"Taxable Income" by Larken Rose pg1(Page 1 of 6)1) OverviewDespite "common knowledge" to the contrary, the income of most Americans is not subject to the United States federal income tax. The strict limits on federal power imposed by the Constitution prohibited Congress from imposing a tax on the incomes of United States citizens who live and work exclusively within the 50 states, and the federal statutes and regulations demonstrate that Congress did not impose such a tax. This was not due to an oversight, or to some technical imperfection in the legislative process. Congress never even attempted to impose such a tax. Instead, a limited income tax was imposed, and was worded in such a way to give the impression that it was applicable to the income of most Americans. However, a more in-depth study of the federal statutes and regulations reveals that the tax is far more limited in scope than the public has been led to believe. While following the proof of this may require concentration, it does not require any "leap of faith," or any questionable "interpretation" of the law. The legal system of the United States is a system of written law, and the words in the law must inform individuals of exactly what the law requires. Therefore, an accurate determination of what the law requires can be accomplished only by an examination of the relevant legal documents themselves, without regard for preconceived assumptions about what the law says. Despite the enormous, complex maze of federal statutes and regulations built up by government lawyers over the years, written in what is virtually a foreign language to most (sometimes called "legalese"), the truth is still quite provable, as will be shown below.Though many have complained about and/or resisted the federal income tax, the truth is that most Americans have no reason to "protest" the law at all. The federal income tax is neither invalid nor unconstitutional. The tax complies fully with the strict Constitutional limitations on the power of Congress. What does warrant protest and demand for correction is how the tax has been (and still is) grossly misrepresented to the American people, and misapplied by federal employees, most of whom are equally ignorant of the truth. Many citizens have been harassed, robbed, and imprisoned unjustly, and the few in government who knew the truth did nothing to stop it. Political power has long been associated with dishonesty and deception, but the misrepresentation of the federal income tax (referred to below as "the Great Deception") constitutes the most massive fraud in the history of the United States. (It is more a conspiracy of ignorance than a conspiracy of secrecy, meaning that most of those involved in the tax industry, including the IRS and tax professionals, are guilty of incompetence and ignorance, rather than intentional deceit.) This report will use the federal statutes and regulations themselves to document that the scope of the federal income tax is far more limited than the public generally believes. It will be shown that while many types of "income" can be taxable, they can be taxable only if they come from specific taxable activities (a.k.a. "sources"), and it will be shown that the taxable "sources" apply only to those engaged in international or foreign commerce, but do not apply to United States citizens living and working exclusively within the 50 states. All non-italicized comments (in brackets) within a citation in this report are comments of the author, and do not appear in the text itself. Also, all bold and underlined emphasis within citations has been added by the author. (Throughout the report there are several "Questions for Doubters" for tax professionals or others who doubt the correctness of this report.)2) The BasicsThe laws enacted by Congress through the legislative process are compiled into statutes in the 50 "Titles" of the United States Code. (Each "Title" deals with a category of law, and Title 26 is the federal tax title, often called the "Internal Revenue Code.") A federal agency then has the duty (assigned by Congress) to implement and enforce the statutes by writing and publishing regulations, which explain that agency’s interpretation of the statutes, as well as setting the rules which govern how the agency will enforce the statutes. The regulations, when published in the Federal Register, are the official notice to the public of what the law requires, and are binding on the federal agencies (including the IRS). For federal taxes, the Secretary of the Treasury is authorized to write such regulations. "Sec. 7805. Rules and regulations(a) Authorization - … the Secretary [of the Treasury] shall prescribe all needful rules and regulations for the enforcement of this title [Title 26]…" [26 USC § 7805](The citation "26 USC § 7805" refers to Section 7805 of the statutes of Title 26, with "USC" meaning "United States Code." The symbol "§" means "section." Citations of regulations are similar, but contain "CFR" instead, meaning "Code of Federal Regulations.")Section 1 of the Title 26 statutes imposes the "income tax" in five different categories (unmarried people, married people filing jointly, etc.). In each case, the wording reads "there is hereby imposed on the taxable income of…" The law generally defines "taxable income" in the following section of the statutes:"Sec. 63. Taxable income defined(a) In general - …the term "taxable income" means gross income minus the deductions allowed by this chapter…" [26 USC § 63]In other words, when someone determines his "gross income," and then subtracts all allowable deductions, the remainder is "taxable income." (So for income to be "taxable income," it must first be "gross income.") The following section of the statutes gives a general definition of "gross income":"Sec. 61. Gross income defined(a) General definition - … gross income means all income from whatever source derived, including (but not limited to) the following items: (1) Compensation for services...;(2) Gross income derived from business;(3) Gains derived from dealings in property;(4) Interest;(5) Rents;(6) Royalties;(7) Dividends;... [more items listed]" [26 USC § 61]This is the point at which many tax "experts" err, either by assuming that the "items" of income listed constitute "sources" of income, or by assuming that "from whatever source derived" means that all of the "items" of income listed, regardless of where they come from, are subject to the "income tax." Both of these assumptions are provably incorrect. (The difference and relationship between "items" and "sources" will be explained below.)3) English vs. LegaleseIn our system of written law, Congress may use a term to mean almost anything, as long as the law itself defines that meaning. When the written law explains the meaning of a term used in the law, standard English usage becomes irrelevant. For example, by the definition in 26 USC § 7701(a)(1), the