Taft v. Bowers is a Supreme Court decision that is rarely studied in law schools or discussed by scholars. Yet, it is a case of vast significance. In the Taft decision, the Supreme Court confirmed that Congress may create non-recognition exceptions to the income tax that merely defer the recognition of income, rather than permanently exclude it. If the Taft case had been decided differently, it is likely that the number of non-recognition provisions in the Internal Revenue Code ( Code ) would be significantly reduced

Repetti, James R.

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\u3cem\u3eTaft v. Bowers\u3c/em\u3e: The Foundation for Non-Recognition Provisions in the Income Tax

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Boston College Law SchoolDigital Commons @ Boston College Law SchoolBoston College Law School Faculty PapersSpring 2-1-2017Taft v. Bowers: The Foundation for Non-Recognition Provisions in the Income TaxJames R. RepettiBoston College Law School, repetti@bc.eduFollow this and additional works at: https://lawdigitalcommons.bc.edu/lsfpPart of the Securities Law Commons, Supreme Court of the United States Commons, Taxation-Federal Commons, and the Tax Law CommonsThis Article is brought to you for free and open access by Digital Commons @ Boston College Law School. It has been accepted for inclusion in BostonCollege Law School Faculty Papers by an authorized administrator of Digital Commons @ Boston College Law School. For more information, pleasecontact nick.szydlowski@bc.edu.Recommended CitationJames R. Repetti. "Taft v. Bowers: The Foundation for Non-Recognition Provisions in the Income Tax." ACTEC Law Journal 42, no.1(2017): 23-27.??????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????- --- - - .. ---- - - ----- -- - -- • - .... - -- 1------------- -------------------------------.::·.----·--------- ~---.----------------·--------.--<<<<·----------.--<·:-,:-., Spring 2016] TAFTv. BOWERS 25 litigated. The predecessors to the Code had excluded gifts from income since the inception of the income tax in 1913.12 The District Court's decision that gifts were not income under the 16th Amendment was consistent with the restricted definition of income then utilized by the Supreme Court. Earlier, in 1920, the Court in Eis-ner v. Macomber13 had narrowly defined income as payments received by a taxpayer for services or the use or sale of her capital. Another Supreme Court decision, Edwards v. Cuba R. Co.,14 had determined in 1925 that payments received by a corporation from the Cuban govern-ment to subsidize construction of a railroad in Cuba were not income under the 16th Amendment because the payments "were not made for services rendered or to be rendered"15 and "were not profits or gains from the use or operation of [the taxpayer's capital, i.e.,] the railroad .•.• " 16 Instead, the Court characterized the payments as non-taxable contributions to capital. Similar reasoning might have excluded gifts to individuals from income for purposes of the 16th Amendment since the receipt of a gift would not be for services or the use or sale of capital.17 The Court of Appeals for the Second Circuit reversed the District Court in a decision that involved three separate opinions by the three-member panel.18 Chief Judge Manton wrote that taxing Elizabeth on all appreciation that had accrued from the date that her father had ac-quired the stock did not violate the 5th or 16th Amendments.19 He rea-soned that Congress had a valid purpose, minimizing tax avoidance by imposing a carryover basis, and that the Elizabeth had full knowledge that the carryover basis would apply.20 In addition, he observed that the amount of income that was taxed was not any greater than the amount that would have been taxed had Elizabeth's father sold the stock.21 Judge Hand concurred in a separate opinion. He said that the 16th Amendment was not violated because the gain taxed clearly represented 12 MAGILL, supra note 2, at 357. 13 252 U.S. 189, 207 (1920). 14 268 U.S. 628 (1925). 15 Id. at 633. 16 Id. 17 For excellent discussions of the evolution of the definition of income, see Marjorie E. Kornhauser, The Origins of Capital Gains Taxation: What's Law Got To Do With It?, 39 Sw. L.J. 869 (1985); Majorie E. Korhnauser, The Constitutional Meaning of Income and the Income Taxation of Gifts, 25 CoNN. L. REv. 1, 11 (1992). Professor Korn-hauser notes that there is some evidence that the term "income" as used in the 16th Amendment was not intended to include gifts, although the matter is far from clear. 18 Bowers v. Taft, 20 F.2d 561, 564 (2d Cir. 1927). 19 Id. at 563. 