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CRS SAYS INDEXING CAPITAL GAINS FOR INFLATION CONTRARY TO DEFINITION.

MAR. 18, 1992

92-286 S

DATED MAR. 18, 1992
DOCUMENT ATTRIBUTES
  • Authors
    Gourevitch, Harry G.
  • Institutional Authors
    Congressional Research Service
  • Code Sections
  • Index Terms
    basis, cost
    capital gains
    capital gains, indexation
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 92-8298
  • Tax Analysts Electronic Citation
    92 TNT 182-185
Citations: 92-286 S

CRS REPORT FOR CONGRESS

SUMMARY

Harry G. Gourevitch Senior Specialist in Taxation and Fiscal Policy

March 18, 1992

Proposals have recently been made to index capital gains for inflation by amending current Treasury regulations rather than the Internal Revenue Code (Code). Advocates of this approach point out that it is not unusual for the Treasury Department to revoke regulations outstanding and to issue new ones in their place. This report examines the issues raised by these proposals.

The report notes that while Code Section 1012 states, "the basis of property shall be the cost of such property," the term 'cost' is not defined in the Section, though it is defined in the Treasury regulations as ". . . the amount paid for . . . such property in cash or other property." The report points out that a regulation which is contrary to a plain and unambiguous statute is invalid, and then examines whether the term 'cost' has a plain and unambiguous meaning despite not being defined in the Code. An examination of the judicial history of Section 1012 shows that 'cost' has consistently been interpreted in a nontechnical, ordinary sense to mean the amount of money paid to acquire property. The report points out that the definition in the Treasury regulations is a restatement of the judicial definition. The report also points out that Congress' extensive involvement with capital gains indexation proposals, its enactment of specific statutory basis adjustments when needed and its reenactment of Section 1012 all suggest it acquiesced in the current administrative definition of "cost".

The Treasury Department would have greater latitude in interpreting the Congressional intent in Section 1012 if the meaning of "cost" were found to be vague and unclear, but even under such circumstances an interpretation must be reasonable to be valid. Two cases, Chevron U.S.A v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984) and Bob Jones University v. United States, 461 U.S. 374 (1983), are discussed in which the Supreme Court upheld changes in administrative interpretations of statutory terms. The report finds that these decisions are not applicable as in both the statutory terms and concepts at issue were admittedly vague and ambiguous, and in one the opinion was partly driven by a fundamental national policy to eliminate racial discrimination in education.

The report concludes that a regulation indexing the cost basis of property for inflation would be contrary to the plain and unambiguous meaning of 'cost' in Section 1012, and that if the issue were to be litigated the courts would be likely to find the regulation invalid. The report also concludes that even if the meaning of 'cost' is deemed to be vague and ambiguous, an indexing regulation would nevertheless be likely to be found invalid as an unreasonable interpretation of Congressional intent. The report further concludes that regardless of whether the Congressional intent in Code Section 1012 is found to be clear or unclear, a regulation adjusting the cost basis of property for inflation would likely be found an attempted usurpation of Congress' legislative authority.

X X X

INTRODUCTION

Proposals have recently been made to index capital gains for inflation by amending the appropriate Treasury regulations rather than the Internal Revenue Code. 1

Code Section 1012 in relevant part provides that "the basis of property shall be the cost of such property." This provision was first enacted in the Revenue Act of 1918, then reenacted by successive revenue acts and renumbered as Section 1012 in the Revenue Code of 1954. The original version in the Revenue Act of 1918 was in relevant part substantially the same as current Section 1012. 2

Following adoption of the Internal Revenue Code of 1954, the Treasury Department issued regulations under Section 1012 providing "In general, the basis of property is the cost thereof. The cost is the amount paid for such property in cash or other property." 3

Advocates of the regulatory indexing approach point out that the only definition of cost appears in the Treasury regulations, as none appears in Code Section 1012 itself. They maintain the Treasury Department has the authority to change the regulatory definition so as to provide that the cost basis of property shall be adjusted upward to take inflation into account. They also point out that it is not unusual for the Treasury Department or other administrative agencies to revoke regulations outstanding and to replace them with new ones.