term "person" includes estates, companies and corporations. While no one would call Walmart a "person" in everyday conversation, Walmart is a "person" under federal tax law. The legal use of a term is often significantly different from basic English, and therefore reading one section of the law alone can be very misleading. As a good example, 26 USC § 5841 states that "[t]he Secretary [of the Treasury] shall maintain a central registry of all firearms in the United States which are not in the possession or under the control of the United States." The law has a far more limited application than this section by itself would seem to imply. In 26 USC § 5845(a) it is made clear that the term "firearm" in these sections does not include the majority of rifles and handguns (while the term "firearm" in basic English obviously would), but does include poison gas, silencers and land mines. The average citizen reading the law will naturally tend to assume that he already knows what the words in the law mean, and may have difficulty accepting that the legal meaning of the words used in the law may bear little or no resemblance to the meaning that those words have in common English. For example, reading the phrase "all firearms" in Section 5841 in a way that excludes most rifles and handguns is contrary to instinctive reading comprehension. (But any lawyer reviewing Sections 5841 and 5845 would confirm that such a reading would be absolutely correct.) Reading one section of the law without being aware of the legal definitions of the words being used can give an entirely incorrect impression about the application of the law. As demonstrated, sometimes the apparent meaning of a simple phrase in the law is very different from the legal meaning. The "income tax" is imposed on "income from whatever source derived." If the law did not explain what constitutes "sources of income," then the law would be interpreted using basic English. However, the law does explain what the term means, and therefore standard English usage is irrelevant. 4) Sources of IncomeTo review, the "income tax" is imposed on "taxable income," which means "gross income" minus deductions. "Gross income" is defined in 26 USC § 61 as "all income from whatever source derived." The phrase "from whatever source derived" may initially appear all-encompassing, but for the specifics about "income from sources," the reader of the law is repeatedly referred to Section 861 and following (of the statutes) and the related regulations. For example, in the full version of Title 26 (with all notes and amendments) which appears on Congress’ own web site, Section 61 itself has the following cross-reference:"Income from sources -Within the United States, see section 861 of this title.Without the United States, see section 862 of this title." So the section which generally defines "gross income" specifically refers to 26 USC § 861 regarding income from "sources" within the United States. A similar reference is also found in the indexes of the United States Code, which (although they vary somewhat in the exact wording) have entries such as:"Income taxSources of incomeDetermination, 26 § 861 et seq…Within the U.S., 26 § 861"Again, income from "sources" within the United States is specifically dealt with by Section 861, and "determination" of sources of income is also dealt with by Section 861 and the following sections. In addition, Sections 79, 105, 410, 414 and 505 each identify Section 861 as the section which determines what constitutes "income from sources within the United States," and Section 306 even uses the phrase "part I of subchapter N (sec. 861 and following, relating to determination of sources of income)." As shown, 26 USC § 861 and following (which make up Part I of Subchapter N of the Code) are very relevant to determining what is considered a "source of income," and Section 861 in particular deals within income from "sources" within the United States. Not surprisingly, Section 861 is entitled "Income from sources within the United States," and the first two subsections of Section 861 are entitled "Gross income from sources within the United States" and "Taxable income from sources within the United States." Section 861 is also the first section of Subchapter N of the Code, which is entitled "Tax based on income from sources within or without the United States." Clearly this is relevant to a tax on "income from whatever source derived." As mentioned before, the statutes passed by Congress are interpreted and implemented by regulations published in the Code of Federal Regulations ("CFR") by the Secretary of the Treasury. The Index of the CFR, under "Income taxes," has an entry that reads "Income from sources inside or outside U.S., determination of sources of income, 26 CFR 1 (1.861-1--1.864-8T)." This is the only entry in the Index relating to income from sources within the United States, and the regulations listed (26 CFR § 1.861-1 and following) correspond to Section 861 of the statutes. (The "26" refers to Title 26, the "1" after "CFR" refers to Part 1 of the regulations ("Income Taxes"), and the ".861" refers to Section 861 of the statutes.) These regulations fall under the heading "Determination of sources of income." The following is how these regulations begin:"Sec. 1.861-1 Income from sources within the United States.(a) Categories of income. Part I (section 861 and following), subchapter N, chapter 1 of the Code, and the regulations thereunder determine the sources of income for purposes of the income tax." [26 CFR § 1.861-1]The meaning of this is unmistakable. The "income tax" is imposed on "income from whatever source derived," and Section 861 and following, and the related regulations, determine what is considered a "source" of income "for purposes of the income tax." The first sentence of the regulations under 26 USC § 861 has stated this since 1954, when Section 861 first came into existence. Note that these define "the" sources of income subject to the tax, meaning there are no others. Therefore, the meaning of "income from whatever source derived" (the definition of "gross income" in Section 61) is limited by Section 861 (and following sections) and the related regulations. The meaning of the phrase "whatever source" depends completely on the meaning of the word "source." The word "whatever" does not expand the meaning of "source" any more than the phrase "all firearms" (in the example above) expands the legal meaning of the word "firearm."The above section of regulations also refutes the common but incorrect position that the "items" of income listed in Section 61 are "sources," since Section 61 is obviously not the section which determines the "sources" of income for purposes of the income tax. (There is a chart at the end of this report showing the outline of Part I of Subchapter N and related regulations, and showing many of the citations used in this