Context for Determining Liability for Federal Income Tax
Federal income taxes imposed by Subtitles A, B & C of the Internal Revenue Code are indirect or excise taxes levied against sources or activities that in one fashion or another produce or rely on a Federal privilege or benefit. The authority for these taxes, the Sixteenth Amendment notwithstanding, is Article I § 8, Clause 1 of the Constitution:
The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defense and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States.
A credible authority that affirms this conclusion is the Congressional Research Service publication titled Frequently Asked Questions Concerning the Federal Income Tax (Library of Congress #97-59 A, Dec. 6, 1996). The answer to the first question the CRS framed specifies that income taxes are subject to the uniformity mandate prescribed by Article I § 8.1, not to the apportionment rule that governs direct taxes:
No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census of Enumeration herein before directed to be taken. (Article I, Section 9, Clause 4)
In the final paragraph of the first answer, the CRS makes the following statement:
All taxes which are not direct are indirect and subject to the rule of uniformity. The rule of uniformity requires that an indirect tax not discriminate geographically. For example, it would violate the rule of uniformity to enact a special income tax rate for residents of the State of Texas; however, it does not violate the rule to have a special income tax rate for individuals who make over $50,000 per year. (page 2)
In subsequent answers the CSR cites the holding in Pollock v. Farmers’ Loan and Trust Company, 157 U.S. 429, rehearing 158 U.S. 601 (1893), in which the Supreme Court of the United States distinguished returns from labor and capital as property subject to the Article I § 9.4 apportionment rule where enterprise that produces profits and gains of an indirect nature are subject to the uniformity rule prescribed by Article I § 8.1. Enterprise that relies on or results in a privilege or benefit falls within the excise or indirect tax category. The privilege or benefit, not the income, is the object of income tax.
This conclusion is reinforced by the report of F. Morse Hubbard, formerly of the legislative drafting research fund of Columbia University and former legislative draftsman in the Treasury Department, the report published in the March 27, 1943 edition of the Congressional Record – House, at pages 2579 et seq.
The heading for the first part of the Hubbard report is titled, “The Income Tax is an Excise Tax, and Income is Merely the Basis for Determining its Amount”. An exert from the Hubbard report on page 2580 frames the nature of Federal income taxes:
The sixteenth amendment authorizes the taxation of income “from whatever source derived” – thus taxing in investment income – “without apportionment among the several States.” The Supreme Court has held that the sixteenth amendment did not extend the taxing power of the United States to new or excepted subjects but merely removed the necessity which might otherwise exist for an apportionment among the States of taxes laid on income whether it be received from one source or another. So the amendment made it possible to bring investment income within the scope of the 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 the activity or owning any property which produces income.
The income tax is, therefore, 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 which they produce. The income is not the subject of the tax; it is the basis for determining the amount of tax.
In Stanton v. Baltic Mining Co. 240 U.S. 103 (1916), the U.S. Supreme Court said “[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…”
In Pen Mutual Indemnity Co. v. Commissioner of Internal Revenue, 32 T.C. 653 at 5659 (1959), the U.S. Tax Court made an even more definitive statement:
In dealing with the scope of the taxing power, the question has sometimes been framed in terms of whether something can be taxed as income under the Sixteenth Amendment. This is an inaccurate formulation of the question and has led to much loose thinking on the subject. The source of the taxing power is not the Sixteenth Amendment; it is Article I, section 8 of the Constitution. It is important that these provisions be clearly understood; what is required is an understanding of fundamental principles. The familiar statement that “at this time we need education in the obvious more than investigation into the obscure” (Holmes, Collective Legal Papers, pp. 292-293), although made in a different context, is peculiarly applicable here.
Where the Congressional Research Service, a former Treasury Department official, the U.S. Supreme Court and the U.S. Tax Court agree, it is reasonable to conclude that Federal income taxes are indirect or excise taxes primarily on privileges and benefits attending or derived from any given enterprise. This conclusion provides the basis for considering income taxes imposed by Subtitles A, B & C of the Internal Revenue Code.
In this context, the normal tax imposed by Chapter 1 and other species of income tax imposed by Subtitle A & B provisions are taxable according to the source from which the item of income is derived. A nonresident alien, foreign corporation or foreign partnership is subject to a uniform flat tax of 30% on items of income derived from sources within the United States while citizens and residents of the United States, along with domestic corporations, trusts, and other juristic entities, are subject to Subtitle A & B income taxes on items of income derived from foreign sources, insular possessions of the United States, and maritime enterprise subject to treaties Government of the United States is party to.