I. A REGULATION THAT CONFLICTS WITH THE PLAIN AND UNAMBIGUOUS MEANING OF A STATUTE IS INVALID

While the Secretary of the Treasury has broad authority to issue regulations implementing the Internal Revenue Code, this authority is not unlimited. The Secretary is without legal authority to issue a tax regulation that is contrary to or inconsistent with the plain meaning of the underlying statutory provision. 4 Such a regulation would clearly be invalid. The basic question, therefore, is whether the term 'cost' in Section 1012, though undefined there, has a plain and unambiguous meaning. For if it does, a conflicting regulation purporting to index capital gains for inflation would be invalid.

Judicial Authority

In Koshland the Supreme Court held that the meaning of Section 113 of the Revenue Act of 1926 (the statutory predecessor of current Section 1012) was plain and unambiguous and that it required the taxpayer to subtract the purchase price of preferred shares (their cost) from the proceeds of their redemption, if the latter is greater. In holding invalid a regulation that conflicted with Section 113 of the 1926 Act, the Court stated:

The property disposed of was the petitioner's preferred stock. IN PLAIN TERMS THE STATUTE DIRECTS THE SUBTRACTION OF ITS COST FROM THE PROCEEDS OF ITS REDEMPTION, IF THE LATTER SUM BE THE GREATER. . . . Where the act uses ambiguous terms, or is of doubtful construction, a clarifying regulation or one indicating the method of its application to specific cases not only is permissible but is to be given great weight by the courts. And the same principle governs where the statute merely expresses a general rule and invests the Secretary of the Treasury with authority to promulgate regulations appropriate to its enforcement. But where, as in this case, the provisions of the act are unambiguous, and its directions specific, there is no power to amend it by regulation. Congress having clearly and specifically declared that in taxing income arising from capital gain the cost of the asset disposed of shall be the measure of the income, the Secretary of the Treasury is without power by regulatory amendment to add a provision that income derived from the capital asset shall be used to reduce cost. 5 (Emphasis added)

Earlier in the opinion the court had described cost of the preferred shares as their purchase price. The Supreme Court in Koshland found cost in Section 113 to have a plain and unambiguous meaning -- the purchase price paid for the preferred stock -- despite the absence of a definition of cost in the statutory provision itself. This construction of 'cost' by the Supreme Court has remained unchanged in later cases.

Other courts have consistently read the term 'cost' in a nontechnical, ordinary sense, as did the Supreme Court in Koshland, to mean the amount of money paid to acquire property. In Edward W. Edwards, a case under Section 113(a) of the Revenue Act of 1939, the Tax Court went to Webster's dictionary for a definition of cost, and concluded it meant the amount of money paid for stock. It stated:

"The regulations do not define the term 'cost,' so we must look elsewhere for a definition. Cost, as defined in Webster's New International Dictionary, is 'the amount or equivalent paid, or given, or charged, or engaged to be paid or given for anything bought or taken in barter or for service rendered.' More succinctly and for our purposes, COST OF THE STOCK IS THE AMOUNT PETITIONER PAID PARAGON FOR THE STOCK." 6 (Emphasis added)

Other courts, without reaching for the dictionary, have also defined 'cost' according to its plain meaning as the amount of money paid for property. In Vandenberge, the 5th Circuit stated:

Section 113(a) of the Revenue Act of 1938 provides that the unadjusted basis of property shall be the cost of such property. The solution to the question raised is as simple and clear as the language of the pivotal statute. THE COST OF THE PROPERTY WAS THE PRICE PAID TO ACQUIRE IT. 7 (Emphasis added)

Still other courts decided, without discussing, that the cost of property is the cash outlay to acquire it. William Gordon Means v. Commissioner, 29 BTA 590, (1933), Lanteen Medical Laboratories, Inc., 10TC 279 (1948).