report.)While the significance of Section 861 and the related regulations may be obvious, the point needs to be thoroughly proven, since most tax professionals concede that Section 861 and its regulations are not about the income of United States citizens living and working exclusively within the United States. (Below it will be shown why it is so significant that "section 861 and following... and the regulations thereunder, determine the sources of income for purposes of the income tax.")This is also suggested by the title of Part I of Subchapter N (of which 861 is the first section), "Source rules and other general rules relating to foreign income." Under the usual overly-broad (and incorrect) interpretation of the legal scope of the term "gross income," this would appear as a contradiction, since "Income from sources within the United States" (the title of Section 861) would at first glance seem to be the opposite of "foreign income." The specific taxable sources shown later demonstrate that income from within the United States can be taxable only if received by certain individuals outside of the United States, thus making the income foreign income.While the title of a part of the statutes may indicate what that part is about, it should be mentioned that 26 USC § 7806(b) states that such titles do not change the actual meaning of the law ("nor shall any… descriptive matter relating to the contents of this title be given any legal effect"). The above explanation for the title of Part I, Subchapter N is therefore not crucial, but does give a possible explanation of why the title is as it is. (Question for Doubters #1: Does Part I (Section 861 and following) of Subchapter N, and related regulations, determine what is considered a "source" of income for purposes of the federal income tax?) Does Part I (Section 861 and following) of Subchapter N, and related regulations, determine what is considered a "source" of income for purposes of the federal income tax?)5) Determining Taxable IncomeIn addition to the fact that Section 861 and following, and related regulations, determine what is considered a "source" of income subject to the income tax, the regulations also repeatedly state that these are also the specific sections to be used to determine "gross income" and "taxable income" from sources within and/or without the United States. "Rules are prescribed for determination of gross income and taxable income derived from sources within and without the United States, and for the allocation of income derived partly from sources within the United States and partly without the United States or within United States possessions. §§ 1.861-1 through 1.864. (Secs. 861-864; ’54 Code.)" [Treasury Decision 6258]The sections which are specifically for determining taxable income from sources within the United States are 26 USC § 861(b) of the statutes, and the corresponding regulations found at 26 CFR § 1.861-8. (The regulations under Section 63, the section defining "taxable income," do not explain how to determine taxable income.) While the relevance of these sections may quickly become obvious, the repeated documentation is important since most tax professionals are already aware that these sections are not about the income of most Americans. Section 861(b) (as mentioned above) is entitled "Taxable income from sources within the United States." This section states that taxable income from sources within the United States is the gross income described in 861(a) minus allowable deductions. The regulations under Section 861 state (in the first paragraph):"The statute provides for the following three categories of income:(1) Within the United States. The gross income from sources within the United States… See Secs. 1.861-2 to 1.861-7, inclusive, and Sec. 1.863-1. The taxable income from sources within the United States… shall be determined by deducting therefrom, in accordance with sections 861(b) and 863(a), [allowable deductions]. See Secs. 1.861-8 and 1.863-1." [26 CFR § 1.861-1(a)(1)](The other two categories of income are income from "without" (outside of) the United States, dealt with by Section 862 and related regulations, and income from sources partly within and partly without the U.S., dealt with by Section 863 and related regulations.) As the above citation states, items of "gross income" from sources within the U.S. are dealt with by 861(a) of the statutes and 1.861-2 through 1.861-7 of the regulations. Taxable income is determined by 861(b) of the statutes, and the corresponding regulations in 1.861-8. These regulations are predictably entitled "Computation of taxable income from sources within the United States and from other sources and activities," and reiterate the point:"Sections 861(b) and 863(a) state in general terms how to determine taxable income of a taxpayer from sources within the United States after gross income from sources within the United States has been determined." [26 CFR § 1.861-8]In the regulations under Section 863 (concerning income from sources inside and outside the U.S.), the following is stated:"Determination of taxable income. The taxpayer's taxable income from sources within or without the United States will be determined under the rules of Secs. 1.861-8 through 1.861-14T for determining taxable income from sources within the United States." [26 CFR § 1.863-1(c)](The vast majority of tax professionals do not use these sections to determine taxable income from sources within the United States. At this point, the average citizen reading this report may guess that there must be some "context," or some other section, or something somewhere which would justify the tax professionals blatantly disregarding and disobeying the clear language used in the citations shown above. There is not.)Note how sections 1.861-8 and following of the regulations are identified as the sections "for determining taxable income from sources within the United States," as well as being the sections to be used whether the income is from sources within or without the United States. A similar structure occurs in the regulations under Section 862 (dealing with income from outside of the United States):"(b) Taxable income. The taxable income from sources without the United States… shall be determined on the same basis as that used in Sec. 1.861-8 for determining the taxable income from sources within the United States." [26 CFR § 1.862-1]Section 1.863-6 of the regulations (dealing with income from within a foreign country or federal possession) also identifies sections 1.861-1 through 1.863-5 as applying "[t]he principles… for determining the gross and the taxable income from sources within and without the United States." Over and over again it is shown that 26 USC § 861(b) of the statutes and 26 CFR § 1.861-8 of the regulations are to be used to determine the taxable income from sources within the United States. (Question for Doubters #2: