"Taxable Income" by Larken Rose pg 2(Page 2 of 6)7) Operative SectionsThe earlier sections of Title 26 (26 USC 61 and following) deal with types of income that may be taxable (such as compensation for services). However, these sections do not specify where the transaction is taking place, or who is receiving the income. Obviously not everyone on earth who receives "compensation for services" is taxable under U.S. law. A separate part of the law, found in Subchapter N, deals with what types of commerce generate taxable income. Subchapter N is entitled "Tax based on income from sources within or without the United States." As the title suggests, this subchapter explains when income from within or without the United States is subject to the income tax. But on examining Subchapter N, it is readily apparent that it relates only to international and foreign commerce, but not to citizens who receive all of their income from within the 50 states. This can be seen by the titles of the five "Parts" of Subchapter N, which are "Source rules and other general rules relating to foreign income" (Part I), "Nonresident aliens and foreign corporations" (Part II), "Income from sources without [outside of] the United States" (Part III), "Domestic international sales corporations" (Part IV), and "International boycott determinations" (Part V). The statutes of Part I of Subchapter N (beginning with 26 USC § 861) give general rules about "within" and "without," but the regulations thereunder make it quite clear that these rules apply only to the taxable activities described throughout the other "Parts" of Subchapter N. "(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)]This term "specific sources" is used in three other places in the regulations, every one of which specifically refers to taxable activities described in the "operative sections" of the statutes throughout Subchapter N (which are listed in 1.861-8(f)(1) of the regulations). In other words, while the regulations list the taxable activities all in one place (26 CFR § 1.861-8(f)(1), the statutes describe those taxable activities in numerous sections throughout all of Subchapter N. The "specific sources" listed in the regulations each refer specifically to sections of the statutes (called "operative sections") describing those activities. For example, item "(iv)" on the list in 1.861-8(f)(1) specifically refers to sections 871(b)(1) and 882(a)(1) of the statutes, which state the following:"A nonresident alien individual engaged in trade or business within the United States… shall be taxable as provided in section 1…" [26 USC § 871(b)(1)]"A foreign corporation engaged in trade or business within the United States… shall be taxable as provided in section 11…" [26 USC § 882(a)(1)] (Section 11 imposes the income tax on corporations, while Section 1 imposes it on individuals) Here the statutes state that these specific activities (or "sources") may produce taxable income. If an "item" of income (such as compensation for services) derives from the activity described in this "operative section," that income is subject to the income tax. The "shall be taxable" phrase would be entirely unnecessary if "from whatever source derived" had the broad meaning that the usual (and incorrect) interpretation of the law gives it. There is no such "shall be taxable" phrase, nor any "operative section" describing an activity in which a United States citizen living and working exclusively within the 50 states receives income from within the 50 states. The regulations under Section 861 make it clear that the "items" of income must derive from a taxable source or activity described in an "operative section" of the statutes in order to be taxable. Other income does not legally constitute "income from whatever source derived." The following analogy may help to clarify the matter of "items" of income and "sources" of income. Suppose that there was a law imposing a tax on "Zonkos," and that the law defined "Zonkos" as "all toys from whatever store derived, including the following toys: plastic cars, dolls, yoyos," etc. Then the law stated that another section "determines the stores for purposes of the Zonko tax," and that section listed "Bob’s Toys," "Toy City," and "ToyWorld" as "toy stores." In this example, there would be two distinct aspects of the term "Zonko": whether an item is a taxable "toy," and whether it comes from a taxable "store." Both criteria would have to be met for it to legally constitute a "Zonko." For example, a baby bottle bought at ToyWorld would not be a "Zonko" (even though it came from a "store"), if baby bottles are not within the legal definition of "toys." Also, a doll bought from "Chuck’s Bargain Basement" also would not be a "Zonko" (even though it is a "toy"), as it did not come from something within the legal meaning of "store." A yoyo from Toyworld would be a "Zonko" as it is both a "toy" and comes from a "store."Similarly, if an "item" of income (such as dividends) does not come from a taxable "source" or activity (such as a foreign corporation doing business within the United States), it does not constitute "gross income." While the law goes to great length to specify which "items" of income may be included in "gross income," the other condition must still be met in order for those items to be taxable: they must derive from a taxable "source" or activity under an "operative section" of Subchapter N (as explained in Section 1.861-8(f)(1) of the regulations). (Note that the definition of "gross income" includes both criteria: "all income from whatever source derived.")8) Summary of Current LawThe current statutes and regulations show the correct, limited application of the "income tax" imposed by 26 USC § 1, which is in conflict with what the public generally believes regarding the matter. To summarize,26 USC § 1 imposes the income tax on "taxable income."26 USC § 63 defines "taxable income" generally as "gross income" minus deductions.26 USC § 61 defines "gross income" generally as income "from whatever source derived."26 USC §§ 861 - 865, and related regulations, determine the taxable "sources of income."26 CFR § 1.861-8 shows that the taxable "sources of income" apply only to those engaged in international or foreign commerce (including commerce within federal possessions). 