T.C. Memo. 2006-77

UNITED STATES TAX COURT

KENNETH DAVID PERRY AND LINDA RUTH PERRY, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 619-04, 18226-04. Filed April 18, 2006.

Ps’ claimed net capital losses were disallowed to the

extent they exceeded $3,000, on authority of sec. 1211(b),

I.R.C. 1986.

Held: This limitation does not prevent the taxes

imposed by secs. 1 and 55, I.R.C. 1986, from being taxes on

income within the meaning of the Sixteenth Amendment to the

Constitution.

Kenneth David Perry and Linda Ruth Perry, pro sese.

Roger W. Bracken, for respondent.

MEMORANDUM OPINION

CHABOT, Judge: Respondent determined deficiencies in 

individual income tax against petitioners in the amounts of
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1 $252 of the 2003 determined deficiency is alternative

minimum tax under section 55; the remaining amount for 2003 and

the entire amount for 2001 are section 1 income tax.

Unless indicated otherwise, all section and subtitle

references are to sections and subtitles of the Internal Revenue

Code of 1986 as in effect for the years in issue.

2 Initially, petitioners also disputed whether the Congress

intended the $3,000 limitation to apply to real economic losses. 

However, on reply brief, petitioners specifically abandon the

Congressional intent issue and ask us to determine only “whether

Congress exceeded its power granted in Amendment XVI of the US

Constitution.” See infra note 4.

$2,465 for 2001 and $21,233.37 for 2003.1 On their 2003 income

tax return, petitioners claimed a $14,543.74 refund on account of

excess withholding. Respondent acknowledged the prepayment, but

withheld refund or credit of this amount. On brief, petitioners

renew their claim for refund.

After concessions by petitioners, the issue for decision is

whether the $3,000 capital loss allowance limitation of section

1211(b) keeps the sections 1 and 55 taxes from being taxes on

income, within the meaning of the Sixteenth Amendment to the

Constitution.2

Background

The instant cases were consolidated for trial, briefing, and

opinion. They were submitted fully stipulated; the stipulations

and the stipulated exhibits are incorporated herein by this

reference.

When the petitions were filed in the instant cases,
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3 The parties’ stipulation that the loss was 1 cent less

than our finding is evidently a typographical error, as shown by

their stipulations as to petitioners’ proceeds and adjusted

basis. 

petitioners resided in Fairfax, Virginia.

Table 1 shows selected items from petitioners’ timely filed

income tax returns (Forms 1040) for 2001 and 2003.

Table 1

Item--Line on 2001 (2003) Form 1040 2001 2003

 7. (7) Wages $253,598.43 $267,398.35

 8a. (8a) Taxable interest 226.05 154.35

 9. (9a) Ordinary dividends 217.85 189.11

 13. (13a) Capital gain or 

 (loss) (9,256.63) (60,641.96)

33. (34) Adjusted gross income 244,785.70 207,099.85

39. (40) Taxable income 221,055.33 179,709.47

58. (60) Total tax 61,222.00 40,749.63

59. (61) Withholding 57,196.78 55,293.37

70. Amount owed 4,025.22

 (70a) Overpayment to be 

 refunded 14,543.74

In 2001, petitioners realized and recognized a long-term

capital loss in the amount of $9,256.63, as they claimed on their

2001 tax return.3 In 2003, petitioners realized and recognized a

net long-term capital loss of $60,641.96, as they claimed on

their 2003 tax return.

In the notice of deficiency for each year, respondent

disallowed the claimed capital loss deduction for that year to

the extent the loss exceeded $3,000, and also made consequential

adjustments to itemized deductions and (for 2003) personal

exemption deductions. Also, the 2003 adjustments resulted in a
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determination of a $252 alternative minimum tax. Petitioners do 

not contest the mathematical correctness of respondent’s

computations.

Discussion

1. The Parties’ Contentions

Respondent maintains that the Sixteenth Amendment to the

United States Constitution “permits Congress to impose ‘taxes on

incomes, from whatever source derived’.” Further, “Congress,

within its sole discretion, may determine the extent to which, if

at all, taxpayers may claim deductions from income they are

required to report.” Finally, respondent contends--

Petitioners have not shown, however, as they

must, that sections 165(f) and 1211(b)

violate constitutional guarantees of due

process and equal protection or breach the

authority granted to the Congress pursuant to

the Sixteenth Amendment to the Constitution.

Petitioners respond that respondent’s references to

deductions miss the point that “a capital loss is an income item. 