Are 26 USC § 861(b) and 26 CFR § 1.861-8 the sections to be used to determine taxable income from sources within the United States?)6) Specific SourcesSection 861 of the statutes uses general language that at first seems to apply to all income coming from within the United States, by saying "The following items of gross income shall be treated as income from sources within the United States:" The section then lists similar "items" of income to those listed in Section 61 (while specifying that they are coming from within the United States). As with Section 61, it is easy to misconstrue this list of "items" as being a list of "sources," which it is not. The regulations related to Section 861 contradict this possible misinterpretation. (And, as will be shown later, the older regulations and statutes make the correct application of the law crystal clear.)The regulations in Section 1.861-8 begins by saying that Section 861(b) of the statutes describes "in general terms" how to determine taxable income from sources within the United States. These same regulations later specify that Section 861 is about items of income derived from "specific sources." "(ii) Relationship of sections 861, 862, 863(a), and 863(b). Sections 861, 862, 863(a), and 863(b) are the four provisions applicable in determining taxable income from specific sources." [26 CFR § 1.861-8(f)(3)(ii)]In the first paragraph of Section 1.861-8 of the regulations (the section "for determining taxable income from sources within the United States"), it is again made clear that the section applies only to the listed "items" of income when derived from "specific sources." "The rules contained in this section apply in determining taxable income of the taxpayer from specific sources and activities…" [26 CFR § 1.861-8(a)]Again, a few paragraphs later, in defining the term "statutory grouping," these regulations again state that taxable income must come from a "specific source.""…the term ‘statutory grouping’ means the gross income from a specific source or activity which must first be determined in order to arrive at ‘taxable income’ from which specific source or activity…" [26 CFR § 1.861-8(a)(4)]In 26 CFR § 1.861-8(f)(1) it is again made clear that Section 1.861-8 (the section "for determining taxable income from sources within the United States") is applicable only to income derived from "specific sources.""…the determination of taxable income of the taxpayer from specific sources or activities and which gives rise to statutory groupings [see previous citation] to which this section is applicable…" [26 CFR § 1.861-8(f)(1)]From these it is clear that the term "source" as used in Sections 61 and 861 does not simply mean any activity from which income is derived. If it did, there would be no need for Section 861 and following, and related regulations, to "determine the sources of income for purposes of the income tax." The following citations show that Section 1.861-8(f)(1) lists the "specific sources" of income subject to the income tax. Again, the first paragraph of 26 CFR § 1.861-8 states the following (the meaning of "operative section" will be explained below):"The rules contained in this section apply in determining taxable income of the taxpayer from specific sources and activities under other sections of the Code, referred to in this section as operative sections. See paragraph (f)(1) of this section for a list and description of operative sections." [26 CFR § 1.861-8(a)(1)]The definition of "statutory grouping" (mentioned above) also refers to "paragraph (f)(1)" as the list of "specific sources.""…the term ‘statutory grouping’ means the gross income from a specific source or activity which must first be determined in order to arrive at ‘taxable income’ from which specific source or activity under an operative section. (See paragraph (f)(1) of this section.)" [26 CFR § 1.861-8(a)(4)]The regulations twice identify "paragraph (f)(1) of this section" (26 CFR § 1.861-8(f)(1)) as the list of specific sources. Paragraph (f)(1) itself confirms this again, and then lists the "specific sources" subject to the income tax:"The operative sections of the Code which require the determination of taxable income of the taxpayer from specific sources or activities and which gives rise to statutory groupings to which this section is applicable include the sections described below.(i) Overall limitation to the foreign tax credit…(ii) [Reserved](iii) DISC and FSC taxable income… [international and foreign sales corporations](iv) Effectively connected taxable income. Nonresident alien individuals and foreign corporations engaged in trade or business within the United States…(v) Foreign base company income…(vi) Other operative sections. The rules provided in this section also apply in determining-- (A) The amount of foreign source items…(B) The amount of foreign mineral income…(C) [Reserved](D) The amount of foreign oil and gas extraction income…(E) (deals with Puerto Rico tax credits)(F) (deals with Puerto Rico tax credits)(G) (deals with Virgin Islands tax credits)(H) The income derived from Guam by an individual…(I) (deals with China Trade Act corporations)(J) (deals with foreign corporations)(K) (deals with insurance income of foreign corporations)(L) (deals with countries subject to international boycott)(M) (deals with the Merchant Marine Act of 1936)" [26 CFR § 1.861-8(f)(1)]None of these "sources" apply to United States citizens who live and work exclusively within the United States. (Federal "possessions," such as Guam, Puerto Rico, etc., are considered "foreign" under the law.) This is the only list of "sources" in Part I of Subchapter N, or the regulations thereunder, which (as the regulations say) "determine the sources of income for purposes of the income tax." The next subsection (1.861-8(g)) gives examples about how 26 CFR § 1.861-8 works, and states that "[i]n each example, unless otherwise specified, the operative section which is applied and gives rise to the statutory grouping of gross income is the overall limitation to the foreign tax credit under section 904(a)," again showing that there must be some "operative section" in order for the section to apply, and in order for there to be taxable income. So, to review, the sections which "determine the sources of income for purposes of the income tax" (namely, 861 and following and related regulations) apply only to income from the "specific sources" listed in 26 CFR § 1.861-8(f)(1). Most people do not receive income from these "sources of income for purposes of the income tax," and most people do not, therefore, receive "income from whatever source derived" (the general definition of "gross income") subject to the income tax.(Question for Doubters #3: Under 26 USC § 861 and 26 CFR § 1.861-8, is income taxable only if derived from "specific sources" related to international and foreign commerce (including federal possessions)?)

