Taxable Gross Income Personal Tips, Wages, And Other Compensation Received For Personal Services Are Not Income
Taxable Gross Income Personal Tips And Wages Are Considered Income And Must Be Taxed As So.
This argument asserts that wages, tips, and other compensation received for personal services are not income, because there is allegedly no taxable gain when a person “exchanges” labor for money. Under this theory, wages are not taxable income because people have basis in their labor equal to the fair market value of the wages they receive; thus, there is no gain to be taxed. A variation of this argument misconstrues section 1341, which deals with computations of tax where a taxpayer restores a substantial amount held under claim of right, to somehow allow a deduction claim for personal services rendered.Another similar argument asserts that wages are not subject to taxation where a person has obtained funds in exchange for their time. Under this theory, wages are not taxable because the Code does not specifically tax these so-called “time reimbursement transactions.” Some take a different approach and argue that the Sixteenth Amendment to the United States Constitution did not authorize a tax on wages and salaries, but only on gain or profit.The Law: For federal income tax purposes, “gross income” means all income from whatever source derived and includes compensation for services. I.R.C. § 61. Any income, from whatever source, is presumed to be income under section 61, unless the taxpayer can establish that it is specifically exempted or excluded. In Reese v. United States, 24 F.3d 228, 231 (Fed. Cir. 1994), the court stated, “an abiding principle of federal tax law is that, absent an enumerated exception, gross income means all income from whatever source derived.” The IRS issued Revenue Ruling 2007-19, 2007-14 I.R.B. 843, advising taxpayers that wages and other compensation received in exchange for personal services are taxable income and warning of the consequences of making frivolous arguments to the contrary.Section 1341 and the cases interpreting it require taxpayers to return funds previously reported as income before they can claim a deduction under claim of right. To have the right to a deduction, the taxpayer should appear to have an unrestricted right to the income in question. See Dominion Resources, Inc. v. United States, 219 F.3d 359 (4th Cir. 2000). It is a frivolous argument to claim a section 1341 deduction when there has been no repayment by the taxpayer of an amount previously reported as income. The Internal Revenue Service issued Revenue Ruling 2004- 29, 2004-1 C.B. 627, warning taxpayers of the consequences of making this frivolous argument.The Sixteenth Amendment provides that Congress shall have the power to lay and collect taxes on income, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration. U.S. Const. amend. XVI. Furthermore, the U.S. Supreme Court upheld the constitutionality of the income tax laws enacted subsequent to ratification of the Sixteenth Amendment in Brushaber v. Union Pacific R.R., 240 U.S. 1 (1916). Since that time, the courts have consistently upheld the constitutionality of the federal income tax.All compensation for personal services, no matter what the form of payment, must be included in gross income. This includes salary or wages paid in cash, as well as the value of property and other economic benefits received because of services performed, or to be performed in the future. Furthermore, criminal and civil penalties have been imposed against individuals relying upon this frivolous argument.Taxpayers who assert the position that wages are not taxable income, or other frivolous positions, may later claim that they were ignorant of or did not purposely disregard the requirements of the tax laws, such as the requirements to report wages and to withhold and pay taxes. Also, a handful of taxpayers who are criminally charged with violations of the internal revenue laws have avoided conviction.Taxpayers should not mistake these cases for an indication that frivolous positions that lead to criminal acquittals are legitimate or that the outcome of other cases will protect a taxpayer from sanctions resulting from noncompliance. Furthermore, while a few defendants have prevailed, the vast majority are convicted. Also, even though a taxpayer may be acquitted of criminal charges of noncompliance with Federal tax laws, the Service is still free to pursue any underlying tax liability and is not barred from determining civil penalties. See Helvering v. Mitchell, 303 U.S. 391 (1938); Price v. Commissioner, T.C. Memo. 1996-204.In November 2004, a federal district court in Ohio barred Michael A. Allamby from preparing federal tax returns and representing taxpayers before the IRS. Mr. Allamby erroneously interpreted the instructions to certain federal tax forms as requiring individuals to report their wages as income only if they invested the wages to earn income.Also, in May 2005, a federal district court in Louisiana permanently barred Richard A. Fuselier and Richard J. Ortt and their organization, Compensation Consultants, from preparing tax returns and promoting tax schemes, such as the “not for profit” scheme, which was based on the premise that wages cannot be taxed.In January 2005, a federal district court in California permanently enjoined Joseph O. Saladino, founder of an organization known as the Freedom and Privacy Committee, from promoting two schemes: the “claim of right” program and the “corporation sole” scheme (discussed below in this outline).In November 2009, Saladino and three codefendants were convicted of conspiracy to defraud the United States by interfering with the IRS’ ability to accurately assess and calculate income taxes. A fourth co-defendant was acquitted and a fifth pled guilty in September. Saladino faces up to five years in prison and $250,000 in fines.Also, in January 2005, a federal district court in North Carolina permanently barred Frank D. Perkinson from selling the “claim of right” program and the “corporation sole” scheme.In June 2006, Richard M. Blackstock was convicted on thirty-two counts of assisting in the preparation of fraudulent returns based on his involvement in filing various returns claiming deductions for wages, salaries and other compensation under the frivolous “claim of right” theory.In March 2008, a federal judge in Michigan barred Donald A. Gray from preparing federal income tax returns. The court found that Gray had been preparing tax returns for his customers based on the theory that wages are not income. The court ordered that Gray be barred from counseling others about the preparation of their returns, from holding himself out as a Certified Public Accountant, and from otherwise interfering with the administration and enforcement of the internal revenue laws.
