Moments in Tax History | Eisner v. Macomber | Income, an Origin Story

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TL Fahring focuses on helping individuals and businesses with a wide variety of matters involving state, federal, and international taxation. He has represented clients in all stages of federal and state tax disputes, including audits, administrative appeals, litigation, and collection matters. Mr. Fahring also has used his tax knowledge to assist clients in planning complex domestic and international transactions, including advising as to potential reporting and withholding requirements.

Mr. Fahring received his J.D. from the University of Texas School of Law, where he graduated with high honors and was inducted into the Order of the Coif and Chancellors honors societies. After clerking for a year at the Texas Eleventh Court of Appeals, he attended New York University School of Law, where he received an LL.M. (Master of Laws) in Taxation and served as a student editor on the Tax Law Review.

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

Summary: In Eisner v. Macomber, the U.S. Supreme Court ruled that for purposes of the Sixteenth Amendment, “income” was “a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital however invested or employed, and coming in, being ‘derived,’ that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal.”  Macomber introduced the realization requirement to the federal income tax, and the decision continues to be cited in such contexts as cryptocurrency hard forks and the constitutionality of provisions denying deductions for cannabis businesses.

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

On February 3, 1913, the Sixteenth Amendment to the U.S. Constitution was ratified. According to the Sixteenth Amendment, “Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”[3]  That same year, Congress passed the Revenue Act of 1913, inaugurating the modern federal individual income tax.[4]

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

On January 1, 1916, Standard Oil Company of California had surplus and undivided profits of about $45,000,000, of which approximately $20,000,000 was earned before March 1, 1913.[6] That month, the company issued a stock dividend of 50% of its outstanding stock, transferring an amount equivalent to this issue from its surplus account to its capital stock account.[7]

Before the stock dividend, Myrtle H. Macomber owned 2,200 shares of company stock, and she received an additional 1,100 shares as a result. Approximately 18.07%, or 198.77 shares with a par value of $19,877, was treated as representing surplus earned between March 1, 1913, and January 1, 1916.[8] The Bureau of Internal Revenue (the name at the time for the Internal Revenue Service) required Ms. Macomber to pay federal income tax on the value of this portion of the stock dividend, which she did under protest.[9]

Holding: The Court held that a shareholder didn’t realize income upon the receipt of a pro rata stock dividend. As a result, a congressional statute that taxed such stock dividends was unconstitutional.

Rationale Behind Holding: The Court determined that the Sixteenth Amendment had to be interpreted in light of the taxing clauses in the Constitution before the Amendment was adopted.[10] The Court noted that prior to the Amendment’s adoption, it had held that Congress couldn’t impose taxes upon rents and profits of real estate and upon returns from investments of personal property without apportioning these taxes among the states according to population, because such taxes were in effect direct taxes upon the property giving rise to such income.[11]  The adoption of the Sixteenth Amendment merely removed the requirement that income taxes be apportioned among the States—it didn’t “extend the taxing power to new subjects . . . .”[12]

Thus, the Court determined that the Sixteenth Amendment had to be interpreted in such a way as to preserve the apportionment requirement found elsewhere in the Constitution.[13] In order to do so, the Court had to puzzle out the meaning of the word “income.”[14]

The Court began by discussing the relationship between “capital” and “income,” observing that “the former [had been] likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time.”[15] Extrapolating from this, the Court concluded that “‘[i]ncome may be defined as 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 . . . .”[16]

The Court then observed that with a stock dividend,

no part of the assets of the company is separated from the common fund, nothing distributed except paper certificates that evidence an antecedent increase in the value of the stockholder’s capital interest resulting from an accumulation of profits by the company, but profits so far absorbed in the business as to render it impracticable to separate them for withdrawal and distribution. . . . [I]t does not alter the preëxisting proportionate interest of any stockholder or increase the intrinsic value of his holding or of the aggregate holdings of the other stockholders as they stood before. The new certificates simply increase the number of the shares, with consequent dilution of the value of each share.[17]

The Court found that in such circumstances,

the stockholder has received nothing out of the company’s assets for his separate use and benefit; on the contrary, every dollar of his original investment, together with whatever accretions and accumulations have resulted from employment of his money and that of the other stockholders in the business of the company, still remains the property of the company, and subject to business risks which may result in wiping out the entire investment. Having regard to the very truth of the matter, to substance and not to form, he has received nothing that answers the definition of income within the meaning of the Sixteenth Amendment.[18]

Thus, the test adopted by the Court for determining “income” under the Sixteenth Amendment was “a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital however invested or employed, and coming in, being ‘derived,’ that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal . . . .”[19]

Reactions to Decision:  The Macomber decision was the only time in the past century that the Supreme Court decided a federal income tax case on constitutional grounds.[20]  Although Macomber has never explicitly been overruled, some have argued that it was overruled in effect the Court’s by Commissioner  v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955), which held that the term “income” included “undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.”[21]  Specifically, the Court ruled that the definition of “income” in Macomber “was not meant to be a touchstone to all future gross income questions.”[22]