These cases show that during a judicial history of more than fifty years the courts have consistently and uniformly read the term 'cost' in Section 1012 and its predecessor according to its plain meaning as the amount of money paid to purchase property. The courts have had no difficulty in finding that 'cost' has a plain and unambiguous meaning despite the fact that it is not defined in the Internal Revenue Code.

Regulatory Authority

In 1957 the Treasury Department adopted regulations under Section 1012 providing in relevant part that: "The cost is the amount paid for such property in cash or other property." 8 This definition, which has been unchanged since its adoption in 1957, is essentially the same as that established by the courts. Since the courts already define 'cost' in Section 1012 as the amount of money paid to acquire property, the Code Section would still retain the same meaning even if the regulation were withdrawn and replaced with a new one. A new regulation, however, would be valid only if not inconsistent with or contrary to the judicially approved meaning.

Congressional Acquiescence of the Regulation

Generally the courts have been cautious about reading too much significance into Congressional inaction. 9 Nevertheless, the fact that in the Tax Reform Act of 1986 Congress reenacted without change Section 1012 of the Internal Revenue Code of 1954 and that prior thereto this section had been consistently interpreted by Regulations section 1.1012-1(a) for nearly thirty years is some indication of Congressional approval of the regulation. 10 Congressional acquiescence can also be inferred from the fact that whenever the Congress saw a need to change the general definition of basis in Section 1012, it acted by adopting specific statutory basis adjustments. In the process of adopting specific basis adjustments Congress is likely to have focused on Section 1012 and the definition of cost in the regulation.

Moreover, in recent years Congress was faced with several major proposals to index the basis of capital assets for inflation which up to now it has rejected. In 1985 the President's tax reform proposals would have allowed individuals to index the original cost basis of capital assets for inflation. 11 And in 1989 a bill indexing capital gains for inflation passed the House but was rejected in Conference. 12 In 1992, the House passed a provision indexing the basis of capital assets for inflation as part of the Tax Fairness and Economic Growth Act of 1992 (H.R. 4210), but its fate is uncertain. Congress' past rejection of major proposals to adjust the basis of capital assets for inflation further supports the view that it acquiesced in the definition of cost in the current regulations.

To summarize, all three branches of government seem to be in accord that "cost' in Section 1012 has a plain and unambiguous meaning of the amount of money paid to acquire property.

Would an Indexing Regulation Conflict with 'Cost' in Section 1012?

Though not stated explicitly in the Code, the cost basis of capital assets, refers to amounts of money expressed in nominal, not inflation adjusted real dollars. As noted by the Tax Court in Hellerman, where the taxpayer contested the constitutionality of being taxed on nominal capital gains unadjusted for inflation:

As was stated by Judge Learned Hand, "[the] meaning [of income] is * * * to be gathered from the implicit assumptions of its use in common speech." United Sates v. Oregon-Washington R. & Nav. Co., 251 F. 211, 212 (2d Cir. 1918). Thus, the meaning of income is not to be construed as an economist might, but as a layperson might. PETITIONERS RECEIVED MANY MORE DOLLARS FOR THE BUILDING THAN THEY HAD PAID FOR THEM. THE EXTRA DOLLARS THEY RECEIVED ARE WELL WITHIN THE COMMON PERCEPTION OF INCOME, EVEN THOUGH EACH 1976 DOLLAR RECEIVED REPRESENTS LESS PURCHASING POWER THAN EACH 1964 DOLLAR PAID. PETITIONERS' NOMINAL GAIN MAY OR MAY NOT EQUAL THEIR REAL GAIN IN AN ECONOMIC SENSE. Nonetheless, neither the Constitution nor tax laws "embody perfect economic theory." See Weiss v. Wiener, 279 U.S. 333, 335 (1929) 13 (Emphasis added)

The current tax policy reflected in Section 1012 is that the cost of property is not adjusted for inflation. A regulation adjusting cost for inflation would represent a complete reversal of this policy and would be contrary to the statutory meaning of cost.