"Taxable Income"
by Larken Rose
(Page 1 of 6)

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1) Overview

Despite "common knowledge" to the contrary, the income of most Americans is not subject to the United States federal income tax. The strict limits on federal power imposed by the Constitution prohibited Congress from imposing a tax on the incomes of United States citizens who live and work exclusively within the 50 states, and the federal statutes and regulations demonstrate that Congress did not impose such a tax. This was not due to an oversight, or to some technical imperfection in the legislative process. Congress never even attempted to impose such a tax. Instead, a limited income tax was imposed, and was worded in such a way to give the impression that it was applicable to the income of most Americans. However, a more in-depth study of the federal statutes and regulations reveals that the tax is far more limited in scope than the public has been led to believe.

While following the proof of this may require concentration, it does not require any "leap of faith," or any questionable "interpretation" of the law. The legal system of the United States is a system of written law, and the words in the law must inform individuals of exactly what the law requires. Therefore, an accurate determination of what the law requires can be accomplished only by an examination of the relevant legal documents themselves, without regard for preconceived assumptions about what the law says. Despite the enormous, complex maze of federal statutes and regulations built up by government lawyers over the years, written in what is virtually a foreign language to most (sometimes called "legalese"), the truth is still quite provable, as will be shown below.

Though many have complained about and/or resisted the federal income tax, the truth is that most Americans have no reason to "protest" the law at all. The federal income tax is neither invalid nor unconstitutional. The tax complies fully with the strict Constitutional limitations on the power of Congress.

What does warrant protest and demand for correction is how the tax has been (and still is) grossly misrepresented to the American people, and misapplied by federal employees, most of whom are equally ignorant of the truth. Many citizens have been harassed, robbed, and imprisoned unjustly, and the few in government who knew the truth did nothing to stop it. Political power has long been associated with dishonesty and deception, but the misrepresentation of the federal income tax (referred to below as "the Great Deception") constitutes the most massive fraud in the history of the United States. (It is more a conspiracy of ignorance than a conspiracy of secrecy, meaning that most of those involved in the tax industry, including the IRS and tax professionals, are guilty of incompetence and ignorance, rather than intentional deceit.)

This report will use the federal statutes and regulations themselves to document that the scope of the federal income tax is far more limited than the public generally believes. It will be shown that while many types of "income" can be taxable, they can be taxable only if they come from specific taxable activities (a.k.a. "sources"), and it will be shown that the taxable "sources" apply only to those engaged in international or foreign commerce, but do not apply to United States citizens living and working exclusively within the 50 states.

All non-italicized comments (in brackets) within a citation in this report are comments of the author, and do not appear in the text itself. Also, all bold and underlined emphasis within citations has been added by the author.

(Throughout the report there are several "Questions for Doubters" for tax professionals or others who doubt the correctness of this report.)

2) The Basics

The laws enacted by Congress through the legislative process are compiled into statutes in the 50 "Titles" of the United States Code. (Each "Title" deals with a category of law, and Title 26 is the federal tax title, often called the "Internal Revenue Code.") A federal agency then has the duty (assigned by Congress) to implement and enforce the statutes by writing and publishing regulations, which explain that agency’s interpretation of the statutes, as well as setting the rules which govern how the agency will enforce the statutes. The regulations, when published in the Federal Register, are the official notice to the public of what the law requires, and are binding on the federal agencies (including the IRS). For federal taxes, the Secretary of the Treasury is authorized to write such regulations.

"Sec. 7805. Rules and regulations
(a) Authorization - … the Secretary [of the Treasury] shall prescribe all needful rules and regulations for the enforcement of this title [Title 26]…" [26 USC § 7805]

(The citation "26 USC § 7805" refers to Section 7805 of the statutes of Title 26, with "USC" meaning "United States Code." The symbol "§" means "section." Citations of regulations are similar, but contain "CFR" instead, meaning "Code of Federal Regulations.")

Section 1 of the Title 26 statutes imposes the "income tax" in five different categories (unmarried people, married people filing jointly, etc.). In each case, the wording reads "there is hereby imposed on the taxable income of…" The law generally defines "taxable income" in the following section of the statutes:

"Sec. 63. Taxable income defined
(a) In general - …the term "taxable income" means gross income minus the deductions allowed by this chapter…" [26 USC § 63]

In other words, when someone determines his "gross income," and then subtracts all allowable deductions, the remainder is "taxable income." (So for income to be "taxable income," it must first be "gross income.") The following section of the statutes gives a general definition of "gross income":

"Sec. 61. Gross income defined
(a) General definition - … gross income means all income from whatever source derived, including (but not limited to) the following items:
(1) Compensation for services...;
(2) Gross income derived from business;
(3) Gains derived from dealings in property;
(4) Interest;
(5) Rents;
(6) Royalties;
(7) Dividends;... [more items listed]" [26 USC § 61]

This is the point at which many tax "experts" err, either by assuming that the "items" of income listed constitute "sources" of income, or by assuming that "from whatever source derived" means that all of the "items" of income listed, regardless of where they come from, are subject to the "income tax." Both of these assumptions are provably incorrect. (The difference and relationship between "items" and "sources" will be explained below.)

3) English vs. Legalese

In our system of written law, Congress may use a term to mean almost anything, as long as the law itself defines that meaning. When the written law explains the meaning of a term used in the law, standard English usage becomes irrelevant. For example, by the definition in 26 USC § 7701(a)(1), the term "person" includes estates, companies and corporations. While no one would call Walmart a "person" in everyday conversation, Walmart is a "person" under federal tax law. The legal use of a term is often significantly different from basic English, and therefore reading one section of the law alone can be very misleading.