A capital loss is not a deductible expense item.” By disallowing

that part of the loss that exceeds $3,000, petitioners contend,

respondent is taxing petitioners on “income that does not exist. 

Petitioners believe that Section 1211(b) violates the power

granted Congress in the Sixteenth Amendment, and if the Court

agrees, it should rule accordingly.”

2. Summary and Conclusion

The Constitution does not require all income items to be
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4 Thus, the Sixteenth Amendment is properly a limited

removal of a limited restriction on the Congress’s broad power to

tax income; the Sixteenth Amendment is not the source of the

power to tax income. See, e.g., Eisner v. Macomber, 252 U.S.

189, 205-206 (1920); Simmons v. United States, 308 F.2d 160, 166

n.21 (4th Cir. 1962); Penn Mutual Indemnity Co. v. Commissioner,

32 T.C. 653, 659-666 (1959), affd. 277 F.2d 16, 19-20 (3d Cir.

1960). As a result, even if a tax does not qualify as an income

tax, that merely leads to whether the tax in question is a

“direct” tax; if the tax in question is not a direct tax, then

the tax in question still does not have to be apportioned.

Petitioners contend they should be allowed to deduct the

entire amounts of their realized and recognized capital losses,

in accordance with their tax returns. For petitioners to

prevail, they might have to persuade us of all the following: 

(1) The limitation of section 1211(b) causes the sections 1 and

55 taxes to not be income taxes under the Sixteenth Amendment;

(continued...)

treated identically. Capital gains and losses are treated

differently from other income items in several respects,

generally more favorably than most other income items. The

section 1211(b) limitation does not cause the sections 1 and 55

taxes to fall outside the sweep of the Sixteenth Amendment.

We agree with respondent’s conclusion.

3. Analysis

Article I, section 8, of the U.S. Constitution gives to the

Congress the “Power To lay and collect Taxes”. Under sections 2 

(cl. 3) and 9 (cl. 4) of article I, “direct” taxes must be

apportioned among the States in proportion to census populations. 

The Sixteenth Amendment has the effect of overriding the directtax-apportionment requirement with respect to “taxes on incomes,

from whatever source derived”.4 Section 61 provides as follows:
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4(...continued)

(2) the sections 1 and 55 taxes as limited by section 1211(b)

constitute direct taxes that must be apportioned; and (3) full

deductibility of capital losses is the preferred way to save the

entire income tax from invalidation.

Because we hold that petitioners have failed to persuade us

as to the first of these three items, we do not explore the

second and third items. 

SEC. 61. GROSS INCOME DEFINED.

(a) General Definition.--Except as

otherwise provided in this subtitle,

[subtitle A, relating to income taxes] gross

income means all income from whatever source

derived, including (but not limited to) the

following items:

(1) Compensation for services, including

fees, commissions, fringe benefits, and similar

items;

(2) Gross income derived from business;

(3) Gains derived from dealings in property;

(4) Interest;

(5) Rents;

(6) Royalties;

(7) Dividends;

(8) Alimony and separate maintenance

payments;

(9) Annuities;

(10) Income from life insurance and endowment

contracts; 

(11) Pensions;

(12) Income from discharge of indebtedness;

(13) Distributive share of partnership gross

income;

(14) Income in respect of a decedent; and

(15) Income from an interest in an estate or

trust.

(b) Cross References.--

For items specifically included in gross

income, see part II (sec. 71 and following). For 
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items specifically excluded from gross income, 

see part III (sec. 101 and following).

A. Different Categories of Income

Nothing in the text of the constitutional provisions

requires all income categories to be treated identically, or

requires all income categories to be added together or offset, in

the case of losses in one or more categories.

United States v. Hudson, 299 U.S. 498 (1937), was a suit for

refund of a 50-percent tax imposed on profits from transfers of

interests in silver bullion. In the course of the Supreme

Court’s analysis, the Court held that this was an income tax and

further held as follows (299 U.S. at 500):

 It is not material that such profit is

taxed, along with other gains, under the

general income tax law, for Congress has

power to impose an increased or additional

tax if satisfied there is need therefor. 

Patton v. Brady, 184 U.S. 608, 620-622.

Wilson Milling Co. v. Commissioner, 138 F.2d 249 (8th Cir.

1943), affg. 1 T.C. 389 (1943), involved an “unjust enrichment

tax” imposed by the Revenue Act of 1934, ch. 277, 48 Stat. 680. 