Congress and the courts have always considered that indexing the Code for inflation and making capital gains policy are the business of Congress to be accomplished by legislation, and not by the Executive branch. Whenever Congress wanted to index particular provisions of the Code, it did so by enacting appropriate legislation. And whenever it considered that particular adjustments to the general definition of cost basis were necessary, it enacted them. An indexing regulation would take this legislative authority away from the Congress.

To summarize, a court would likely find an indexing regulation invalid as contrary to the plain and unambiguous meaning of 'cost' in Section 1012 and an attempted usurpation of Congress' legislative authority.

II. AN ADMINISTRATIVE INTERPRETATION OF A VAGUE OR AMBIGUOUS STATUTE MUST BE REASONABLE TO BE VALID

If a statutory term is vague or ambiguous an administrative agency has greater latitude in interpreting its meaning and the underlying Congressional intent. But even then an administrative interpretation must be reasonable to be valid. 14 In Chevron the Supreme Court upheld the validity of an Environmental Protection Agency regulation issued in 1981 interpreting the term 'stationary source' of air pollution in The Clean Air Acts Amendments of 1977. The 1981 regulation which was issued after a new administration took office replaced an earlier 1980 regulation which had taken a stronger pollution control stand. In upholding the 1981 regulation, the Court stressed that the statutory term was not defined by Congress and that Congressional intent on the issue was unclear.

The regulatory indexing issue here is different from Chevron as 'cost' in Section 1012 and its predecessors has for more than thirty years been given a plain and unambiguous meaning by the courts and the Treasury regulations. In addition, unlike Chevron there are indications that Congress acquiesced in the administrative definition of 'cost'.

In Bob Jones University, 15 cited in the Wall Street Journal editorial as support for its position, the Supreme Court allowed the Internal Revenue Service to change its policy on granting tax exemptions to nonprofit private educational institutions. In 1971 the Internal Revenue Service announced it would no longer grant tax exemptions to private schools that do not have a racially nondiscriminatory policy, whereas before it had granted tax-exempt status to private schools regardless of their racial admission policies. The new position was based on the Treasury's view that to qualify for tax exemption under the Code an organization had to qualify under the common law concept of charity and that a charitable organization may not act contrary to the public policy of discouraging racial discrimination.

In Bob Jones University the Supreme Court superimposed on the tax-exemption provisions of the Code a common-law concept of charity which was not even mentioned or defined in the Code or the implementing regulations. Also, the decision was partly driven by the fundamental government policy to combat racial discrimination in education. These two factors -- the admitted ambiguity of the concept interpreted and the government's fundamental policy to rid education of racial discrimination -- make Bob Jones University inapplicable here. Not only has the term 'cost' had a consistently clear and unambiguous meaning, but also up to now Congress has rejected major proposals to adopt a policy indexing capital gains for inflation.

While the Treasury Department would have greater latitude in interpreting "cost" in Section 1012 if the term were deemed to be vague and unclear, its interpretation of Congressional intent would still have to be reasonable to be valid. It is difficult to imagine how a regulation that would index the cost basis of property for inflation could possibly be a reasonable interpretation of the intent in Section 1012. Congress knows that, unless inflation adjustments are expressly provided, amounts of money referred to in the Internal Revenue Code are expressed in nominal dollars, not inflation adjusted dollars. That is why Congress in recent years expressly provided that the amounts in the tax brackets, the standard deduction and the personal exemption shall be indexed for inflation. That is also why the Congress in the past has rejected major proposals to index the cost basis of capital assets for inflation.