As a good example, 26 USC § 5841 states that "[t]he Secretary [of the Treasury] shall maintain a central registry of all firearms in the United States which are not in the possession or under the control of the United States." The law has a far more limited application than this section by itself would seem to imply. In 26 USC § 5845(a) it is made clear that the term "firearm" in these sections does not include the majority of rifles and handguns (while the term "firearm" in basic English obviously would), but does include poison gas, silencers and land mines. The average citizen reading the law will naturally tend to assume that he already knows what the words in the law mean, and may have difficulty accepting that the legal meaning of the words used in the law may bear little or no resemblance to the meaning that those words have in common English. For example, reading the phrase "all firearms" in Section 5841 in a way that excludes most rifles and handguns is contrary to instinctive reading comprehension. (But any lawyer reviewing Sections 5841 and 5845 would confirm that such a reading would be absolutely correct.) Reading one section of the law without being aware of the legal definitions of the words being used can give an entirely incorrect impression about the application of the law.

As demonstrated, sometimes the apparent meaning of a simple phrase in the law is very different from the legal meaning. The "income tax" is imposed on "income from whatever source derived." If the law did not explain what constitutes "sources of income," then the law would be interpreted using basic English. However, the law does explain what the term means, and therefore standard English usage is irrelevant.

4) Sources of Income

To review, the "income tax" is imposed on "taxable income," which means "gross income" minus deductions. "Gross income" is defined in 26 USC § 61 as "all income from whatever source derived." The phrase "from whatever source derived" may initially appear all-encompassing, but for the specifics about "income from sources," the reader of the law is repeatedly referred to Section 861 and following (of the statutes) and the related regulations. For example, in the full version of Title 26 (with all notes and amendments) which appears on Congress’ own web site, Section 61 itself has the following cross-reference:

"Income from sources -
Within the United States, see section 861 of this title.
Without the United States, see section 862 of this title."

So the section which generally defines "gross income" specifically refers to 26 USC § 861 regarding income from "sources" within the United States. A similar reference is also found in the indexes of the United States Code, which (although they vary somewhat in the exact wording) have entries such as:

"Income tax
Sources of income
Determination, 26 § 861 et seq…
Within the U.S., 26 § 861"

Again, income from "sources" within the United States is specifically dealt with by Section 861, and "determination" of sources of income is also dealt with by Section 861 and the following sections. In addition, Sections 79, 105, 410, 414 and 505 each identify Section 861 as the section which determines what constitutes "income from sources within the United States," and Section 306 even uses the phrase "part I of subchapter N (sec. 861 and following, relating to determination of sources of income)."

As shown, 26 USC § 861 and following (which make up Part I of Subchapter N of the Code) are very relevant to determining what is considered a "source of income," and Section 861 in particular deals within income from "sources" within the United States. Not surprisingly, Section 861 is entitled "Income from sources within the United States," and the first two subsections of Section 861 are entitled "Gross income from sources within the United States" and "Taxable income from sources within the United States." Section 861 is also the first section of Subchapter N of the Code, which is entitled "Tax based on income from sources within or without the United States." Clearly this is relevant to a tax on "income from whatever source derived."

As mentioned before, the statutes passed by Congress are interpreted and implemented by regulations published in the Code of Federal Regulations ("CFR") by the Secretary of the Treasury. The Index of the CFR, under "Income taxes," has an entry that reads "Income from sources inside or outside U.S., determination of sources of income, 26 CFR 1 (1.861-1--1.864-8T)." This is the only entry in the Index relating to income from sources within the United States, and the regulations listed (26 CFR § 1.861-1 and following) correspond to Section 861 of the statutes. (The "26" refers to Title 26, the "1" after "CFR" refers to Part 1 of the regulations ("Income Taxes"), and the ".861" refers to Section 861 of the statutes.) These regulations fall under the heading "Determination of sources of income." The following is how these regulations begin:

"Sec. 1.861-1 Income from sources within the United States.
(a) Categories of income. Part I (section 861 and following), subchapter N, chapter 1 of the Code, and the regulations thereunder determine the sources of income for purposes of the income tax." [26 CFR § 1.861-1]

The meaning of this is unmistakable. The "income tax" is imposed on "income from whatever source derived," and Section 861 and following, and the related regulations, determine what is considered a "source" of income "for purposes of the income tax." The first sentence of the regulations under 26 USC § 861 has stated this since 1954, when Section 861 first came into existence. Note that these define "the" sources of income subject to the tax, meaning there are no others. Therefore, the meaning of "income from whatever source derived" (the definition of "gross income" in Section 61) is limited by Section 861 (and following sections) and the related regulations. The meaning of the phrase "whatever source" depends completely on the meaning of the word "source." The word "whatever" does not expand the meaning of "source" any more than the phrase "all firearms" (in the example above) expands the legal meaning of the word "firearm."

The above section of regulations also refutes the common but incorrect position that the "items" of income listed in Section 61 are "sources," since Section 61 is obviously not the section which determines the "sources" of income for purposes of the income tax.

(There is a chart at the end of this report showing the outline of Part I of Subchapter N and related regulations, and showing many of the citations used in this report.)