Relevant Case Law:
Cheek v. United States, 498 U.S. 192 (1991) – the Supreme Court reversed and remanded Cheek’s conviction of willfully failing to file federal income tax returns and willfully attempting to evade income taxes solely on the basis of erroneous jury instructions. The Court noted, however, that Cheek’s argument, that he should be acquitted because he believed in good faith that the income tax law is unconstitutional, “is unsound, not because Cheek’s constitutional arguments are not objectively reasonable or frivolous, which they surely are, but because the [law regarding willfulness in criminal cases] does not support such a position.” Id. (emphasis added). On remand, Cheek was convicted on all counts and sentenced to jail for a year and a day. Cheek v. United States, 3 F.3d 1057 (7th Cir. 1993), cert. denied, 510 U.S. 1112 (1994).Commissioner v. Kowalski, 434 U.S. 77 (1977) – the Supreme Court found that payments are considered income where the payments are undeniably accessions to wealth, clearly realized, and over which a taxpayer has complete dominion.Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 429-30 (1955) – referring to the statute’s words “income derived from any source whatever,” the Supreme Court stated, “this language was used by Congress to exert in this field ‘the full measure of its taxing power.’ . . . And the Court has given a liberal construction to this broad phraseology in recognition of the intention of Congress to tax all gains except those specifically exempted.”United States v. Becker, 965 F.2d 383, 389 (7th Cir. 1992), cert. denied, 07 U.S. 971 (1993) – the court found defendant’s contention that wages are not income to be “ridiculous.”United States v. Sloan, 939 F.2d 499, 500 (7th Cir. 1991), cert. denied, 502 U.S. 1060 (1992) – in rejecting defendant’s argument that the revenue laws of the United States do not impose a tax on income, the court recognized the “Internal Revenue Code imposes a tax on all income.”United States v. Connor, 898 F.2d 942, 943-44 (3d Cir. 1990), cert. denied, 497 U.S. 1029 (1990) – the court stated that “[e]very court which has ever considered the issue has unequivocally rejected the argument that wages are not income.”Stelly v. Commissioner, 761 F. 2d 1113 (5th Cir. 1985), cert. denied, 474 U.S. 851 (1985) – the Fifth Circuit affirmed the Tax Court’s holding against the taxpayer’s argument that taxing wage and salary income is a violation of the constitution because compensation for labor is an exchange, not gain. The Fifth Circuit also fined the taxpayer for bringing a frivolous appeal. United States v. White, 769 F. 2d 511 (8th Cir. 1985) – the court issued a permanent injunction to prevent the promotion of the argument that there is no tax imposed on an exchange of property (labor) in an equal exchange for property (wages).United States v. Richards, 723 F.2d 646, 648 (8th Cir. 1983) – the court upheld conviction and fines imposed for willfully failing to file tax returns, stating that the taxpayer’s contention that wages and salaries are not income within the meaning of the Sixteenth Amendment is “totally lacking in merit.”Lonsdale v. Commissioner, 661 F.2d 71, 72 (5th Cir. 1981) – the court rejected as “meritless” the taxpayer’s contention that the “exchange of services for money is a zero-sum transaction . . . .”United States v. Romero, 640 F.2d 1014, 1016 (9th Cir. 1981) – the court affirmed Romero’s conviction for willfully failing to file tax returns, finding, in part, that “[t]he trial judge properly instructed the jury on the meaning of [‘income’ and ‘person’]. Romero’s proclaimed belief that he was not a ‘person’ and that the wages he earned as a carpenter were not ‘income’ is fatuous as well as obviously incorrect.”Callahan v. Commissioner, 103 