We welcome guest blogger Bryan Camp. Bryan is the George H. Mahon Professor of Law at Texas Tech School of Law. Bryan is a prolific and engaging writer. We worked together at the Office of Chief Counsel, IRS for several years where I had the pleasure of watching fellow bureaucrats react to his wonky writing. This is the first of a three part series dispelling common myths about taxes and the tax system. Perfect reading for the week we perhaps think most about the American tax system. Keith
This post originally appeared on the Forbes PT site on April 13, 2015.
The Tax Code is a puzzle. Whether one views it as an engaging enigma or a ridiculous riddle, everyone has to deal with it and with the agency that administers it: the IRS. And an IRS letter in your mailbox cannot help but bring feelings of dread, even if the contents turn out to be a refund check. It is not surprising then, to find more than a few myths about the income tax and the IRS in our popular and political culture. Here are some of them.
1. The Income Tax Started in 1913.
One common myth is that the income tax started in 1913, after passage of the 16th Amendment to the Constitution. For example, Judge Boasberg, a highly educated federal judge in the prestigious U.S. District for the District of Columbia, recently wrote in one of his opinions: “…the casual student of history knows that the Sixteenth Amendment authorizing the modern federal income tax was not ratified until 1913.”
Forget 1913. The watershed year for the modern income tax in the United States was 1862. That was when, in desperate need of revenue to fund the Civil War, Congress passed a revenue act of unprecedented scope and complexity. Before then, the federal government had raised its revenue from external sources via customs duties, or tariffs, on imports. But the Revenue Act of 1862 did not just toy with tariffs. It created a vast number of brand-spanking new taxes imposed on those within the United States, thus generating “internal revenue.” Most of the taxes were excise taxes—taxes on the production or consumption of myriad articles of commerce, everything from candles to cloth to pickles. Birthed along with this welter of new excise taxes, however, was a new kind of tax called the income duty. It was just the runt of this litter; private compilations of the tax laws published over the next several years did not even have “income” in their titles. Few foresaw how big that runt would grow or how much of the 1862 statutory language would still be operative over 150 years later, embedded in the current Tax Code.
This newfangled income duty was so successful in raising revenue that Congress kept renewing it until 1872, seven years after the Civil War ended. And Congress revived it again in 1894. It was then opponents raised a question about whether a tax on income was a “direct tax” within the meaning of the U.S. Constitution. If it was, then Congress would have to apportion the revenue among the states, a political death blow to any tax. In 1894 the Supreme Court dealt the blow in Pollock v. Farmer’s Loan, where it decided that a tax on income received from rental property was a “direct tax.” Note this did not make the tax unconstitutional, it just made the tax unconstitutional without apportionment.
That is what the 16th Amendment was all about: removing the apportionment requirement, not authorizing the tax itself. Even before the 16th Amendment Congress doggedly kept writing income tax laws. In 1909 Congress started taxing the business income of corporations, and the Supreme Court held that was not a direct tax and so was not subject to apportionment. In 1912, based on the success of the 1909 legislation, the House Ways and Means Committee approved a draft bill to impose a similar income tax on the business income of individuals. The Committee Report contains a lengthy analysis of why that version of an income tax would survive a constitutional challenge. The passage of the 16th Amendment, however, obviated the need for such legerdemain and so instead of a new “excise” tax, Congress simply tacked an income tax provision onto the 1913 Underwood Tariff Act, much as it had tacked the income duty on the revenue bill back in 1862.
2. The “IRS Code.”
Another common myth is about something called the “IRS Code.” For example, Ted Cruz routinely claims “there are more words in the IRS Code than in the Bible.” The line gets a lot of laughs even though the comparison makes little sense. The Spanish Inquisition, Crusades, and French wars of religion involving the Huguenots should be proof enough that fewer words bring little advantage when it comes to clarity, fairness, or social acceptance.
There is no “IRS Code.” Since 1926 the federal tax laws have been arranged by subject matter in a compendium called the United State Code, or “US Code.” Each subject gets its own title number. So, for example, you can find all the bankruptcy statutes collected in Title 11, also known separately as the “Bankruptcy Code.” And you find all the federal tax laws compiled in Title 26, also known separately as the “Internal Revenue Code” or “IRC” or “Tax Code.” All of those are quite acceptable shorthands. But “IRS Code” makes no sense. The IRS is the agency that administers the Tax Code. It is stuck with the same tax laws that you and I are stuck with, laws enacted by Congress and signed by the President.