9) Taxing PowerWhile the current statutes and regulations document the limited application of the federal income tax, it is important to explain the reason why such a limit exists. Without an explanation of why the law is as it is, the conclusion may be unbelievable to some (regardless of the actual evidence). Certainly the limitation was not due to Congress not wanting to tax all income. Without some obstacle to Congress’ power, the tax which most people now believe exists (a tax on the income of most Americans) would certainly have been imposed. According to the Supreme Court, the broad and general wording which Congress used to define "gross income" was intended to tax all income within their power to tax."This Court has frequently stated that this language [defining "gross income"] was used by Congress to exert in this field ‘the full measure of its taxing power.’" [Commissioner v. Glenshaw Class Co., 348 U.S. 426 (1955)]This ruling is speaking specifically of Section 22(a) of the Internal Revenue Code of 1939, which is the predecessor to the current 26 USC § 61. Congress has stated that the scope of "gross income" did not change when the law was rearranged and reworded. (It should be mentioned that the current tax code is basically just the income tax of 1913, but with many amendments over the years adding, removing, rewording, and renumbering various sections. The fundamental nature and origin of the tax remains intact.)The general language of the definition of "gross income" (past and present) may give an initial impression of an unlimited tax on the income of every individual. However, the meaning of a statute passed by Congress is limited to those matters which the Constitution puts under federal jurisdiction. "It is elementary law that every statute is to be read in the light of the constitution. However broad and general its language, it cannot be interpreted as extending beyond those matters which it was within the constitutional power of the legislature to reach." [McCullough v. Com. Of Virginia, 172 U.S. 102 (1898)](Notice that this is not some radical decision, but is considered "elementary law.")In other words, a statute may be more restricted that its general wording suggests. The above case goes on to say that Constitutional restrictions are to be assumed when reading a statute (state or federal), even though they are not stated. "So, although general language was introduced into the statute of 1871, it is not to be read as reaching to matters in respect to which the legislature had no constitutional power, but only as to those matters within its control. And, if there were, as it seems there were, certain special taxes and dues, which, under the existing provisions of the state constitution, could not be affected by legislative action, the statute is to be read as though it in terms excluded them from its operation." [McCullough v. Com. Of Virginia, 172 U.S. 102 (1898)]So a federal statute is to be read as though it specifically excludes matters which the Constitution does not put under federal jurisdiction. So while, as the Supreme Court said, Congress intended to use the "full measure of its taxing power" by using such a generally-worded definition of "gross income," the Supreme Court also admits that the income tax "cannot be applied to any income which Congress has no power to tax" [William E. Peck & Co. v. Lowe, 247 U.S. 165 (1918)]. So the general wording must be interpreted in light of the Constitutional limits on Congress’ power. But this could pose a problem for the average citizen. How is he to know what the Constitutional limits are on Congress’ power (when even federal judges disagree with each other on the matter)? As mentioned at the beginning of this report, the Secretary of the Treasury is empowered (by statute) to implement and interpret the law. When the Treasury regulations are published in the Federal Register, that becomes the official notice to the public of what the law requires. Therefore, while the statutes may use general language (which might at first glance seem to include matters outside of federal jurisdiction), the regulations must give specifics. Though it is phrased somewhat differently than the current 26 USC § 61, the definition of "gross income" found in Section 22(a) of the 1939 Code appears all-encompassing. The regulations under the 1939 Code, however, are very telling. (The term "net income" was used back then, which would later become "taxable income.")"Sec. 29.21-1. Meaning of net income. The tax imposed by chapter 1 is upon income. Neither income exempted by statute or fundamental law... enter into the computation of net income as defined by section 21."The term "fundamental law" refers to the Constitution (as countless court rulings show). While the general wording of the statutes makes no such reference, here the regulations imply that some income not exempted by statute is nonetheless exempt from taxation under the Constitution. Note the distinction between income exempted by statute, and income exempted by the Constitution. This occurs again later in the same section:"(b) Gross income, meaning income (in the broad sense) less income which is by statutory provision or otherwise exempt from the tax imposed by chapter 1. (See section 22.)"Again, the regulations are admitting that some things not exempted by statute are nonetheless exempt from federal taxation. The above citation refers us to Section 22 (of the 1939 Code) for the meaning of "gross income." The regulations under that section begin as follows:"Sec. 29.22(a)-1. What included in gross income.Gross income includes in general [items of income listed] derived from any source whatever, unless exempt from tax by law. (See section 22(b) and 116.)"This refers the reader to Section 22(b) to learn what income is "exempt from tax." After saying that certain items are specifically exempted by statute, the regulations under section 22(b) (referred to in the previous citation) state:"No other items are exempt from gross income except (1) those items of income which are, under the Constitution, not taxable by the Federal Government; (2) those items of income which are exempt from tax on income under the provisions of any Act of Congress still in effect; and (3) the income exempted under the provisions of section 116."Again the regulations explicitly state that some income is not constitutionally taxable, even though it is not specifically exempted by any statute passed by Congress. The statutes need not mention this, because (as shown above), the Constitutional limitations are to be assumed when reading any statute. But because the regulations must give specifics, the fact that some income not exempt by statute is exempted by the Constitution is specifically stated in the regulations. (Many tax professionals are at a loss to explain this; they are unable to identify anything which is not taxable under the constitution, but which is not exempted by statute.)(Question for Doubters #4: What types of income not exempted by statute are nonetheless, under the Constitution, not taxable by the federal government?)10) Constitutional LimitsAt this point it is reasonable to consider what types of income might be (as the older regulations state) "under the Constitution, not taxable by the Federal Government." While the public seems largely ignorant of this fact, Congress has legal power over only those few matters which the Constitution puts under federal jurisdiction (and the Tenth Amendment clearly states this). Within the 50 states, Congress has legal control over only those matters listed in Article I, Section 8 of the Constitution. "We start with first principles. The Constitution creates a Federal Government of enumerated powers. See U.S. Const., Art. I, 8. As James Madison wrote, "[t]he powers delegated by the proposed Constitution to the federal government are few and defined. Those which are to remain in the State governments are numerous and indefinite." The Federalist No. 45, pp. 292-293 (C. Rossiter ed. 1961)." [United States v. Lopez, 514 U.S. 549 (1995)]In the 1995 case cited above, the Supreme Court threw out the "Gun Free School Zone" law (18 USC § 922(q)) as unconstitutional, on the grounds that it was outside of Congress’ enumerated