While the significance of Section 861 and the related regulations may be obvious, the point needs to be thoroughly proven, since most tax professionals concede that Section 861 and its regulations are not about the income of United States citizens living and working exclusively within the United States. (Below it will be shown why it is so significant that "section 861 and following... and the regulations thereunder, determine the sources of income for purposes of the income tax.")

This is also suggested by the title of Part I of Subchapter N (of which 861 is the first section), "Source rules and other general rules relating to foreign income." Under the usual overly-broad (and incorrect) interpretation of the legal scope of the term "gross income," this would appear as a contradiction, since "Income from sources within the United States" (the title of Section 861) would at first glance seem to be the opposite of "foreign income." The specific taxable sources shown later demonstrate that income from within the United States can be taxable only if received by certain individuals outside of the United States, thus making the income foreign income.

While the title of a part of the statutes may indicate what that part is about, it should be mentioned that 26 USC § 7806(b) states that such titles do not change the actual meaning of the law ("nor shall any… descriptive matter relating to the contents of this title be given any legal effect"). The above explanation for the title of Part I, Subchapter N is therefore not crucial, but does give a possible explanation of why the title is as it is.

(Question for Doubters #1: Does Part I (Section 861 and following) of Subchapter N, and related regulations, determine what is considered a "source" of income for purposes of the federal income tax?) Does Part I (Section 861 and following) of Subchapter N, and related regulations, determine what is considered a "source" of income for purposes of the federal income tax?)

5) Determining Taxable Income

In addition to the fact that Section 861 and following, and related regulations, determine what is considered a "source" of income subject to the income tax, the regulations also repeatedly state that these are also the specific sections to be used to determine "gross income" and "taxable income" from sources within and/or without the United States.

"Rules are prescribed for determination of gross income and taxable income derived from sources within and without the United States, and for the allocation of income derived partly from sources within the United States and partly without the United States or within United States possessions. §§ 1.861-1 through 1.864. (Secs. 861-864; ’54 Code.)" [Treasury Decision 6258]

The sections which are specifically for determining taxable income from sources within the United States are 26 USC § 861(b) of the statutes, and the corresponding regulations found at 26 CFR § 1.861-8. (The regulations under Section 63, the section defining "taxable income," do not explain how to determine taxable income.) While the relevance of these sections may quickly become obvious, the repeated documentation is important since most tax professionals are already aware that these sections are not about the income of most Americans.

Section 861(b) (as mentioned above) is entitled "Taxable income from sources within the United States." This section states that taxable income from sources within the United States is the gross income described in 861(a) minus allowable deductions. The regulations under Section 861 state (in the first paragraph):

"The statute provides for the following three categories of income:
(1) Within the United States. The gross income from sources within the United States… See Secs. 1.861-2 to 1.861-7, inclusive, and Sec. 1.863-1. The taxable income from sources within the United States… shall be determined by deducting therefrom, in accordance with sections 861(b) and 863(a), [allowable deductions]. See Secs. 1.861-8 and 1.863-1." [26 CFR § 1.861-1(a)(1)]

(The other two categories of income are income from "without" (outside of) the United States, dealt with by Section 862 and related regulations, and income from sources partly within and partly without the U.S., dealt with by Section 863 and related regulations.)

As the above citation states, items of "gross income" from sources within the U.S. are dealt with by 861(a) of the statutes and 1.861-2 through 1.861-7 of the regulations. Taxable income is determined by 861(b) of the statutes, and the corresponding regulations in 1.861-8. These regulations are predictably entitled "Computation of taxable income from sources within the United States and from other sources and activities," and reiterate the point:

"Sections 861(b) and 863(a) state in general terms how to determine taxable income of a taxpayer from sources within the United States after gross income from sources within the United States has been determined." [26 CFR § 1.861-8]

In the regulations under Section 863 (concerning income from sources inside and outside the U.S.), the following is stated:

"Determination of taxable income. The taxpayer's taxable income from sources within or without the United States will be determined under the rules of Secs. 1.861-8 through 1.861-14T for determining taxable income from sources within the United States." [26 CFR § 1.863-1(c)]

(The vast majority of tax professionals do not use these sections to determine taxable income from sources within the United States. At this point, the average citizen reading this report may guess that there must be some "context," or some other section, or something somewhere which would justify the tax professionals blatantly disregarding and disobeying the clear language used in the citations shown above. There is not.)

Note how sections 1.861-8 and following of the regulations are identified as the sections "for determining taxable income from sources within the United States," as well as being the sections to be used whether the income is from sources within or without the United States. A similar structure occurs in the regulations under Section 862 (dealing with income from outside of the United States):

"(b) Taxable income. The taxable income from sources without the United States… shall be determined on the same basis as that used in Sec. 1.861-8 for determining the taxable income from sources within the United States." [26 CFR § 1.862-1]

Section 1.863-6 of the regulations (dealing with income from within a foreign country or federal possession) also identifies sections 1.861-1 through 1.863-5 as applying "[t]he principles… for determining the gross and the taxable income from sources within and without the United States." Over and over again it is shown that 26 USC § 861(b) of the statutes and 26 CFR § 1.861-8 of the regulations are to be used to determine the taxable income from sources within the United States.

(Question for Doubters #2: Are 26 USC § 861(b) and 26 CFR § 1.861-8 the sections to be used to determine taxable income from sources within the United States?)

