Moments In Tax History | Eisner v. Macomber | Income, An Origin Story

• Published date: 01 August 2022
• Law Firm: Freeman Law
• Author: Mr TL Fahring

Eisner v. Macomber, 252 U.S. 189 (1920)

Summary: In Eisner v. Macomber, the U.S. Supreme Court ruled that for purposes of the Sixteenth Amendment, "income" 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." Macomber introduced the realization requirement to the federal income tax, and the decision continues to be cited in such contexts as cryptocurrency hard forks and the constitutionality of provisions denying deductions for cannabis businesses.

Background: The U.S. Constitution prohibits Congress from imposing an unapportioned direct tax.¹ In 1895, the U.S. Supreme Court ruled that an attempt by Congress to tax incomes uniformly throughout the United States was unconstitutional due to this constitutional prohibition.²

On February 3, 1913, the Sixteenth Amendment to the U.S. Constitution was ratified. According to the Sixteenth Amendment, "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."³ That same year, Congress passed the Revenue Act of 1913, inaugurating the modern federal individual income tax.⁴

The Revenue Act of 1916 further modified the individual income tax. In relevant part, the Revenue Act of 1916 provided that a stock dividend shall be considered income in the amount of its cash value.⁵

On January 1, 1916, Standard Oil Company of California had surplus and undivided profits of about $45,000,000, of which approximately $20,000,000 was earned before March 1, 1913.⁶ That month, the company issued a stock dividend of 50% of its outstanding stock, transferring an amount equivalent to this issue from its surplus account to its capital stock account.⁷

Before the stock dividend, Myrtle H. Macomber owned 2,200 shares of company stock, and she received an additional 1,100 shares as a result. Approximately 18.07%, or 198.77 shares with a par value of $19,877, was treated as representing surplus earned between March 1, 1913, and January 1, 1916.⁸ The Bureau of Internal Revenue (the name at the time for the Internal Revenue Service) required Ms. Macomber to pay federal income tax on the value of this portion of the stock dividend, which she did under protest.⁹

Holding: The Court held that a shareholder didn't realize income upon the receipt of a pro rata stock...