Moreover, Congress has enacted basis adjustments whenever it saw a need for them. In the face of this manifest Congressional policy on selective indexing, basis adjustments and capital gains, to find in Section 1012 a Congressional intent that somehow accommodates an inflation adjustment of the basis of property would seem to be very farfetched. No one has questioned that the making of tax policy is the business of Congress, not of the Executive branch, and yet such an indexing regulation would be making tax policy, not merely clarifying existing policy. As such it would be an attempted usurpation of Congress' legislative authority even if the Congressional intent in Section 1012 were deemed to be vague or unclear.

CONCLUSION

Despite the absence of a definition of 'cost' in Section 1012 the term has a generally accepted plain and unambiguous meaning of the amount of money paid to acquire property. This meaning has been generally accepted by the courts and the Treasury Department and it appears also to be accepted by the Congress. A new regulation that would redefine cost as cost adjusted for inflation would represent a major change in capital gains policy and would be contrary to the meaning of "cost" now embodied in Section 1012 and Regulations Section 1012-1(a). Accordingly, if the issue were to be litigated, it is likely the courts would find such an indexing regulation invalid.

Even if the term 'cost' in Section 1012 were deemed to be vague and unclear, an indexing regulation is unlikely to be sustained by the courts as it likely would be found an unreasonable interpretation of Congressional intent.

Regardless of whether the Congressional intent in Section 1012 is clear or unclear, a regulation adjusting the basis of property for inflation would likely be found an attempted usurpation of Congress' legislative authority.

 

FOOTNOTES

 

 

1 See, for example, article by Craig Paul Roberts, "Instant Way to Cut Capital Gains Tax?" in The Washington Times of January 22, 1992, and editorial in The Wall Street Journal of January 28, 1992, on Presidential Indexation.

2 Section 202(a) of the Revenue Act of 1918 in relevant part stated:

BASIS FOR DETERMINING GAIN OR LOSS.

SEC. 202. (a) That for the purpose of ascertaining the gain derived or loss sustained from the sale or other disposition of property, real, personal, or mixed, the basis shall be --

(2) In the case of property acquired on or after [March 1, 1913], the cost thereof;"

3 Treasury Regulations, Sec. 1.1012-1(a).

4 Koshland v. Helvering, 295 U.S. 441, (1936). At issue there was the validity of a regulation that reduced the cost basis of preferred stock in the face of section 113 of the Revenue Act of 1926, the statutory predecessor of Section 1012, providing that the basis for determining gain from the sale of property is the cost of such property.

5 Koshland v. Helvering, 298 U.S. 441, 446-7 (1935).

6 Edward W. Edwards v. Commissioner, 19 TC 275, 279 (1952).

7 Vadenberge v. Commissioner, 147 F.2d 167, 168 (1945) cert. denied, 325 U.S. 875 (1945).

8 Treasury Regulations Section 1.1012.1(a).

9 See, Bob Jones University v. United States, 461 U.S. 574, 600 (1983).

10 See, Fribourg Navigation Co. v. Commissioner, 383 U.S. 272, 283 (1966).

11 President's Tax Proposals to the Congress for Fairness, Growth and Simplicity (1985).

12 Rept. of the Committee of Conference on the Revenue Reconciliation Act of 1989 (H.R. 3299), 209, 101st Cong., 1st Sess.

13 Hellerman v. Commissioner 77TC 1361, 1366 (1981).

14 Chevron U.S.A v Natural Resources Defense Council, 467 U.S. 837, 843 (1984).

15 Bob Jones University v. United States, 461 U.S. 574; (1983).

 

END OF FOOTNOTES
DOCUMENT ATTRIBUTES
  • Authors
    Gourevitch, Harry G.
  • Institutional Authors
    Congressional Research Service
  • Code Sections
  • Index Terms
    basis, cost
    capital gains
    capital gains, indexation
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 92-8298
  • Tax Analysts Electronic Citation
    92 TNT 182-185
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