TAX COURT OPINION

Case: Kenneth David & Linda Ruth Perry
Docket Number: 619-04
Judge: Chabot
Opinion Type: memo
Filed: 04/18/2006
Pages: 14

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 they exceeded $3,000, on authority of sec. 1211(b), extent I.R.C. 1986. Held: Th,is limitation does not prevent the taxes imposed by secs. income within the meaning of Constitution. 1 and 55, I.R.C. 1986, from being taxes on the Sixteenth Amendment to the 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 BBRyan Ap - 2 - $2,465 for 2001 and $21,233.37 for 2003.¹ On th ir 2003 income tax return, petitioners claimed a $14,543.74 refhnd on account of excess withholding. Respondent acknowledged the prepayment, but withheld refund or credit of this amount. On brhief, 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 eing taxes on income, within the meaning of the Sixteenth Ameqdment 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 he ein by this reference. When the petitions were filed in the insta(tt cases, ¹ $252 of the 2003 determined deficiency i alternative minimum tax under section 55; the entire amount for 2001 are section 1 income tax. the remaining amo ant for 2003 and Unless indicáted 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 whe her the Congress intended the $3,000 limitation to apply to real economic losses. However, on reply brief, petitioners specifically abandon the Congressional Congress exceeded!its power granted in Amendmen.t XVI of the US Constitution." intent issue and ask us to determine only "whether See infra note 4. petitioners resided in Fairfax, Virginia. - 3 - Table 1 shows selected items from petitioners' timely filed income tax returns (Forms 1040) for 2001 and 2003. Item--Line on 2001 (2003) Form 1040 2001 2003 Table 1 7. 8a. 9. 13. 33. 39. 58. 59. 70. (70a) Wages Taxable interest (7) (8a) (9a) Ordinary dividends (13a) Capital gain or (loss) Taxable income (34) Adjusted gross income (40) (60) Total (61) Withholding Amount owed Overpayment to be tax refunded $253,598.43 226.05 217.85 $267,398.35 154.35 189.11 (9,256.63) 244,785.70 221,055.33 61,222.00 57,196.78 4,025.22 (60,641.96) 207,099.85 179,709.47 40,749.63 55,293.37 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 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. determination of a $252 alternative minimum tax. Petitioners do not contest the mathematical correctness .of respþndent' s computations. 1. The Parties' Contentions Discussion Respondent maintains that the Sixteenth Amendment to the United States Constitution "permits Congress to impose 'taxes on "Congress, (cid:16)042 incomes, from whatever source derived' ." Furth r, within its sole discretion, may determine the extent to which, if at all, taxpayers may claim deductions from inc me they are required to report." Finally, respondent contedds-- that sections 165(f) and 1211(b) Petitioners have not shown, however, as theymust, violate constitutional guarantees of process and equal protection or breacn the authority granted to the Congress purhuant the Sixteenth Amendment to the Constitution. ue to Petitioners respond that respondent' s refe ences to deductions miss the point that "a capital loss s an income item. A capital loss is not a deductible expense item " By disallowing that part of the loss that exceeds $3,000, peti ioners contend, respondent is taxing petitioners on "income tha does not exist. Petitioners believe that Section 1211(b) violat s the power granted Congress in the Sixteenth Amendment, and if the Court agrees, it should rule accordingly." 2. Summary and Cdnclusion The Constitution does not require all incohte items to be - 5 - 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 tó 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 arti-cle I, "direct" taxes must be apportioned among the .States in proportion to census populations. The Sixteenth Amendment has the effect of overriding the direct- tax-apportionment requirement with respect to "taxes on incomes, from whatever source derived".4 Section 61 provides as follows: 4 Thus, the Sixteenth Amendment is properly a limited is not the source of the Sixteenth Amendment the See, e.g., Eisner v. Macomber, 252 U.S. removal of a limited restriction on the Congress's broad power to tax income; power to tax income. 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). tax, "direct" tax; the tax in question still does not have to be apportioned. As a result, even if a tax does not qualify as an income that merely leads to whether the tax in question is a if the tax in question is not a direct tax,' then Petitioners contend they should be allowed to deduct the entire amounts of their realized and recognized capital in accordance with their tax returns. prevail, (1) The limitation of section 1211(b) causes the sections 1 and 55 taxes to not be income taxes under the Sixteenth Amendment; they might have to persuade us of all For petitioners to the following: losses, (continued...) - 6 - 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 aource derived, following items: including (but not limited toh the (1) Compensation for servic s, including fees, commissions, items; fringe benefit , and similar Interest; (2) Gross income derived from business; (3) Gains derived from dealings in property; (4) (5) Rents; (6) Royalties; (7) Dividends; (8) Alimony and separate maiptenance payments; (9) Annuities; (10) Income from life insurance and endowment contracts; . (11) Pensions; (12) (13) Distributive share of p rtnership gross Income from discharge o indebtedness; income; (14) (15) Income in respect of a Income from an interest in an estate or ecedent; and trust. (b) Cross References.