Nonresident aliens and foreign corporations do not have the constitutionally secured right to conduct business in the United States. Whatever income-producing enterprise they undertake within the United States is a privilege. Likewise, citizens and residents of the United States are entitled to engage in income-producing enterprise in foreign jurisdictions and under auspices of commercial treaties as a benefit derived from government negotiation, representation and/or consent. A comprehensive list of taxable “sources” for citizens, residents and domestic corporations of the United States is published at 26 CFR § 1.861-8(f)(1)(vi). The “item” of income, whether a wage, interest or any of other item listed at 26 U.S.C. § 61, is subject to Subtitle A & B income taxes only as the income is received under auspices of a benefit or privilege that is not substantive in nature.
This application is confirmed by the definition of “withholding agent” at 26 U.S.C. § 7701(a)(16) and the fact that withholding agents are required to withhold at the source on income paid to nonresident aliens, foreign corporations and foreign partnerships (26 U.S.C. §§ 1441, 1442, 1443 & 1461). They are not required to withhold at the source on citizens and residents of the United States (See particularly 26 CFR § 1.1441-5 in 1998 and earlier editions).
While all taxes in Subtitles A, B & C are categorized as income taxes, there is a distinction between those imposed by Subtitles A & B and those imposed by Subtitle C. The object of all Subtitle C taxes is wages, and for purposes of clarity, Subtitle C taxes are classified different than Subtitle A & B taxes. The U.S. Supreme Court addressed the matter in Commissioner v. Kowalski, 434 U.S. 77 (1977):
The income tax is imposed on taxable income, 26 U.S.C. § 1. Generally, this is gross income minus allowable deductions, 26 U.S.C. § 63(a). Section 61(a) defines as gross income "all income from whatever source derived" including, under § 61(a)(1), "[c]ompensation for services." The withholding tax, in some contrast, is confined to wages, § 3402(a), and § 3401(a) defines as "wages," all remuneration (other than fees paid to a public official) for services performed by an employee for his employer, including the cash value of all remuneration paid in any medium other than cash.
Taxes imposed by Chapters 21 through 24 in Subtitle C are classified as employment taxes (26 CFR § 601.401). They, too, are subject to the uniformity rule so are therefore excise taxes, but social welfare taxes, particularly those imposed by Chapter 21, are unique in that they are not generally applicable in States of the Union. Definitions of “State”, “United States” and “citizen” at 26 CFR § 31.3121(e)-1 limit application to the District of Columbia and insular possessions of the United States. The Social Security tax was imposed in Alaska and Hawaii prior to admission to the Union, but not since.
In 1935 when Congress first enacted a social welfare tax, the U.S. Supreme Court overturned the act as the Constitution does not authorize taxing one person for the benefit of another or otherwise implementing a national social welfare program. The following statement in Railroad Retirement Board v. Alton Railroad Co., 295 U.S. 330, 55 S. Ct. 758 (1935) is as true today as when it was written:
The catalogue of means and actions which might be imposed upon an employer in any business, tending to the satisfaction and comfort of his employees, seems endless. Provision for free medical attendance, nursing, clothing, food, housing, and education of children, and a hundred other matters might with equal propriety be proposed as tending to relieve the employee of mental strain and worry. Can it fairly be said that the power of Congress to regulate interstate commerce extends to the prescription of any or all of these things? It is not apparent that they are really and essentially related solely to the social welfare of the worker, and therefore remote from any regulation of commerce as such? We think the answer is plain. These matters obviously lie outside the orbit of congressional power.
The subsequent Social Security Act of 1935 was promulgated under auspices of Congress’ plenary power within territory belonging to the United States. While legislatures in States of the Union have contracted to participate in the Social Security program, the agreements extend only to officers and employees of state governments and political subdivisions of the states, not to general populations of the several States.
The government personnel tax imposed by Chapter 24, also classified as an employment tax, is reasonably straight forward. The “employee” subject to the tax is defined as a government employee at 26 U.S.C. § 3401(c), and the “employer” employs the government employee, per § 3401(d). The definitive link in the legislative evolution is the Public Salary Tax Act of 1939. Government employment entails privileges and benefits including availability of credit hypothecated on (underwritten by) credit of the United States, employment and unemployment assurances of various sorts, etc.
It is significant that the United States Tax Court does not have subject matter jurisdiction over Subtitle C employment taxes (26 CFR § 601.102(b)(2)(i)) and the Internal Revenue Service is charged with responsibility for maintaining various Department of the Treasury systems of records and serving as an information source, but does not have administrative enforcement authority in States of the Union. IRS has statutory authority for administration of Chapters 1, 2 & 21 taxes in insular possessions of the United States (26 U.S.C. § 7701(a)(12)(B)) and Social Security tax in the Northern Mariana Islands (Treasury Order 150-18).
