Eisner v. Macomber
252 U.S. 189, 40 S.Ct. 189, 64 L.Ed. 521 (1920)
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Rule of Law:
For something to be considered 'income' taxable under the Sixteenth Amendment, it must be a gain that is derived from capital, severed from that capital, and received by the taxpayer for their separate use and disposal. A stock dividend is not income because it does not sever corporate assets for the shareholder's benefit but merely changes the form of their capital investment.
Facts:
- On January 1, 1916, the Standard Oil Company of California had approximately $50,000,000 in outstanding capital stock and a surplus of about $45,000,000 in accumulated profits.
- A significant portion of these profits had been earned after March 1, 1913, the effective date of the Sixteenth Amendment.
- In January 1916, the company's board of directors decided to readjust its capitalization by issuing a 50% stock dividend.
- To do this, the company transferred an amount equal to the par value of the new shares from its 'surplus' account to its 'capital stock' account on its books.
- Myrtle H. Macomber, who owned 2,200 shares of the company's stock, received an additional 1,100 shares as part of this stock dividend.
- This transaction did not distribute any of the company's assets to Macomber or any other shareholder; it only increased the number of shares representing each shareholder's proportional interest in the company.
Procedural Posture:
- The Collector of Internal Revenue assessed an income tax against Myrtle H. Macomber based on the par value of the stock dividend she received.
- Macomber paid the tax under protest.
- Her claim for a refund was disallowed by the Commissioner of Internal Revenue.
- Macomber sued Mark Eisner, the Collector of Internal Revenue, in the United States District Court to recover the tax payment.
- The District Court overruled the government's general demurrer to Macomber's complaint.
- When the government declined to plead further, the District Court entered a final judgment in favor of Macomber.
- Eisner, representing the government, brought a writ of error, appealing the case directly to the Supreme Court of the United States.
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Issue:
Does a stock dividend, representing a corporation's capitalization of profits, constitute 'income' taxable by Congress without apportionment under the Sixteenth Amendment?
Opinions:
Majority - Mr. Justice Pitney
No. A stock dividend is not 'income' under the Sixteenth Amendment because it is fundamentally a change in the form of a shareholder's capital interest, not a realized gain. The court defined income as a gain 'derived from' and 'severed from' capital, which is then received by the taxpayer for their separate use. A stock dividend fails this test because it 'takes nothing from the property of the corporation, and adds nothing to the interests of the shareholders.' The shareholder's proportional interest in the company's assets remains unchanged; they simply hold more pieces of paper representing that same interest. To tax a stock dividend is to tax an unrealized appreciation in capital, which would be a direct tax requiring apportionment, a requirement the Sixteenth Amendment only removed for taxes on 'income'.
Dissenting - Mr. Justice Holmes
Yes. A stock dividend should be considered taxable income under the Sixteenth Amendment. The amendment's language should be interpreted according to its common understanding at the time of its adoption, not by using technical legal distinctions. The purpose of the amendment was to eliminate complex debates over what constituted a 'direct tax.' Most ordinary people who voted for the amendment would have understood 'incomes' to include something like a stock dividend, and that popular understanding should govern its interpretation.
Dissenting - Mr. Justice Brandeis
Yes. A stock dividend is substantively equivalent to a cash dividend that the shareholder then uses to purchase new stock, which would be taxable income. The court should look at the economic substance of the transaction, not its form. Financiers, investors, and state laws commonly regarded stock dividends as a distribution of profits. The majority's decision creates a loophole that allows the wealthiest business owners to receive their profits in a form that escapes taxation, which frustrates the purpose of the Sixteenth Amendment to tax incomes 'from whatever source derived'.
Analysis:
This decision established the crucial constitutional requirement of 'realization' for income taxation, meaning a gain must be tangibly separated from capital before it can be taxed. By narrowly defining 'income,' the Court significantly limited Congress's taxing power and created a foundational distinction between unrealized appreciation in asset value (not income) and realized gain (income). This 'realization' principle became a cornerstone of U.S. tax law, profoundly influencing corporate finance and tax-planning strategies for decades, though subsequent legislation and court decisions have since narrowed its application.
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