powers described in Article I, Section 8. Not only did the court say this, but the lawyers on the other side tried to argue that the law was about regulating "interstate commerce" (which Article I, Section 8 puts under federal jurisdiction), demonstrating that they agreed that the law had to be based on something in Article I, Section 8. Article I, Section 8 does include the "power to lay and collect taxes," but does not say what may be taxed by Congress. This allows for two options. The first option is that there are essentially no limitations on what Congress can tax (though there are certain rules on how "direct" and "indirect" taxes must be imposed). The problem with this option is that it would essentially negate the entire Constitution, as this option would give Congress the jurisdiction and power to control anything and everything, provided it exerted that control through tax legislation. For example, if this option were true, in response to the Lopez decision mentioned above, Congress could simply impose a $1,000,000 tax on carrying a firearm near a school, to get around the restriction that would otherwise exist. The Supreme Court seems to agree that this option cannot be. The court said that they could not allow Congress to control by tax legislation matters which they have no jurisdiction to regulate. (Congress was attempting, in this case, to control "child labor" within the states through tax legislation.) The Supreme Court said the following:"Grant the validity of this law, and all that Congress would need to do, hereafter, in seeking to take over to its control any one of the great number of subjects of public interest, jurisdiction of which the states have never parted with, and which are reserved to them by the Tenth Amendment, would be to enact a detailed measure of complete regulation of the subject and enforce it by a socalled tax upon departures from it. To give such magic to the word 'tax' would be to break down all constitutional limitation of the powers of Congress and completely wipe out the sovereignty of the states." [Bailey v. Drexel Furniture Co., 259 U.S. 20 (1922)]In the same year, the court also ruled on the Future Trading Act, which imposed a tax "on all contracts for the sale of grain for future delivery." The court quoted the citation above, and immediately afterward said this:"This has complete application to the act before us, and requires us to hold that the provisions of the act we have been discussing cannot be sustained as an exercise of the taxing power of Congress conferred by section 8, article 1." [Hill v. Wallace, 259 U.S. 44 (1922)]Clearly the court saw that Congress’ power to lay and collect taxes does not grant unlimited jurisdiction over everything within the states. To ignore the limits of federal jurisdiction when reading the taxation clause would lead to concluding that Congress can control everything by tax legislation. (In fact, this reading would also mean that Congress has the power to tax everyone in China, since the taxing clause does not mention geographical jurisdiction either.) The second option is that "the power to lay and collect taxes" applies only to matters otherwise under federal jurisdiction. For example, Article I, Section 8 specifically puts international commerce under federal jurisdiction, and Article IV, Section 3 gives Congress control of federal possessions. However, "intrastate" commerce (commerce that happens entirely within a single state) is not under federal jurisdiction. So the power to tax, together with the clauses giving Congress jurisdiction over international commerce, and commerce within federal possessions, would give Congress the power to tax income from international commerce, and income from federal possessions. The Supreme Court made an interesting comment in 1918 related to this. The case concerned the income tax act of 1913 (which is the basis of the current tax), and how it applied to a domestic corporation in the business of buying things in the states and selling them in foreign countries. The corporation was arguing that the tax in this case violated the provision of the Constitution which forbids the federal government from taxing exports from any state. "[T]he act obviously could not impose a tax forbidden by the Constitution... The Constitution broadly empowers Congress not only 'to lay and collect taxes, duties, imposts, and excises,' but also ‘to regulate commerce with foreign nations.’ So, if the prohibitory clause [meaning the clause forbidding taxes on exports from states] invoked by the plaintiff be not in the way, Congress undoubtedly has power to lay and collect such a tax as is here in question." [William E. Peck & Co. v. Lowe, 247 U.S. 165 (1918)]In other words, if not for the question about whether this was a tax on state exports, this income would be taxable because Congress is given the general power "to lay and collect taxes," and is given specific jurisdiction over "regulat[ing] commerce with foreign nations." The court obviously thought the second clause was relevant to whether Congress could tax such income. The courts have long argued over the concept that "the power to tax is the power to destroy," meaning that the ability to tax something implies the ability to regulate it or to forbid it entirely. This conversely implies that if a government has no jurisdiction to regulate or forbid an activity, then it also has no jurisdiction to tax that activity. There are numerous Supreme Court cases dealing with the concept. "[N]o state has the right to lay a tax on interstate commerce in any form... and the reason is that such taxation is a burden on that commerce, and amounts to a regulation of it, which belongs solely to congress. This is the result of so many recent cases that citation is hardly necessary." [Leloup v. Port of Mobile, 127 U.S. 640 (1888)]In this case the court is stating the restrictions on what a state can tax, but the underlying logic is clear. Taxing commerce is a burden on that commerce, and amounts to a regulation of commerce. While Congress is authorized to regulate interstate commerce (commerce crossing state lines) and international commerce, it has no jurisdiction over intrastate commerce (commerce occurring entirely within a single state). By the simple logic above, that means Congress cannot tax income from intrastate commerce. "No interference by Congress with the business of citizens transacted within a state is warranted by the Constitution, except such as is strictly incidental to the exercise of powers clearly granted to the legislature." [License Tax Cases, 72 U.S. 462 (1866)]It is true that the opinions of the courts have fluctuated significantly on this, from saying that the power to tax requires the power to regulate, to saying that Congress may tax things it cannot regulate, provided that taxation does not amount to regulation under the guise of a "tax." But considering the massively complex "social engineering" in the income tax laws (punishing some behaviors and rewarding others) it would be difficult to argue that it would not constitute an attempt to regulate behavior. However, the courts’ position on the matter is ultimately irrelevant. Regardless of what the courts think Congress could tax, the statutes and regulations show what