-- For items specifically included in gross income, see part II (sec. 71 and Tollowing). For 4(...continued) the sections 1 and 55 taxes as limited by section 1211(b) (2) constitute direct taxes that must be apportioned! and (3) deductibility of capital entire income tax from invalidation. losses is the preferred way to save the full Because we hold that petitioners have failed to persuade us these three items, we do not éxplore the as to the first of second and third items. 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 provlslons 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 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. income tax law, 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 tax upon a person in a year when was without power to impose an unjust enrichment his operations as a whole resulted in a loss, which is to say, in such a situation, may not segregate a particular type of special income and impose a in effect, that Congress, tax upon it. The Supreme Court, - 8 - income tax act and "impose an however, has held that Congress may en$ct a special increased or additional tax" upon certain profits, although they are also taxable under the general income tax law. United Stbtes v. Hudson, 299 U.S. 498, 500 * opinion that, since Congress may imposb an additional income received by a taxpayer, it may do so regardless of whether or not his opera.ions as a whole for the entire taxable yeariresult in a profit taxable under the provisions of the general tax upon a particular type income tax law. * * * * *. It ib our f Consistent with the foregoing, under presen: 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 special y taxed category of income is not reduced by losses from other ca egories of Income. B. Capital Gains and Losses Section 1 imp ses incóme taxes on individua s. Over the years, section 1(h) has provided limitations of yarious sorts on _ 9 _ 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 3 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 indïvidual, 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, connected with a trade or business; and though not * * * * * * * (f) Capital Losses.--Losses from sales or exchanges .of capital assets shall.be allowed only to the extent allowed in sections 1211 and 1212. Y - 10 - 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 1.n 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 categor..es that result 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 caee of a married individual filing a a separate return), or (2) the excess of such losses over such gains. - 11 - 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 - 12 - taxable income was not a Sixteenth Amendment-per itted income tax. 87 F.2d at 324-325. The Circuit Court of Appeals analyzed the sátuation as follows (87 F.2d at 325): While the computation of income is made it cuts altogether too true, and therefore taxable, the fact tha they the period and determining net inco e with due and necessary regard to periods of time, which are established years either calendar or fiscal, fine to say that income can only be ascertained by putting together all the profit and loss transactions of accordingly regardless of may in whole or in part be quite unreldted except for the time element and the fadt that they were those of the same taxpayer. for instance, a separate and distinct transaction during the year results in ;a net realized gain to the taxpayer in and of itself, received, but Congress may, or may not, have allowed deductions which as a matter of computation will relieve that income id whole or in part otherwise it would be subject. from the taxation to which * income which is taxed has been If, * * Accordingly, the Circuit Court of Appeals upheld |the constitutionality of the section 23(r) limitatio . 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 I - 13 - items purchased by the respondent's action from gross court in the Davis case, wherein the court taking from all receipts "certain speaks of necessary items like cost of property sold", and contends that denies him the right to deduct receipts the cost of all him in the conduct of his business. 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 aggregate cost creates income where none in fact .exists and, application of 23(r) unconstitutional as to his business. the right to reduce gross receipts by therefore, makes the In other That portion of petitioner's argument in the The income in whole is answered in part by the court from taxation, and by the further taxable income for that period, and the relative to the denial of his right to use cost 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 or in part statement that "net income for any taxable period need not necessarily b.e the same as net variation may be to the extent that Congress has seen fit either to allow, deny deductions within its control as a matter of grace." (Emphasis supplied.) ·facts in this proceeding illustrate the truth of This petitioner as a matter of 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 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 tax.. the court's observations. income. However, income.subject to to limit, or to fact * * * The foregoing disposes of all of petitioners' contentions, - 14 - 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 alte native minimum tax, which is part of the 2003 determined defici ncy, 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 othef reason, including constitutional guarantees of' due procens and equal protection. We do not decide theoretically possible constitutional questions unless they are properl presented and must be resolved in order to decide the case bef re us. Kessler v. Commissioner, 87 T. C. 1285, 1293-1294 (1986) and cases there cited), affd. without published opinion. 838 F.2 1215 (6th Cir. 1988). In light of the foregoing, Decisions wil] be entered for respondent.