Today, many of us take for granted agreed upon terms, but there’s usually an arduous road to establishing their definition. With the internet in particular, “privacy” has taken on myriad new meanings that need to be explored and defined. As recently as 2021, websites in the US need to announce their cookie policy — while it may not prevent cookies, having transparency into how your data is being used is a step in the right direction.
Almost all sites are now incentivized to make them secure, transitioning from http to https to encrypt your breadcrumb from site to site and limit hackers. This not only keeps your credit card number safe online, but also your data.
And yet, as recently as 100 years ago, another topic was hotly debated: income. Specifically, what qualifies as taxable income.
Towne V. Eisner
The case of Towne v. Eisner (1918) was a pivotal court case for tax rights and laws (at the time). This court case evaluated the full breadth of the term “income.” The term came under contention when a shareholder (Henry R Towne) challenged the tax authorities (Mark Eisner) on the issue of the taxability of stock dividend transactions.
This case is significant for a number of reasons, but one reason for its significance stands out among others. Through this case, the basic principle that income places someone in an advantageous position was firmly established. This “principle of advantageous position,” is still at the heart of our definition of income today.
The Debate
After a company transferred $1.5 million in profits to its capital account, the taxpayer received a stock dividend consistent with his preexisting ownership stake in the company. The newly received stock had a value of roughly $417,450. Eisner’s team contended that this stock dividend was income within the meaning of the tax law of 1913 – and that this construction of the term “income” within the tax law of 1913 was also consistent with the construction of the same term in the sixteenth amendment – and assessed a tax liability on the taxpayer.
Though Towne received additional shares, he did not take a cash dividend, and so the question before the court was whether a valid tax liability could be assessed given that the taxpayer was not actually placed in a financially superior or advantageous position following the stock dividend.
The Revenue Act of 1913
The most relevant law in this case was the Revenue Act of 1913. This act contained an income tax provision which was freed from the traditional rule of apportionment. The taxpayer claimed that stock dividends fell outside of the definition of “income” as it was defined within this act.
Judge Rules? Towne Wins
The Supreme Court of the U.S. ruled in favor of Towne (the taxpayer) and threw out the tax liability assessed by the tax authorities (Eisner). The court cited several earlier cases involving corporate stock dividends in its decision. The quintessential fact which decided the matter was that the taxpayer was not placed in a financially superior position by way of the transaction. What had occurred was merely a reissuing of stock certificates in order to properly reflect the proportional interests of the shareholder. The taxpayer did not actually gain anything from the transaction, he was not placed in a more advantageous position, and so the court ruled that it would be incorrect to say that the taxpayer had received taxable income.
As mentioned above, this basic principle has endured up to the present day and continues to inform our conception of taxable income. This even defined “income” in various other contexts as well; for instance, the provisions of section 1031 of the tax code follows the idea that gains should not be taxable if it were theoretical rather than actual. Again, though we may see this principle as self-evident today, it was a long road.