Where administration of the Chapter 24 government personnel tax is concerned, the Department of Treasury has been helpful in resolving confusion. One of the invaluable resources posted on the Department of the Treasury web site is the Treasury Financial Manual, produced by the Financial Management Service. Volume I, Part 3, Chapter 4000 prescribes the process by which Federal employee taxes are to be collected by the employer agency then the agency must transfer withholdings to IRS:
Section 4010 - SCOPE AND APPLICABILITY
This chapter prescribes procedures for (1) withholding and depositing Federal income, social security, and medicare taxes on wages paid to civilian and military employees; (2) for filing tax returns with the Internal Revenue Service (IRS); and (3) for filing income tax statements with the Social Security Administration (SSA).
For information beyond the scope of this chapter, refer to IRS Publication 15, Circular E, Employer's Tax Guide, or an IRS office. Circular E describes employer tax responsibilities; explains withholding, depositing, and reporting requirements; and paying taxes. It explains the forms your employees must use and those you must send to the IRS and SSA.
Withheld Federal taxes will be transferred to the IRS using the FEDTAX application of the Government-On-line Accounting Link System (GOALS). Any Federal agency that has not been established on FEDTAX should contact GOALS Marketing, Financial Management Service (FMS), on FTS 874-8788 or 202-874-8788.
Withholding of qualified State, county and local taxes, in accordance with 31 CFR § 215, is then prescribed in Volume I, Part 3, Chapter 5000, reproduced here in part:
Section 5010 - SCOPE AND APPLICABILITY
This chapter provides instructions for withholding State, city, or county income taxes when an agreement has been reached between a State, city, or county and the Secretary of the Treasury. Agreements between the Secretary of the Treasury and States, cities, or counties prescribe how Federal agencies withhold State, city, or county income or employment taxes from the compensation of Federal employees and Armed Forces members. (See 31 CFR 215 at Appendix 1).
A list of States that have entered into agreements, and designated State tax offices to receive inquiries, is included as Appendix 2. A list of cities and counties that have entered into agreements, the type of tax to be withheld for each city or county, and the designated city or county tax offices to receive inquiries is included as Appendix 3. A list of States, cities, and counties with other-than-standard agreements is at Appendix 4.
The Treasury Financial Management Service must notify an agency head when the agency is required to withhold government personnel tax (26 U.S.C. § 3403) and must issue the Form 8655 Reporting Agent Authorization certificate. (See Internal Revenue Manual § 3.0.258.4 (11/21/97), January 1999 edition on CD)
It is significant that government personnel other than those responsible for withholding at the source are not required to keep books and records (26 CFR § 31.6001-1(d)) and must file returns with the Internal Revenue Service for refunds only in unique circumstance (26 CFR § 601.401). Normally the employee is supposed to secure refunds directly from the employer (See 26 CFR §§ 31.6001 through the end of Part 31). However, in the event a government employee owes additional Chapter 24 government personnel tax and any other employment tax withheld at the source, the designated agency officer is responsible for administrative collection efforts. If administrative collection is unsuccessful, the General Accounting Office is charged with responsibility for verifying the obligation, then if necessary, the Attorney General may initiate civil litigation for collection. (5 U.S.C. §§ 5512 et seq.)
To summarize, all Federal taxes categorized as income taxes are indirect or excise taxes where the income is not the object, but merely provide the measure of the tax. The object is the benefit or privilege attending or derived from the income source or activity.
Income taxes imposed by Subtitles A, B & C of the Internal Revenue Code are divided into two classifications: Normal tax and other taxes imposed by provisions of Subtitles A & B are classified as income taxes where social welfare and government personnel taxes imposed by provisions of Subtitle C are classified as employment taxes.
Where taxes imposed by Subtitles A & B are concerned, nonresident aliens, foreign corporations and foreign partnerships are subject to a 30% flat tax on items of income derived from sources within the United States while citizens, residents and domestic corporations of the United States are subject to graduated tax on items of income derived from foreign sources, insular possessions and maritime enterprise regulated by treaty. In all cases the source from which income is derived would not necessarily be available without some form of privilege or benefit granted or secured by Government of the United States.
Employment taxes imposed by provisions of Subtitle C include social welfare and government personnel taxes, both of which are withheld from wages at the source. Social Security tax imposed by Chapter 21 is applicable only in territory belonging to the United States where Congress has plenary power while government personnel tax imposed by Chapter 24 is limited to those designated as employees at 26 U.S.C. § 3401(c).
The Internal Revenue Service has statutory authority for administration of income taxes imposed by Chapters 1, 2 & 21 in insular possessions of the United States, and under delegation of authority from the Secretary of the Treasury administers the Northern Mariana Islands Social Security tax.
The Treasury Financial Management Service is required to notify and certify government agencies responsible for withholding employment taxes then designated agency officers and the General Accounting Office have administrative enforcement authority to the point of litigation for collection.
In the event any of the Subtitle A, B & C graduated income taxes are erroneously imposed on enterprise secured as a substantive right, the application fraudulently and unconstitutionally converts the tax to a direct tax that is subject to the apportionment rule.