The Circuit Court of Appeals dealt with the taxpayer’s

constitutional challenge as follows (138 F.2d at 251):

But the petitioner asserts that Congress

was without power to impose an unjust

enrichment tax upon a person in a year when

his operations as a whole resulted in a loss,

which is to say, in effect, that Congress, in

such a situation, may not segregate a

particular type of income and impose a

special tax upon it. The Supreme Court,
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however, has held that Congress may enact a

special income tax act and “impose an

increased or additional tax” upon certain

profits, although they are also taxable under

the general income tax law. United States v.

Hudson, 299 U.S. 498, 500 * * *. It is our

opinion that, since Congress may impose an

additional tax upon a particular type of

income received by a taxpayer, it may do so

regardless of whether or not his operations

as a whole for the entire taxable year result

in a profit taxable under the provisions of

the general income tax law. * * *

Consistent with the foregoing, under present law many

categories of income are treated differently from other 

types of income. For example, wages (sec. 61(a)(1)) received

with respect to most kinds of employment are subject to taxes

under section 3101 (F.I.C.A. taxes), in addition to the section 1

taxes on income. Self-employment income (sec. 61(a)(2)) is

subject to taxes under section 1401 (self-employment taxes), in

addition to the section 1 taxes on income. Premature

distributions from certain types of annuities (sec. 61(a)(9)) and

retirement arrangements (sec. 61(a)(11)) are subject to

additional taxes under several subsections of section 72. In

each of these instances, the base of the specially taxed category

of income is not reduced by losses from other categories of

income.

B. Capital Gains and Losses

Section 1 imposes income taxes on individuals. Over the

years, section 1(h) has provided limitations of various sorts on
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5 Section 165 provides in pertinent part as follows:

SEC. 165. LOSSES.

 (a) General Rule.--There shall be

allowed as a deduction any loss

sustained during the taxable year

and not compensated for by

insurance or otherwise.

 * * * * * * *

 (c) Limitation on Losses of

Individuals.--In the case of an

individual, the deduction under

subsection (a) shall be limited 

to-- 

 (1) losses incurred in a

trade or business;

 (2) losses incurred in

any transaction entered into

for profit, though not

connected with a trade or

business; and

 * * * * * * *

 (f) Capital Losses.--Losses from

sales or exchanges of capital

assets shall be allowed only to the

extent allowed in sections 1211 and

1212.

the income tax as applied to net capital gains (see sec.

61(a)(3)), such that the marginal tax rates on net capital gains

ordinarily are less than the marginal tax rates on other types of

income. More recently, section 1(h)(11) has provided similar

beneficial treatment to “qualified dividend income”. See sec.

61(a)(7).

Section 1655 provides generally for the treatment of losses
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6 Section 1211(b) provides as follows:

SEC. 1211. LIMITATION ON CAPITAL

LOSSES.

 * * * * * * *

 (b) Other Taxpayers.--In the case

of a taxpayer other than a

corporation, losses from sales or

exchanges of capital assets shall

be allowed only to the extent of

the gains from such sales or

exchanges, plus (if such losses

exceed such gains) the lower of--

 (1) $3,000 ($1,500 in the case 

 of a married individual filing a

 a separate return), or

 (2) the excess of such losses 

 over such gains.

in determining the base for the section 1 income tax. Section

165 limits the allowance of capital losses to what is allowed in

sections 1211 and 1212.

Section 1211(b) allows, for individuals, capital losses only 

to the extent of capital gains, plus no more than $3,000.6

Section 1211(a) provides a much more limited capital loss

allowance for corporations. Section 1212 provides for capital

loss carrybacks and carryovers; those rules are in general more

generous to corporations than to individuals. Respondent noted

petitioners’ eligibility for capital loss carryovers treatment;

petitioners do not claim eligibility for carryback treatment.

As a result of the foregoing, although capital gains and 

losses are thrown into the mix of income categories that result
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in “taxable income”, for many purposes capital gains and losses

are treated differently from other categories of income.

It is apparent from the foregoing that over the decades the

Congress has chosen to treat capital gains and losses differently

from other categories of income; this category of income has been

only partially integrated into the section 1 ground rules.

C. “Income That Does Not Exist”

Petitioners claim that the effect of the $3,000 loss

limitation is to tax them on “income that does not exist.” They

are mistaken. Petitioners are being taxed under section 1 only

on the aggregate of the other categories of income that they in

fact realized, recognized, and reported--their income that does

exist. Supra table 1.