6) Specific Sources

Section 861 of the statutes uses general language that at first seems to apply to all income coming from within the United States, by saying "The following items of gross income shall be treated as income from sources within the United States:" The section then lists similar "items" of income to those listed in Section 61 (while specifying that they are coming from within the United States). As with Section 61, it is easy to misconstrue this list of "items" as being a list of "sources," which it is not. The regulations related to Section 861 contradict this possible misinterpretation. (And, as will be shown later, the older regulations and statutes make the correct application of the law crystal clear.)

The regulations in Section 1.861-8 begins by saying that Section 861(b) of the statutes describes "in general terms" how to determine taxable income from sources within the United States. These same regulations later specify that Section 861 is about items of income derived from "specific sources."

"(ii) Relationship of sections 861, 862, 863(a), and 863(b). Sections 861, 862, 863(a), and 863(b) are the four provisions applicable in determining taxable income from specific sources." [26 CFR § 1.861-8(f)(3)(ii)]

In the first paragraph of Section 1.861-8 of the regulations (the section "for determining taxable income from sources within the United States"), it is again made clear that the section applies only to the listed "items" of income when derived from "specific sources."

"The rules contained in this section apply in determining taxable income of the taxpayer from specific sources and activities…" [26 CFR § 1.861-8(a)]

Again, a few paragraphs later, in defining the term "statutory grouping," these regulations again state that taxable income must come from a "specific source."

"…the term ‘statutory grouping’ means the gross income from a specific source or activity which must first be determined in order to arrive at ‘taxable income’ from which specific source or activity…" [26 CFR § 1.861-8(a)(4)]

In 26 CFR § 1.861-8(f)(1) it is again made clear that Section 1.861-8 (the section "for determining taxable income from sources within the United States") is applicable only to income derived from "specific sources."

"…the determination of taxable income of the taxpayer from specific sources or activities and which gives rise to statutory groupings [see previous citation] to which this section is applicable…" [26 CFR § 1.861-8(f)(1)]

From these it is clear that the term "source" as used in Sections 61 and 861 does not simply mean any activity from which income is derived. If it did, there would be no need for Section 861 and following, and related regulations, to "determine the sources of income for purposes of the income tax." The following citations show that Section 1.861-8(f)(1) lists the "specific sources" of income subject to the income tax.

Again, the first paragraph of 26 CFR § 1.861-8 states the following (the meaning of "operative section" will be explained below):

"The rules contained in this section apply in determining taxable income of the taxpayer from specific sources and activities under other sections of the Code, referred to in this section as operative sections. See paragraph (f)(1) of this section for a list and description of operative sections." [26 CFR § 1.861-8(a)(1)]

The definition of "statutory grouping" (mentioned above) also refers to "paragraph (f)(1)" as the list of "specific sources."

"…the term ‘statutory grouping’ means the gross income from a specific source or activity which must first be determined in order to arrive at ‘taxable income’ from which specific source or activity under an operative section. (See paragraph (f)(1) of this section.)" [26 CFR § 1.861-8(a)(4)]

The regulations twice identify "paragraph (f)(1) of this section" (26 CFR § 1.861-8(f)(1)) as the list of specific sources. Paragraph (f)(1) itself confirms this again, and then lists the "specific sources" subject to the income tax:

"The operative sections of the Code which require the determination of taxable income of the taxpayer from specific sources or activities and which gives rise to statutory groupings to which this section is applicable include the sections described below.
(i) Overall limitation to the foreign tax credit…
(ii) [Reserved]
(iii) DISC and FSC taxable income… [international and foreign sales corporations]
(iv) Effectively connected taxable income. Nonresident alien individuals and foreign corporations engaged in trade or business within the United States…
(v) Foreign base company income…
(vi) Other operative sections. The rules provided in this section also apply in determining--
(A) The amount of foreign source items…
(B) The amount of foreign mineral income…
(C) [Reserved]
(D) The amount of foreign oil and gas extraction income…
(E) (deals with Puerto Rico tax credits)
(F) (deals with Puerto Rico tax credits)
(G) (deals with Virgin Islands tax credits)
(H) The income derived from Guam by an individual…
(I) (deals with China Trade Act corporations)
(J) (deals with foreign corporations)
(K) (deals with insurance income of foreign corporations)
(L) (deals with countries subject to international boycott)
(M) (deals with the Merchant Marine Act of 1936)" [26 CFR § 1.861-8(f)(1)]

None of these "sources" apply to United States citizens who live and work exclusively within the United States. (Federal "possessions," such as Guam, Puerto Rico, etc., are considered "foreign" under the law.) This is the only list of "sources" in Part I of Subchapter N, or the regulations thereunder, which (as the regulations say) "determine the sources of income for purposes of the income tax."

The next subsection (1.861-8(g)) gives examples about how 26 CFR § 1.861-8 works, and states that "[i]n each example, unless otherwise specified, the operative section which is applied and gives rise to the statutory grouping of gross income is the overall limitation to the foreign tax credit under section 904(a)," again showing that there must be some "operative section" in order for the section to apply, and in order for there to be taxable income.

So, to review, the sections which "determine the sources of income for purposes of the income tax" (namely, 861 and following and related regulations) apply only to income from the "specific sources" listed in 26 CFR § 1.861-8(f)(1). Most people do not receive income from these "sources of income for purposes of the income tax," and most people do not, therefore, receive "income from whatever source derived" (the general definition of "gross income") subject to the income tax.

(Question for Doubters #3: Under 26 USC § 861 and 26 CFR § 1.861-8, is income taxable only if derived from "specific sources" related to international and foreign commerce (including federal possessions)?)

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