Congress did tax. Whether the courts think Congress has the constitutional power to tax the income of all Americans is only relevant if Congress attempts to impose such a tax, which has not occurred. (The courts cannot expand the scope of a tax just by saying that Congress could have taxed more if they had wanted to.)Brief mention should be made of the 16th Amendment to the Constitution, since there is a common but erroneous belief that the 16th Amendment expanded Congress’ power to tax incomes. The purpose of the 16th Amendment, according to the Supreme Court in Brushaber v. Union Pacific (240 U.S. 1), and again in Stanton v. Baltic Mining (240 U.S. 103) was to make it clear that the income tax is, and has always been, an indirect "excise" tax, which never required apportionment. The Secretary of the Treasury agreed with the Court in Treasury Decision 2303:"The Sixteenth Amendment. The provisions of the sixteenth amendment conferred no new power of taxation, but simply prohibited [Congress’ original power to tax incomes] from being taken out of the category of indirect taxation, to which it inherently belonged, and being placed in the category of direct taxation subject to apportionment." [Treasury Decision 2303]An in-depth explanation of direct and indirect taxes, and how they must be imposed, is not necessary here. The only relevant point is that Congress’ taxing jurisdiction was not expanded by the 16th Amendment. (Question for Doubters #5: Under Article I, Section 8 (first clause) of the Constitution, can Congress control anything and everything within the 50 states, provided that that control is exerted through tax legislation?)11) Exempt IncomeThe above issue of Constitutional limits on Congress’ taxing power is not intended to dispute the constitutionality of the income tax. In fact, the opinion of this author, the readers, and even the courts regarding the question of taxing jurisdiction ends up being irrelevant in this case. The statutes of Congress, together with the regulations of the Secretary of the Treasury (which must also be approved by Congress), show that they believe their jurisdiction to tax incomes was limited to individuals involved in international and foreign commerce. ("International commerce" means trade which crosses country borders, such as income from within the United States going to nonresident aliens. "Foreign commerce" means trade which happens entirely outside of the United States, such as a U.S. citizen working and getting paid in a foreign country, or in a federal possession.)As discussed above, the regulations under 22(a) of the 1939 Code show that the meaning of "gross income" does not include income which is exempt by statute, or other income which is "under the Constitution, not taxable by the Federal Government." But, as stated before, the regulations must specifically inform the public of what is required, rather than leaving people to guess at what is Constitutionally taxable. The following is the first paragraph of the 1945 regulations under the section of statutes defining "gross income":"39.22(a)-1 What included in gross income (a) Gross income includes in general [items of income listed] derived from any source whatever, unless exempt from tax by law. See sections 22(b) and 116. [the regulations under the cited section states that some income not exempted by statute is "under the Constitution, not taxable by the Federal Government"] In general, income [not "gross income"] is the gain derived from capital, from labor, or from both combined, provided it be understood to include profit gained through a sale or conversion of capital assets. Profits of citizens, residents, or domestic corporations derived from sales in foreign commerce must be included in their gross income; but special provisions are made for nonresident aliens and foreign corporations by sections 211 to 238, inclusive, and, in certain cases, by section 251, for citizens and domestic corporations deriving income from sources within possessions of the United States. Income may be in the form of cash or of property." [items of income listed] derived from any source whatever, unless exempt from tax by law. See sections 22(b) and 116. [the regulations under the cited section states that some income not exempted by statute is "under the Constitution, not taxable by the Federal Government"] In general, income [not "gross income"] is the gain derived from capital, from labor, or from both combined, provided it be understood to include profit gained through a sale or conversion of capital assets. Profits of citizens, residents, or domestic corporations derived from sales in foreign commerce must be included in their gross income; but special provisions are made for nonresident aliens and foreign corporations by sections 211 to 238, inclusive, and, in certain cases, by section 251, for citizens and domestic corporations deriving income from sources within possessions of the United States. Income may be in the form of cash or of property."Keeping in mind the matter of taxing jurisdiction, it becomes clear that the Secretary of the Treasury in these regulations was informing the public of which matters are constitutionally taxable by the federal government. This list of taxable activities is completely absent from 22(a) of the 1939 statutes. As the Supreme Court has stated, "the statute is to be read as though it in terms exclude[s]" matters not within the constitutional power of the government to tax. At the same time, the regulations must give specifics to the public of what the law requires, and here they do so. Not surprisingly, the list of taxable activities in these regulations matches precisely those matters which the Constitution puts under federal jurisdiction (international and foreign commerce, and federal possessions). Anyone claiming that this list of taxable activities is not exclusive (claiming instead that other types of income are also taxable) encounters a logical problem. One must then claim that the regulations specifically say that some income not exempt by statute is exempt under the Constitution, but that those regulations never give any indication as to what income is meant. If this list is not the explanation of what is constitutionally taxable, then no further explanation seems to exist (which would violate the requirement that the regulations specifically state what the law requires). In addition, one would be hard pressed to explain why these regulations bother to specifically point out these taxable activities (when the statutes do not), if this is not a complete list of what the Secretary believed to be constitutionally taxable. While the regulations specifically mention the Constitutional limitations, and the limits are to be assumed when reading the statutes, this is not to say that the statutes give no indication of the limited nature of the tax. While the general statutory definition of "gross income" by itself may be misleading, there is plenty of evidence in the statutes that shows that Congress knew the limits of its power, and stayed within those bounds. Most notably, the entire structure and contents of Subchapter N ("Tax based on income from sources within or without the United States") indicates that it is about international and foreign commerce.