The tax treatment of capital losses has varied over the

years. As discussed in Davis v. United States, 87 F.2d 323 (2d

Cir. 1937), section 23(r) of the Revenue Act of 1932, ch. 209, 47

Stat. 169, 183, allowed losses from the sale or exchange of

stocks and bonds held for less than 2 years only to the extent of

gains from the sale of such securities. The taxpayer in Davis

had $13,285 of what we now would call short-term capital losses,

which was greater than the amount of his net taxable income. 87

F.2d at 324. The taxpayer contended that, as a result, he did

not have net income for the taxable year, so that his “net

taxable income” was not income, and thus the tax on his net
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taxable income was not a Sixteenth Amendment-permitted income

tax. 87 F.2d at 324-325.

The Circuit Court of Appeals analyzed the situation as

follows (87 F.2d at 325):

 While the computation of income is made

with due and necessary regard to periods of

time, which are established years either

calendar or fiscal, it cuts altogether too

fine to say that true, and therefore taxable,

income can only be ascertained by putting

together all the profit and loss transactions

of the period and determining net income

accordingly regardless of the fact that they

may in whole or in part be quite unrelated

except for the time element and the fact that

they were those of the same taxpayer. If,

for instance, a separate and distinct

transaction during the year results in a net

realized gain to the taxpayer in and of

itself, income which is taxed has been

received, but Congress may, or may not, have

allowed deductions which as a matter of 

computation will relieve that income in whole

or in part from the taxation to which

otherwise it would be subject. * * *

Accordingly, the Circuit Court of Appeals upheld the

constitutionality of the section 23(r) limitation.

To the same effect is White v. Commissioner, 37 B.T.A. 1106

(1938). The taxpayer sustained a net loss in his securities

trading. 37 B.T.A. at 1109. After discussing Davis v. United

States, supra, we stated in White as follows (37 B.T.A. at 1110-

1111):

 This petitioner, however, asserts that the

deduction he seeks is not a statutory

deduction, but falls within the first

classification of deductions made by the
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court in the Davis case, wherein the court

speaks of taking from all receipts “certain

necessary items like cost of property sold”,

and contends that the respondent’s action

denies him the right to deduct from gross

receipts the cost of all items purchased by

him in the conduct of his business. In other

words petitioner denies that he can have

income in any amount until he has recovered

his aggregate cost, and his entire argument

is based upon the proposition that the denial

of the right to reduce gross receipts by

aggregate cost creates income where none in

fact exists and, therefore, makes the

application of 23(r) unconstitutional as to

his business.

 That portion of petitioner’s argument

relative to the denial of his right to use

cost is answered in part by the court in the

Davis case, supra, wherein it states that a

net gain realized by a taxpayer from a

separate and distinct transaction constitutes

income that may, or may not, be subject to

tax depending upon whether the Congress has

allowed deductions which as a matter of

computation will relieve that income in whole

or in part from taxation, and by the further

statement that “net income for any taxable

period need not necessarily be the same as

net taxable income for that period, and the

variation may be to the extent that Congress

has seen fit either to allow, to limit, or to

deny deductions within its control as a

matter of grace.” (Emphasis supplied.) The

facts in this proceeding illustrate the truth

of the court’s observations. This petitioner

as a matter of fact lost money upon the basis

of his operations over the entire year, and

if all his losses were deductible he could

have no statutory net income. However, in

the absence of a statutory right to reduce

other income by losses from stock

speculations, and in view of the specific

limitation of 23(r), petitioner’s computation

must show a statutory net income subject to

tax. * * *

The foregoing disposes of all of petitioners’ contentions,
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including the asserted constitutional distinction between a

“capital loss” and “a deductible expense item.”

Our analysis has dealt with the tax imposed by section 1. 

The same analysis applies to the section 55 alternative minimum

tax, which is part of the 2003 determined deficiency, and which

was not separately argued by the parties.

Petitioners do not contend that the $3,000 limitation of

section 1211(b) is unconstitutional for any other reason,

including constitutional guarantees of due process and equal

protection. We do not decide theoretically possible

constitutional questions unless they are properly presented and

must be resolved in order to decide the case before us. Kessler

v. Commissioner, 87 T.C. 1285, 1293-1294 (1986) (and cases there

cited), affd. without published opinion. 838 F.2d 1215 (6th Cir.

1988).

In light of the foregoing,

Decisions will be entered

for respondent.