Why Do We Have an Income Tax?

Why Do We Have an Income Tax?

Why Do We Have an Income Tax?

Why Do We Have an Income Tax?

If, in the midst of sorting receipts and studying the latest changes in the US income tax laws, you suddenly wonder “What is the origin of this annual ritual in the weeks leading up to April 15th?” here are some answers.

Taxes are embedded in the history of our country.  “No taxation without representation” was a rallying cry leading to the American revolution and the ultimate independence from Great Britain.  The Boston Tea Party was an act of protest by the American colonists against Great Britain for the Tea Act in which they dumped many chests of tea into Boston Harbor. The cuts to taxation on tea undermined American smugglers, who destroyed the tea in retaliation for its exemption from taxes.

According to an article on the Library of Congress website, the origin of the income tax on individuals is generally cited as the passage of the 16th Amendment, passed by Congress on July 2, 1909, and ratified February 3, 1913; however, its history actually goes back even further. During the Civil War Congress passed the Revenue Act of 1861 which included a tax on personal incomes to help pay war expenses. The tax was repealed ten years later.

However, in 1894 Congress enacted a flat rate Federal income tax, which was ruled unconstitutional the following year by the U.S. Supreme Court because it was a direct tax not apportioned according to the population of each state. The 16th amendment, ratified in 1913, removed this objection by allowing the Federal government to tax the income of individuals without regard to the population of each State.

Further reorganization came in the 1950s, replacing the patronage system with career employees. The IRS Restructuring and Reform Act of 1998 prompted the most comprehensive reorganization and modernization of IRS in nearly half a century and established a Taxpayer Advocate Service as an independent voice inside the agency on behalf of the taxpayer.

April 15th has not always been the filing deadline. March 1st was the date specified by Congress in 1913, after the passage of the 16th amendment. In 1918 Congress pushed the date forward to March 15th, where it remained until the tax overhaul of 1954, when the date was again moved ahead to April 15th.

Wikipedia writes that tax statutes passed after the ratification of the Sixteenth Amendment in 1913 are sometimes referred to as the “modern” tax statutes. Hundreds of Congressional acts have been passed since 1913, as well as several codifications (i.e., topical reorganizations) of the statutes.

The modern interpretation of the Sixteenth Amendment taxation power can be found in Commissioner v. Glenshaw Glass Co. 348 U.S. 426 (1955). In that case, a taxpayer had received an award of punitive damages from a competitor, and sought to avoid paying taxes on that award. The U.S. Supreme Court observed that Congress, in imposing the income tax, had defined income to include:

gains, profits, and income derived from salaries, wages, or compensation for personal service . . . of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever.

The Court held that “this language was used by Congress to exert in this field the full measure of its taxing power”, and that “the Court has given a liberal construction to this broad phraseology in recognition of the intention of Congress to tax all gains except those specifically exempted.”

The Court then enunciated what is now understood by Congress and the Courts to be the definition of taxable income, “instances of undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.” The defendant in that case suggested that a 1954 rewording of the tax code had limited the income that could be taxed, a position which the Court rejected, stating:

The definition of gross income has been simplified, but no effect upon its present broad scope was intended. Certainly punitive damages cannot reasonably be classified as gifts, nor do they come under any other exemption provision in the Code. We would do violence to the plain meaning of the statute and restrict a clear legislative attempt to bring the taxing power to bear upon all receipts constitutionally taxable were we to say that the payments in question here are not gross income.

These are all interesting historical facts to ponder as you prepare to file your 2017 income taxes in 2018.  Palm Beach Tax Service holds the answers to all your questions, whether you need help with QuickBooks in Lantana Florida a bookkeeper in Lake Worth or Palm Beach bookkeeping.  Give us a call today.

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