A.F.T.R.2d 2400, 2009 U.S. App. LEXIS 11342 (7th Cir. May 27, 2009) – the court rejected the petitioner’s argument that only “the gain from wages” (not the wages themselves) is taxable and characterized the argument as “beyond frivolous.” The court also imposed a $4,000 penalty for filing a frivolous appeal.Abdo v. United States, 234 F.Supp.2d 553 (M.D. N.C. 2002), aff’d, 63 Fed. Appx. 163 (4th Cir. 2003), cert. denied, 540 U.S. 1120 (2004) – the tax preparer prepared returns based on the argument that labor is an exchange for wages and not taxable. The court cited Connor, supra, when finding that the tax preparer misstated the law.McCoy v. United States, 88 A.F.T.R.2d (RIA) 7116, 2001 U.S. Dist. LEXIS 18986 (N.D. Tex. Nov. 16, 2001), appeal dismissed, 54 Fed. Appx. 406 (5th Cir. 2002) – the court rejected the taxpayer’s argument that wages received were not income and described this position as meritless.Sumter v. United States, 61 Fed. Cl. 517, 523 (2004) – the court found the taxpayer’s “claim of right” argument as “devoid of any merit” and that section 1341 only applies to situations in which the claimant is compelled to return the taxed item because of a mistaken presumption that the right held was unrestricted and, thus, the item was previously reported, erroneously, as taxable income. Section 1341 was inapplicable to Ms. Sumter, because she had a continuing, unrestricted claim of right to her salary income and had not been compelled to repay that income in a later tax year.Pugh v. Commissioner, T.C. Memo. 2009-138, 97 T.C.M. (CCH) 1791 (2009) – stating that the “petitioner advances shopworn arguments characteristic of tax defier rhetoric,” the court rejected the taxpayer’s argument that his wages were not taxable because of section 1341. The court imposed a $15,000 section 6673 penalty for advancing frivolous arguments.Carskadon v. Commissioner, T.C. Memo. 2003-237, 86 T.C.M. (CCH) 234, 236 (2003)- the court rejected the taxpayer’s frivolous argument that “wages are not taxable because the Code, which states what is taxable, does not specifically state that ‘time reimbursement transactions,’ a term of art coined by [taxpayers], are taxable.” The court imposed a $2,000 penalty against the taxpayers for raising “only frivolous arguments which can be characterized as tax protester rhetoric.”Wheelis v. Commissioner, T.C. Memo. 2002-102, 83 T.C.M. (CCH) 1543- 45 (2002), aff’d, 63 Fed. Appx. 375 (9th Cir. 2003) – the court rejected the taxpayer’s frivolous argument that his wages were not taxable based on his belief that “[p]roperty (money) exchanged for property (labor not subject to tax)” is not subject to income taxation. The court stated that such claims have been “consistently and thoroughly rejected” by the courts and imposed a penalty against Wheelis in the amount of $10,000 for making frivolous arguments.Cullinane v. Commissioner, T.C. Memo. 1999-2, 77 T.C.M. (CCH) 1192, 1193 (1999) – noting that “[c]ourts have consistently held that compensation for services rendered constitutes taxable income and that taxpayers have no tax basis in their labor,” the court found Cullinane liable for the failure to file penalty, stating that “[his] argument that he is not required to pay tax on compensation for services does not constitute reasonable cause.”Abrams v. Commissioner, 82 T.C. 403, 413 (1984) – the court rejected the argument that wages are not income, sustained the failure to file penalty, and awarded damages of $5,000 for pursuing a position that was “frivolous and groundless . . . and maintained primarily for delay.”Reading v. Commissioner, 70 T.C. 730 (1978), aff’d, 614 F.2d 159 (8th Cir. 1980) – the court said the entire amount received from the sale of one’s services constitutes income within the meaning of the Sixteenth Amendment.