"Taxable Income"
by Larken Rose
(Page 2 of 6)

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7) Operative Sections

The earlier sections of Title 26 (26 USC 61 and following) deal with types of income that may be taxable (such as compensation for services). However, these sections do not specify where the transaction is taking place, or who is receiving the income. Obviously not everyone on earth who receives "compensation for services" is taxable under U.S. law. A separate part of the law, found in Subchapter N, deals with what types of commerce generate taxable income.

Subchapter N is entitled "Tax based on income from sources within or without the United States." As the title suggests, this subchapter explains when income from within or without the United States is subject to the income tax. But on examining Subchapter N, it is readily apparent that it relates only to international and foreign commerce, but not to citizens who receive all of their income from within the 50 states. This can be seen by the titles of the five "Parts" of Subchapter N, which are "Source rules and other general rules relating to foreign income" (Part I), "Nonresident aliens and foreign corporations" (Part II), "Income from sources without [outside of] the United States" (Part III), "Domestic international sales corporations" (Part IV), and "International boycott determinations" (Part V).

The statutes of Part I of Subchapter N (beginning with 26 USC § 861) give general rules about "within" and "without," but the regulations thereunder make it quite clear that these rules apply only to the taxable activities described throughout the other "Parts" of Subchapter N.

"(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)]

This term "specific sources" is used in three other places in the regulations, every one of which specifically refers to taxable activities described in the "operative sections" of the statutes throughout Subchapter N (which are listed in 1.861-8(f)(1) of the regulations). In other words, while the regulations list the taxable activities all in one place (26 CFR § 1.861-8(f)(1), the statutes describe those taxable activities in numerous sections throughout all of Subchapter N. The "specific sources" listed in the regulations each refer specifically to sections of the statutes (called "operative sections") describing those activities. For example, item "(iv)" on the list in 1.861-8(f)(1) specifically refers to sections 871(b)(1) and 882(a)(1) of the statutes, which state the following:

"A nonresident alien individual engaged in trade or business within the United States… shall be taxable as provided in section 1…" [26 USC § 871(b)(1)]

"A foreign corporation engaged in trade or business within the United States… shall be taxable as provided in section 11…" [26 USC § 882(a)(1)] (Section 11 imposes the income tax on corporations, while Section 1 imposes it on individuals)

Here the statutes state that these specific activities (or "sources") may produce taxable income. If an "item" of income (such as compensation for services) derives from the activity described in this "operative section," that income is subject to the income tax. The "shall be taxable" phrase would be entirely unnecessary if "from whatever source derived" had the broad meaning that the usual (and incorrect) interpretation of the law gives it.

There is no such "shall be taxable" phrase, nor any "operative section" describing an activity in which a United States citizen living and working exclusively within the 50 states receives income from within the 50 states. The regulations under Section 861 make it clear that the "items" of income must derive from a taxable source or activity described in an "operative section" of the statutes in order to be taxable. Other income does not legally constitute "income from whatever source derived."

The following analogy may help to clarify the matter of "items" of income and "sources" of income. Suppose that there was a law imposing a tax on "Zonkos," and that the law defined "Zonkos" as "all toys from whatever store derived, including the following toys: plastic cars, dolls, yoyos," etc. Then the law stated that another section "determines the stores for purposes of the Zonko tax," and that section listed "Bob’s Toys," "Toy City," and "ToyWorld" as "toy stores."

In this example, there would be two distinct aspects of the term "Zonko": whether an item is a taxable "toy," and whether it comes from a taxable "store." Both criteria would have to be met for it to legally constitute a "Zonko." For example, a baby bottle bought at ToyWorld would not be a "Zonko" (even though it came from a "store"), if baby bottles are not within the legal definition of "toys." Also, a doll bought from "Chuck’s Bargain Basement" also would not be a "Zonko" (even though it is a "toy"), as it did not come from something within the legal meaning of "store." A yoyo from Toyworld would be a "Zonko" as it is both a "toy" and comes from a "store."

Similarly, if an "item" of income (such as dividends) does not come from a taxable "source" or activity (such as a foreign corporation doing business within the United States), it does not constitute "gross income." While the law goes to great length to specify which "items" of income may be included in "gross income," the other condition must still be met in order for those items to be taxable: they must derive from a taxable "source" or activity under an "operative section" of Subchapter N (as explained in Section 1.861-8(f)(1) of the regulations). (Note that the definition of "gross income" includes both criteria: "all income from whatever source derived.")

8) Summary of Current Law

The current statutes and regulations show the correct, limited application of the "income tax" imposed by 26 USC § 1, which is in conflict with what the public generally believes regarding the matter.

To summarize,

26 USC § 1 imposes the income tax on "taxable income."
26 USC § 63 defines "taxable income" generally as "gross income" minus deductions.
26 USC § 61 defines "gross income" generally as income "from whatever source derived."
26 USC §§ 861 - 865, and related regulations, determine the taxable "sources of income."
26 CFR § 1.861-8 shows that the taxable "sources of income" apply only to those engaged in international or foreign commerce (including commerce within federal possessions).

9) Taxing Power

While the current statutes and regulations document the limited application of the federal income tax, it is important to explain the reason why such a limit exists. Without an explanation of why the law is as it is, the conclusion may be unbelievable to some (regardless of the actual evidence). Certainly the limitation was not due to Congress not wanting to tax all income. Without some obstacle to Congress’ power, the tax which most people now believe exists (a tax on the income of most Americans) would certainly have been imposed.

According to the Supreme Court, the broad and general wording which Congress used to define "gross income" was intended to tax all income within their power to tax.