The Macomber decision had its dissents. Justice Oliver Wendell Holmes believed that the term “income” “should be read in ‘a sense most obvious to the common understanding at the time of its adoption.’”[23] Holmes opined that “[t]he known purpose of [the Sixteenth] Amendment was to get rid of nice questions as to what might be direct taxes, and I cannot doubt that most people not lawyers would suppose when they voted for it that they put a question like the present to rest.”[24]

Justice Louis D. Brandeis for his part argued that the issuance of a cash and stock dividends were equivalent mechanisms for distributing out corporate wealth and should equally be subject to federal income tax.[25]  To hold otherwise would enable “the owners of the most successful businesses in America . . . to escape taxation on a large part of what is actually their income.”[26]

Continued Relevance:  The Macomber decision continues to be relied upon in various contexts.

Perhaps most influentially, Macomber introduced the realization requirement to the federal income tax.  Under the realization requirement, federal income tax generally can only be assessed when there is a change in a taxpayer’s relationship to property.[27] While debate continues about whether the realization requirement is a constitutional requirement (as Macomber hints at) or a matter of administrative convenience, it remains an important aspect of the federal income tax to this day.[28]

Recently, the decision has been cited as authority for the idea that cryptocurrency hard forks should not be taxed.[29]  Macomber has also been used in challenges to the constitutionality of Section 280E’s denial of credits and deductions with respect to cannabis businesses[30] and Section 965’s repatriation tax.[31]


[1] See U.S. Const. art. I, § 9, cl. 4.

[2] Pollock v. Farmers’ Loan & Trust Co., 157 U.S. 429 (1895).

[3] U.S. Const. amend. XVI.

[4] Revenue Act of 1913, Pub. L. No. 63-16, 38 Stat. 166 (1913).

[5] Revenue Act of 1916, Pub. L. No. 64-271, § 2(a), 39 Stat. 756, 757 (1916).

[6] Eisner v. Macomber, 252 U.S. 189, 200 (1920).

[7] Macomber, 252 U.S. at 200.

[8] Macomber, 252 U.S. at 200-01.

[9] Id. at 201.

[10] Id. at 205.

[11] Id. (citing Pollock, 18. U.S. 601).

[12] Macomber, 252 U.S. at 206.

[13] Id.

[14] Id.  Notably, the Court held that Congress’s definition of income didn’t conclude the matter, because Congress couldn’t change the Constitution by mere legislation. Id.

[15] Id.

[16] Id.  at 206-07 (quoting Stratton’s Independence v. Howbert, 231 U.S. 399, 415 (1913) and Doyle v. Mitchell Bros. Co., 247 U.S. 179, 185 (1918)).

[17] Macomber, 252 U.S. at 210-11.

[18] Id. at 211.

[19] Id. at 209.

[20] Reuven Avi-Yonah, Should U.S. Tax Law Be Constitutionalized? Centennial Reflections on Eisner v. Macomber (1920), 16 Duke J. Const. L. & Pub. Pol’y 65, 66 (1921).

[21] Reuven Avi-Yonah, Should U.S. Tax Law Be Constitutionalized? Centennial Reflections on Eisner v. Macomber (1920), 16 Duke J. Const. L. & Pub. Pol’y 65, 67 (1921).

[22] Glenshaw Glass, 348 U.S. at 431.

[23] Macomber, 252 U.S. at 219 (Holmes, J., dissent).

[24] Id. at 220 (Holmes, J., dissent).

[25] Id. at 221, 237-38 (Brandeis, J., dissent).

[26] Id. at 237 (1920) (Brandeis, J., dissent).

[27] Alice G. Abreu & Richard K. Greenstein, Defining Income, 11 Fla. Tax Rev. 295, 336 (2011).

[28] For cases implying that the realization requirement is not constitutional, see Helvering v. Horst, 311 U.S. 112, 116 (1940) (“[T[he rule that income is not taxable until realized . . . [is] founded on administrative convenience . . . .” and Helvering v. Griffiths, 318 U.S. 371, 393-94 (1943) (stating that Horst “undermined further the original theoretical bases of the decision in Eisner v. Macomber.”).

[29] David G. Chamberlain, Forking Belief in Cryptocurrency: A Tax Non-Realization Event, 24 Fla. Tax. Rev. 651 (2021).

[30] Beckett Cantley & Geoffrey Dietrich, The Cannabis Conundrum: Constitutional & Policy Concerns in Taxation of the Marijuana Industry, 10 Legis. & Pol’y Brief 39, 57-58 (2021).

[31] See Moore v. United States, No. 20-36122 (9th Cir. June 7, 2022) (Read our blog post write-up here).