Landmark Supreme Court tax case reaches 100

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Just about everyone who has studied tax law is familiar with the landmark Supreme Court decision in Eisner v. Macomber. It was first argued before the court 100 years ago, on April 16, 1919. (It was reargued later that year and decided in 1920.)

The case involved stock dividends — additional shares — issued by Standard Oil of California, which were received by Mrs. Macomber and were treated as income by the government. Mrs. Macomber paid the tax under protest and sued Mark Eisner, the collector of internal revenue, for a refund. The court ruled that the stock dividend was not a realization of gain by Mrs. Macomber.

Justice Mahlon Pitney delivered the majority opinion: “A stock dividend shows that the company’s accumulated profits have been capitalized, instead of distributed to the shareholders or retained as surplus available for distribution in money or in kind should opportunity offer. Far from being a realization of profits of the stockholder, it tends rather to postpone such realization, in that the fund represented by the new stock has been transferred from surplus to capital, and no longer is available for actual distribution.”

Pitney boiled down the case to what he saw as the overriding circumstances. “The essential and controlling fact is that 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.”

Justices Oliver Wendell Holmes and Louis Brandeis issued dissenting opinions.

Despite its age, the decision still has meaning for today, according to Michael Graetz, a professor of tax law at Columbia University. “Eisner v. Macomber is a classic case, one that I teach in my federal income tax class every year, even though its current status is questionable,” he said. “Proportional stock dividends, the subject of the dispute, are now exempt from tax by statute. The court’s definition of income — suggesting that only income derived from labor or capital can be taxed — was abandoned in the Glenshaw Glass case in 1955, which held that windfalls such as the punitive damages at issue could be made subject to income tax. And its constitutional decision suggesting that the realization requirement might be constitutionally required has been questioned in many decisions upholding mark-to-market rules.

“But Macomber may enjoy a new life this century,” he observed. “Chief Justice [John] Roberts cited it in NFIB v. Sebelius, the Obamacare case, in his discussion of what constitutes a direct tax and must be apportioned to the states under the Constitution. If an annual wealth tax, like the one proposed by Elizabeth Warren, is ever enacted, Eisner v. Macomber will certainly be cited in the challenges that will inevitably follow.”

And of special note to Accounting Today readers, one of the co-counsels on the case for Mrs. Macomber was George Welwood Murray, the great-grandfather of former Accounting Today columnist and Wolters Kluwer tax author George Jones. In his “Histories of the Predecessor Firms of Milbank Tweed Hope & Webb,” Murray shared his memories of how he and another co-counsel, Charles Evans Hughes, came to be involved in the Eisner case:

“There came to be a good many stock dividends,” he wrote. “For instance, the Standard Oil Company of California issued several such and the amounts involved were very large. We became ourselves counsel in an already pending case, Towne v. Eisner, Collector. The attorney, Mr. Louis H. Porter, for Mr. Towne was glad to take us in as direct counsel rather than merely as friends of the court. This is how we came to prepare the brief and Judge Hughes to make the argument in the Supreme Court. It was the first case he had argued there since his retirement from the court. Still later, we brought a case which we had ourselves gotten up, Macomber v. Eisner, Collector. This case was argued twice and decided favorably to us, and became the classic authority as to stock dividends.These were really great cases.”

Murray noted that in the Towne stock dividend case, “Justice Holmes used a somewhat famous phrase. Wishing to distinguish between the meaning of ‘income’ as used in the Sixteenth Amendment from the meaning of the same word as used in the Revenue Act. he said: ‘A word is not a crystal, transparent and unchanged, it is the skin of a living thought.’”

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