"This Court has frequently stated that this language [defining "gross income"] was used by Congress to exert in this field ‘the full measure of its taxing power.’"
[Commissioner v. Glenshaw Class Co., 348 U.S. 426 (1955)]

This ruling is speaking specifically of Section 22(a) of the Internal Revenue Code of 1939, which is the predecessor to the current 26 USC § 61. Congress has stated that the scope of "gross income" did not change when the law was rearranged and reworded. (It should be mentioned that the current tax code is basically just the income tax of 1913, but with many amendments over the years adding, removing, rewording, and renumbering various sections. The fundamental nature and origin of the tax remains intact.)

The general language of the definition of "gross income" (past and present) may give an initial impression of an unlimited tax on the income of every individual. However, the meaning of a statute passed by Congress is limited to those matters which the Constitution puts under federal jurisdiction.

"It is elementary law that every statute is to be read in the light of the constitution. However broad and general its language, it cannot be interpreted as extending beyond those matters which it was within the constitutional power of the legislature to reach." [McCullough v. Com. Of Virginia, 172 U.S. 102 (1898)]

(Notice that this is not some radical decision, but is considered "elementary law.")

In other words, a statute may be more restricted that its general wording suggests. The above case goes on to say that Constitutional restrictions are to be assumed when reading a statute (state or federal), even though they are not stated.

"So, although general language was introduced into the statute of 1871, it is not to be read as reaching to matters in respect to which the legislature had no constitutional power, but only as to those matters within its control. And, if there were, as it seems there were, certain special taxes and dues, which, under the existing provisions of the state constitution, could not be affected by legislative action, the statute is to be read as though it in terms excluded them from its operation."
[McCullough v. Com. Of Virginia, 172 U.S. 102 (1898)]

So a federal statute is to be read as though it specifically excludes matters which the Constitution does not put under federal jurisdiction. So while, as the Supreme Court said, Congress intended to use the "full measure of its taxing power" by using such a generally-worded definition of "gross income," the Supreme Court also admits that the income tax "cannot be applied to any income which Congress has no power to tax" [William E. Peck & Co. v. Lowe, 247 U.S. 165 (1918)]. So the general wording must be interpreted in light of the Constitutional limits on Congress’ power. But this could pose a problem for the average citizen. How is he to know what the Constitutional limits are on Congress’ power (when even federal judges disagree with each other on the matter)?

As mentioned at the beginning of this report, the Secretary of the Treasury is empowered (by statute) to implement and interpret the law. When the Treasury regulations are published in the Federal Register, that becomes the official notice to the public of what the law requires. Therefore, while the statutes may use general language (which might at first glance seem to include matters outside of federal jurisdiction), the regulations must give specifics.

Though it is phrased somewhat differently than the current 26 USC § 61, the definition of "gross income" found in Section 22(a) of the 1939 Code appears all-encompassing. The regulations under the 1939 Code, however, are very telling. (The term "net income" was used back then, which would later become "taxable income.")

"Sec. 29.21-1. Meaning of net income. The tax imposed by chapter 1 is upon income. Neither income exempted by statute or fundamental law... enter into the computation of net income as defined by section 21."

The term "fundamental law" refers to the Constitution (as countless court rulings show). While the general wording of the statutes makes no such reference, here the regulations imply that some income not exempted by statute is nonetheless exempt from taxation under the Constitution. Note the distinction between income exempted by statute, and income exempted by the Constitution. This occurs again later in the same section:

"(b) Gross income, meaning income (in the broad sense) less income which is by statutory provision or otherwise exempt from the tax imposed by chapter 1. (See section 22.)"

Again, the regulations are admitting that some things not exempted by statute are nonetheless exempt from federal taxation. The above citation refers us to Section 22 (of the 1939 Code) for the meaning of "gross income." The regulations under that section begin as follows:

"Sec. 29.22(a)-1. What included in gross income.
Gross income includes in general [items of income listed] derived from any source whatever, unless exempt from tax by law. (See section 22(b) and 116.)"

This refers the reader to Section 22(b) to learn what income is "exempt from tax." After saying that certain items are specifically exempted by statute, the regulations under section 22(b) (referred to in the previous citation) state:

"No other items are exempt from gross income except (1) those items of income which are, under the Constitution, not taxable by the Federal Government; (2) those items of income which are exempt from tax on income under the provisions of any Act of Congress still in effect; and (3) the income exempted under the provisions of section 116."

Again the regulations explicitly state that some income is not constitutionally taxable, even though it is not specifically exempted by any statute passed by Congress. The statutes need not mention this, because (as shown above), the Constitutional limitations are to be assumed when reading any statute. But because the regulations must give specifics, the fact that some income not exempt by statute is exempted by the Constitution is specifically stated in the regulations. (Many tax professionals are at a loss to explain this; they are unable to identify anything which is not taxable under the constitution, but which is not exempted by statute.)

(Question for Doubters #4: What types of income not exempted by statute are nonetheless, under the Constitution, not taxable by the federal government?)

10) Constitutional Limits

At this point it is reasonable to consider what types of income might be (as the older regulations state) "under the Constitution, not taxable by the Federal Government." While the public seems largely ignorant of this fact, Congress has legal power over only those few matters which the Constitution puts under federal jurisdiction (and the Tenth Amendment clearly states this). Within the 50 states, Congress has legal control over only those matters listed in Article I, Section 8 of the Constitution.

"We start with first principles. The Constitution creates a Federal Government of enumerated powers. See U.S. Const., Art. I, 8. As James Madison wrote, "[t]he powers delegated by the proposed Constitution to the federal government are few and defined. Those which are to remain in the State governments are numerous and indefinite." The Federalist No. 45, pp. 292-293 (C. Rossiter ed. 1961)."
[United States v. Lopez, 514 U.S. 549 (1995)]

In the 1995 case cited above, the Supreme Court threw out the "Gun Free School Zone" law (18 USC § 922(q)) as unconstitutional, on the grounds that it was outside of Congress’ enumerated powers described in Article I, Section 8. Not only did the court say this, but the lawyers on the other side tried to argue that the law was about regulating "interstate commerce" (which Article I, Section 8 puts under federal jurisdiction), demonstrating that they agreed that the law had to be based on something in Article I, Section 8.

