurred in the prosecution of work 
under a contract for the purpose of earning profits are not capital 
investments, the cost of which, if converted, must first be restored 
from the proceeds before there is a capital gain taxable as income. 
Accordingly, a dredging contractor, recovering a judgment for breach of 
warranty of the character of the material to be dredged, must include 
the amount thereof in the gross income of the year in which it was 
received, rather than of the years during which the contract was 
performed, even though it merely represents a return of expenditures 
made in performing the contract and resulting in a loss. The gain or 
profit subject to tax under the Sixteenth Amendment is the excess of 
receipts over allowable deductions during the accounting period, without 
regard to whether or not such excess represents a profit ascertained on 
the basis of particular transactions of the taxpayer when they are 
brought to a conclusion. Burnet v. Sanford & Brooks Co., 282 U.S. 359 
(1931).
        The grant on denial of deductions is not based on the taxpayers' 
engagement in constitutionally protected activities, and, accordingly, 
no deduction is granted for sums expended in combating legislation, 
enactment of which would destroy taxpayer's business. Commarano v. 
United States, 358 U.S. 498 (1959).
        Likewise, when tank truck owners, either intentionally for 
business reasons or unintentionally, violate state maximum weight laws, 
and incur fines, the latter are not deductible, for fines are penalties 
rather than tolls for the use of highways, and Congress is not to be 
viewed as having intended to encourage enterprises to violate state 
policy. Tank Truck Rentals v. Commissioner, 356 U.S. 30 (1958); Hoover 
Express Co. v. United States, 356 U.S. 38 (1958).
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        Also, a taxpayer who erected a $3,000,000 office building on 
land, the unimproved worth of which was $660,000, and who subsequently 
purchased the lease on the latter for $2,100,000 is entitled to compute 
depreciation over the remaining useful life of the building on that 
portion of $1,440,000, representing the difference between the price and 
the unimproved value, as may be allocated to the building; but he cannot 
deduct the $1,440,000 as a business expense incurred in eliminating the 
cost of allegedly excessive rentals under the lease, nor can he treat 
that sum as a prepayment of rent to be amortized over the 21-year period 
that the lease was to run.\50\

        \50\Millinery Corp. v. Commissioner, 350 U.S. 456 (1956).
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        Diminution of Loss.--Mere diminution of loss is neither gain, 
profit, nor income. Accordingly, one who in 1913 borrowed a sum of money 
to be repaid in German marks and who subsequently lost

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the money in a business transaction cannot be taxed on the curtailment 
of debt effected by using depreciated marks in 1921 to settle a 
liability of $798,144 for $113,688, the ``saving'' having been exceeded 
by a loss on the entire operation.\51\

        \51\Bowers v. Kerbaugh-Empire Co., 271 U.S. 170 (1926).