So why does Cruz use the term “IRS Code”? After all, he went to Harvard Law School. He knows better. Pronouncing “I-R-S Code” also takes more syllables than saying “Tax Code.” So it’s not a short cut.
The most likely reason is political. The term is a convenient mash-up that attempts to associate responsibility for the tax laws to the agency that administers them. Saying “IRS Code” implies that the IRS is responsible for the tax laws, that the IRS wrote the words of the statutes. Hate one, hate both. By using the term, Cruz can blame the agency for all the words in the Code when the reality is that Congress—where Cruz sometimes works—is responsible for the verbiage, however excessive one believes it to be.
Other politicians are more honest about the matter. For example, in a February 3, 2015, Senate Finance hearing, Senator Orrin Hatch candidly acknowledged to IRS Commissioner John Koskinen (during minute 42 of the hearing video) that “the length of the tax laws have more than tripled since 1975…We should not blame you for this. Congress is the one that keeps adding to your growing responsibilities.”
So, please, the next time you hear the term “IRS Code,” ask yourself whether the person using that term is being ignorant or manipulative. Those are the only two reasons for using the term.
3. Income Taxes are Self-Assessed.
One of the most common myths is that our tax system is based on self-assessment. Not to pick on the good Judge Boasberg, whom we met in looking at the 1913 myth, but in that same court opinion, he buys into this myth as well, declaring “our system is basically one of self-assessment,” a phrase he actually takes from this IRS regulation! Heck, if the IRS says so, why is this a myth? Well, the very next sentence of the regulation shows why: it explains that each taxpayer “is required to file a prescribed form of return which shows the facts upon which tax liability may be determined and assessed.” And who does that assessment? Why, the IRS.
Our system is not one of “self-assessment.” I don’t care who is propagating this myth, whether it’s a judge, a politician, or the taxing agency itself. They are just wrong. Wrong as a matter of law. Wrong as a matter of fact.
As a matter of law, our system is not one of self-assessment. It is a system of self-reporting only. Section 6201 of the Tax Code tells us who makes the assessment and it does not say “the taxpayer shall assess” or “the taxpayer shall self-assess.” It says, “the Secretary shall assess.” Section 6203 explains that the assessment “shall be made by recording the liability of the taxpayer in the office of the Secretary in accordance with rules or regulations prescribed by the Secretary.” It does not say the assessment is made “by the taxpayer in accordance with forms, rules or regulations prescribed by the Secretary.” If, somehow, the proper IRS official does not sign the proper document, then there is no assessment for the IRS to collect, regardless of what the taxpayer submitted on his or her return. Taxpayers have actually won in court when they submitted returns that were not then properly assessed, sometimes to the tune of multiple millions of dollars in lost taxes. If our system were, truly, a system of self-assessment, those cases would never happen.
Nor is our system is one of self-assessment as a factual matter. It is more accurately described as a system of coerced self-reporting, as anyone who received an erroneous W-2 or 1099 will attest. It is true that the IRS accepts a high percentage of taxpayer returns as filed and records the tax liabilities reported on those returns. This might lead one to believe the system is one of self-assessment de facto if not de jure. To understand why that belief is wrong one must first understand that assessments, are not ministerial actions but are discretionary actions, as seen in the case law: they reflect a judgment of what taxes are owed. In fact, the IRS does not have to make an assessment; it could choose to instead file suit in federal court. Go read §6501(a) of the Tax Code, the statute of limitations on assessment. Did you ever stop to ask why it reads that the IRS must either assess or bring proceedings in court without assessment within three years after the return is filed? It is because an assessment is an administrative judgment of taxes owed, which triggers administrative collection powers; it is an alternative to the IRS filing a complaint in court and obtaining a court judgment.
So while taxpayers file returns, they do not assess their own taxes. Nor does the IRS blindly accept returns as filed and assess taxes based on whatever the taxpayer puts on a return. But more on that tomorrow, when we get to Myth #5.