Article I, Section 8 does include the "power to lay and collect taxes," but does not say what may be taxed by Congress. This allows for two options. The first option is that there are essentially no limitations on what Congress can tax (though there are certain rules on how "direct" and "indirect" taxes must be imposed). The problem with this option is that it would essentially negate the entire Constitution, as this option would give Congress the jurisdiction and power to control anything and everything, provided it exerted that control through tax legislation. For example, if this option were true, in response to the Lopez decision mentioned above, Congress could simply impose a $1,000,000 tax on carrying a firearm near a school, to get around the restriction that would otherwise exist.

The Supreme Court seems to agree that this option cannot be. The court said that they could not allow Congress to control by tax legislation matters which they have no jurisdiction to regulate. (Congress was attempting, in this case, to control "child labor" within the states through tax legislation.) The Supreme Court said the following:

"Grant the validity of this law, and all that Congress would need to do, hereafter, in seeking to take over to its control any one of the great number of subjects of public interest, jurisdiction of which the states have never parted with, and which are reserved to them by the Tenth Amendment, would be to enact a detailed measure of complete regulation of the subject and enforce it by a socalled tax upon departures from it. To give such magic to the word 'tax' would be to break down all constitutional limitation of the powers of Congress and completely wipe out the sovereignty of the states."
[Bailey v. Drexel Furniture Co., 259 U.S. 20 (1922)]

In the same year, the court also ruled on the Future Trading Act, which imposed a tax "on all contracts for the sale of grain for future delivery." The court quoted the citation above, and immediately afterward said this:

"This has complete application to the act before us, and requires us to hold that the provisions of the act we have been discussing cannot be sustained as an exercise of the taxing power of Congress conferred by section 8, article 1."
[Hill v. Wallace, 259 U.S. 44 (1922)]

Clearly the court saw that Congress’ power to lay and collect taxes does not grant unlimited jurisdiction over everything within the states. To ignore the limits of federal jurisdiction when reading the taxation clause would lead to concluding that Congress can control everything by tax legislation. (In fact, this reading would also mean that Congress has the power to tax everyone in China, since the taxing clause does not mention geographical jurisdiction either.)

The second option is that "the power to lay and collect taxes" applies only to matters otherwise under federal jurisdiction. For example, Article I, Section 8 specifically puts international commerce under federal jurisdiction, and Article IV, Section 3 gives Congress control of federal possessions. However, "intrastate" commerce (commerce that happens entirely within a single state) is not under federal jurisdiction. So the power to tax, together with the clauses giving Congress jurisdiction over international commerce, and commerce within federal possessions, would give Congress the power to tax income from international commerce, and income from federal possessions.

The Supreme Court made an interesting comment in 1918 related to this. The case concerned the income tax act of 1913 (which is the basis of the current tax), and how it applied to a domestic corporation in the business of buying things in the states and selling them in foreign countries. The corporation was arguing that the tax in this case violated the provision of the Constitution which forbids the federal government from taxing exports from any state.

"[T]he act obviously could not impose a tax forbidden by the Constitution... The Constitution broadly empowers Congress not only 'to lay and collect taxes, duties, imposts, and excises,' but also ‘to regulate commerce with foreign nations.’ So, if the prohibitory clause [meaning the clause forbidding taxes on exports from states] invoked by the plaintiff be not in the way, Congress undoubtedly has power to lay and collect such a tax as is here in question."
[William E. Peck & Co. v. Lowe, 247 U.S. 165 (1918)]

In other words, if not for the question about whether this was a tax on state exports, this income would be taxable because Congress is given the general power "to lay and collect taxes," and is given specific jurisdiction over "regulat[ing] commerce with foreign nations." The court obviously thought the second clause was relevant to whether Congress could tax such income.

The courts have long argued over the concept that "the power to tax is the power to destroy," meaning that the ability to tax something implies the ability to regulate it or to forbid it entirely. This conversely implies that if a government has no jurisdiction to regulate or forbid an activity, then it also has no jurisdiction to tax that activity. There are numerous Supreme Court cases dealing with the concept.

"[N]o state has the right to lay a tax on interstate commerce in any form... and the reason is that such taxation is a burden on that commerce, and amounts to a regulation of it, which belongs solely to congress. This is the result of so many recent cases that citation is hardly necessary." [Leloup v. Port of Mobile, 127 U.S. 640 (1888)]

In this case the court is stating the restrictions on what a state can tax, but the underlying logic is clear. Taxing commerce is a burden on that commerce, and amounts to a regulation of commerce. While Congress is authorized to regulate interstate commerce (commerce crossing state lines) and international commerce, it has no jurisdiction over intrastate commerce (commerce occurring entirely within a single state). By the simple logic above, that means Congress cannot tax income from intrastate commerce.

"No interference by Congress with the business of citizens transacted within a state is warranted by the Constitution, except such as is strictly incidental to the exercise of powers clearly granted to the legislature." [License Tax Cases, 72 U.S. 462 (1866)]

It is true that the opinions of the courts have fluctuated significantly on this, from saying that the power to tax requires the power to regulate, to saying that Congress may tax things it cannot regulate, provided that taxation does not amount to regulation under the guise of a "tax." But considering the massively complex "social engineering" in the income tax laws (punishing some behaviors and rewarding others) it would be difficult to argue that it would not constitute an attempt to regulate behavior.