20 Id. at 562-63. 2 1 Id. at 563. 26 ACTEC LAW JOURNAL [Vol. 42:23 appreciation that had occurred after the donor purchased the stock.22 He further reasoned that the 16th Amendment did not require that in-come subject to tax be the income of the actual taxpayer, stating that "[t]he language of the Amendment itself gives Congress power to lay 'taxes on incomes,' not on persons."23 Judge Swan dissented, citing Edwards v. Cuba R. Co. 24 He argued that property "obtained by gift is capital, not income in the hands of the donee upon its receipt. "25 He concluded that taxing gain that had ac-crued while Elizabeth's father had held the stock was the same as taxing a portion of the capital that Elizabeth had received as a gift.26 The Supreme Court (with Chief Justice Taft recusing himself) unan~ imously affirmed the Court of Appeals for the Second Circuit.27 The Court noted that without a carryover basis, the appreciation that had occurred prior to the gift would forever escape taxation.28 Moreover, the Court determined, the imposition of a tax on the taxpayer did not impose a hardship.29 The Court stated: In truth the stock represented only a single investment of capi-tal - that made by the donor. And when through sale or con-version the increase was separated therefrom, it became income from that investment in the hands of the recipient ... according to the very words of the Sixteenth Amendment. By requiring the recipient of the entire increase to pay a part into the public treasury, Congress deprived her of no right and sub-jected her to no hardship. She accepted the gift with knowl-edge of the statute and, as to the property received, voluntarily assumed the position of her donor. When she sold the stock she actually got the original sum invested, plus the entire ap-preciation . . . . 30 Adopting the reasoning of Judge Hand in the Court of Appeals deci-sion, the Court succinctly concluded: There is nothing in the Constitution which lends support to the theory that gain actually resulting from the increased value of capital can be treated as taxable income in the hands of the 22 Id. at 564. 23 Id. 2 4 Id. at 565. 25 Id. 26 Id. 27 Taft v. Bowers, 278 U.S. 470, 484 (1929). 28 Id. at 482-83. 29 Id. at 482. 30 Id. Spring 2016] TAFT v. BOWERS recipient only so far as the increase occurred while he owned the property.31 27 The significance of the holding in Taft cannot be overstated. By holding that gain taxed to the taxpayer need not be the gain that had accrued while the taxpayer held the asset, the Court confirmed that non-recognition provisions may defer the recognition of income. The result is that gain avoided by a transferee in such non-recognition transactions as corporate reorganizations, like-kind exch~nges and gifts, may be taxed at a future date when the transferee disposes of the property in a taxable transaction. The case is also important because it represents an important step in the Court's evolution towards an expansive definition of income. Early Court decisions suggested a narrow approach to the definition of income with only amounts received by the taxpayer for her services or the use or sale of her capital qualifying as income. By holding that taxa-ble gains need not have accrued while the current taxpayer held the property, the Court started to shift focus away from the taxpayer's activ-ity in generating income to whether the taxpayer had simply exper-ienced an accession to wealth. This movement to a broad concept of income stands in stark contrast to the narrow approach the Court pur-sued in defining the tax base of the estate tax. Early Supreme Court decisions on the estate tax, such as Helvering v. Safe Deposit & Trust Co.,32 established that the estate tax base, the "gross estate" as defined in section 2033 of the Code, was to be defined narrowly. The result is that in the estate tax, Congress was subsequently always playing "catch up," expanding the scope of the gross estate by adopting or amending sections 2034 to 2044 of the Code to deal with new estate planning abuses.33 In contrast, there has been little need to expand the concept of income in the income tax and, indeed, sections 71 to 138 of the Code generally limit the expansiveness of income as interpreted by the courts. 31 Id. at 484. 32 316 U.S. 56, 62-63 (1942). 33 PAUL R. McDANIEL, JAMES R. REPETTI & PAULL. CARON, FEDERAL WEALTH TRANSFER TAXATION 108 (7th ed. 2015). 

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\u3cem\u3eTaft v. Bowers\u3c/em\u3e: The Foundation for Non-Recognition Provisions in the Income Tax

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