However, the courts’ position on the matter is ultimately irrelevant. Regardless of what the courts think Congress could tax, the statutes and regulations show what Congress did tax. Whether the courts think Congress has the constitutional power to tax the income of all Americans is only relevant if Congress attempts to impose such a tax, which has not occurred. (The courts cannot expand the scope of a tax just by saying that Congress could have taxed more if they had wanted to.)

Brief mention should be made of the 16th Amendment to the Constitution, since there is a common but erroneous belief that the 16th Amendment expanded Congress’ power to tax incomes. The purpose of the 16th Amendment, according to the Supreme Court in Brushaber v. Union Pacific (240 U.S. 1), and again in Stanton v. Baltic Mining (240 U.S. 103) was to make it clear that the income tax is, and has always been, an indirect "excise" tax, which never required apportionment. The Secretary of the Treasury agreed with the Court in Treasury Decision 2303:

"The Sixteenth Amendment. The provisions of the sixteenth amendment conferred no new power of taxation, but simply prohibited [Congress’ original power to tax incomes] from being taken out of the category of indirect taxation, to which it inherently belonged, and being placed in the category of direct taxation subject to apportionment." [Treasury Decision 2303]

An in-depth explanation of direct and indirect taxes, and how they must be imposed, is not necessary here. The only relevant point is that Congress’ taxing jurisdiction was not expanded by the 16th Amendment.

(Question for Doubters #5: Under Article I, Section 8 (first clause) of the Constitution, can Congress control anything and everything within the 50 states, provided that that control is exerted through tax legislation?)

11) Exempt Income

The above issue of Constitutional limits on Congress’ taxing power is not intended to dispute the constitutionality of the income tax. In fact, the opinion of this author, the readers, and even the courts regarding the question of taxing jurisdiction ends up being irrelevant in this case. The statutes of Congress, together with the regulations of the Secretary of the Treasury (which must also be approved by Congress), show that they believe their jurisdiction to tax incomes was limited to individuals involved in international and foreign commerce.

("International commerce" means trade which crosses country borders, such as income from within the United States going to nonresident aliens. "Foreign commerce" means trade which happens entirely outside of the United States, such as a U.S. citizen working and getting paid in a foreign country, or in a federal possession.)

As discussed above, the regulations under 22(a) of the 1939 Code show that the meaning of "gross income" does not include income which is exempt by statute, or other income which is "under the Constitution, not taxable by the Federal Government." But, as stated before, the regulations must specifically inform the public of what is required, rather than leaving people to guess at what is Constitutionally taxable. The following is the first paragraph of the 1945 regulations under the section of statutes defining "gross income":

"39.22(a)-1 What included in gross income (a) Gross income includes in general [items of income listed] derived from any source whatever, unless exempt from tax by law. See sections 22(b) and 116. [the regulations under the cited section states that some income not exempted by statute is "under the Constitution, not taxable by the Federal Government"] In general, income [not "gross income"] is the gain derived from capital, from labor, or from both combined, provided it be understood to include profit gained through a sale or conversion of capital assets. Profits of citizens, residents, or domestic corporations derived from sales in foreign commerce must be included in their gross income; but special provisions are made for nonresident aliens and foreign corporations by sections 211 to 238, inclusive, and, in certain cases, by section 251, for citizens and domestic corporations deriving income from sources within possessions of the United States. Income may be in the form of cash or of property." [items of income listed] derived from any source whatever, unless exempt from tax by law. See sections 22(b) and 116. [the regulations under the cited section states that some income not exempted by statute is "under the Constitution, not taxable by the Federal Government"] In general, income [not "gross income"] is the gain derived from capital, from labor, or from both combined, provided it be understood to include profit gained through a sale or conversion of capital assets. Profits of citizens, residents, or domestic corporations derived from sales in foreign commerce must be included in their gross income; but special provisions are made for nonresident aliens and foreign corporations by sections 211 to 238, inclusive, and, in certain cases, by section 251, for citizens and domestic corporations deriving income from sources within possessions of the United States. Income may be in the form of cash or of property."

Keeping in mind the matter of taxing jurisdiction, it becomes clear that the Secretary of the Treasury in these regulations was informing the public of which matters are constitutionally taxable by the federal government. This list of taxable activities is completely absent from 22(a) of the 1939 statutes. As the Supreme Court has stated, "the statute is to be read as though it in terms exclude[s]" matters not within the constitutional power of the government to tax. At the same time, the regulations must give specifics to the public of what the law requires, and here they do so. Not surprisingly, the list of taxable activities in these regulations matches precisely those matters which the Constitution puts under federal jurisdiction (international and foreign commerce, and federal possessions).

Anyone claiming that this list of taxable activities is not exclusive (claiming instead that other types of income are also taxable) encounters a logical problem. One must then claim that the regulations specifically say that some income not exempt by statute is exempt under the Constitution, but that those regulations never give any indication as to what income is meant. If this list is not the explanation of what is constitutionally taxable, then no further explanation seems to exist (which would violate the requirement that the regulations specifically state what the law requires).

In addition, one would be hard pressed to explain why these regulations bother to specifically point out these taxable activities (when the statutes do not), if this is not a complete list of what the Secretary believed to be constitutionally taxable.

While the regulations specifically mention the Constitutional limitations, and the limits are to be assumed when reading the statutes, this is not to say that the statutes give no indication of the limited nature of the tax. While the general statutory definition of "gross income" by itself may be misleading, there is plenty of evidence in the statutes that shows that Congress knew the limits of its power, and stayed within those bounds. Most notably, the entire structure and contents of Subchapter N ("Tax based on income from sources within or without the United States") indicates that it is about international and foreign commerce.

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