Federal Income Tax. And Government Entitlement Programs
(Credit for this section is due here to Larkin Rose, Theft by Deception.)
Robert Johhnson is a U.S. citizen who lives and works in NY State. He does various jobs for his neighbors, who pay him for his services. Our goal here is to determine if the federal income tax statutes and regulations show Rob's income to be taxable at all. While most people assume their income is taxable we will examine the law
Title 26 of the United States Code deals with Federal taxes and is titled Internal Revenue Code. It is divided into several subtitles A,B,C,D,E, etc. which deal with different aspects of Federal tax law. The first subtitle, Subtitle A is where the income tax statutes are found. Subtitle A is divided into several chapters. Chapter 1 is where the basic federal income tax is found. chapter 1 is divided into many subchapters but only a few are relevant to determining whether Rob's income is taxable. The first subchapter (A)DETERMINATION OF TAX LIABILITY is an obvious place to begin. 26 USC 1.1-1
. The first part of that subchapter is titled TAX ON INDIVIDUALS the first section 1 is titled TAX IMPOSED. There is a tax imposed on unmarried individuals.
26 USC 1.1-1
"THERE IS HEREBY IMPOSED ON THE TAXABLE INCOME OF EVERY INDIVIDUAL OTHER THAN A SURVIVING SPOUSE AS DEFINED IN SECTION 2(A)OR THE HEAD OF A HOUSEHOLD AS DEFINED IN SECTION 2(B) WHO IS NOT MARRIED.
This section gives a chart but does not define taxable income. Subchapter B or 26 USC 1.61-1
is titled. COMPUTATION OF TAXABLE INCOME. Part 1 is titled DEFINITION OF GROSS INCOME, ADJUSTED GROSS INCOME, TAXABLE INCOME, ETC. In this part we find section 63 titled TAXABLE INCOME DEFINED.
26 USC 1.63-1
TAXABLE INCOME DEFINED
(a) In general except as provided in subsection (b) for purposes of this subtitle the term "taxable income" means GROSS INCOME MINUS THE DEDUCTIONS ALLOWED BY THIS CHAPTER (OTHER THAN THE STANDARD DEDUCTION).
So the equation is GROSS INCOME minus DEDUCTIONS = TAXABLE INCOME. As opposed to guessing at what gross income means we want to see how the law defines it.
26 USC 1.61-1
GROSS INCOME DEFINED
(a) general definition)
Except as otherwise provided in this subtitle, gross income means ALL INCOME FROM WHATEVER SOURCE DERIVED, including (but not limited to) the following items:
1 compensation for services, including fees, commissions, fringe benefits, and similar items; 2 Gross income derived from business: 3 Gains derived from dealings in property: 4 interest; 5 rents.
At this point it seems Rob recieves gross income and therefor taxable income as well. To be thorough we examine the regulations.
26 CFR 1.61-1
(a general definition. Gross income means all income from whatever source derived, unless excluded by law. Gross income includes income realized in any form, whether in money, property, or services. Income may be realized therefor, in the form of services, meals, accommodations, stock, or other property as well as in cash.
Rob wonders if the law may somewhere exclude his income. Near by sections show some specific types of income are excluded. In example section 101 shows that certain life insurance proceeds are excluded from income for the purposes of the income tax. In short nothing in these nearby sections show that Robs income is not gross income. Again section 1 imposes the tax, the regulations reiterate what we have learned. The tax is upon taxable income which is determined by subtracting allowable deductions from gross income, further down those regulations 26 CFR 1.1-1
it also state that citizens of the US such as Rob are liable for the tax whether the income is from sources within or without the United States. In Rob's case all his income comes from within the US. Everything we have seen up to this point makes it seem that Rob's income is taxable. Tax professionals and the IRS use the same sections we have reviewed to determine if the income of an individual is taxable. If we look no further into the law it would seem that Robs income is taxable, but we will look further.
In leagaleese some words used in common english are redefined to mean something completely different from what a word normally means. Without knowing the leagal definitions it can be difficult to understand the meaning of some laws. For example another area of title 26 unrelated to income tax says that the secretary of the treasury shall maintain a central registry of all firearms in the United States. Section 5841 Registration of firearms. Section 5845 Definitions, defines the term fire arm for the purposes of that law. The legal definition of fire arm bears little resemblance to the meaning of the word firearm in common english. The legal definition includes machine guns and short barrell shotguns but does not include the vast majority of revolvers hand guns shot guns and rifles, even semi automatic military rifles are excluded, but then it includes bombs and poison gas which common english does not identify with a fire arm. If the average citizen were to examine section 5841 alone he would almost certainly get the wrong impression of what the law required. Because of legaleese the reader must undrestand the precise meaning of words used in the law.
For review 26 USC 1.1-1
imposes a tax on taxable income, 26 USC 1.63-1
generally defines taxable income to mean gross income minus deductions. and 26 USC 1.61-1
defines gross income to mean all income from whatever source derived. To most people the term FROM WHATEVER SOURCE DERIVED would be synonymous with, "no matter where it comes from". But what is the exact legal meaning of the term source? In each of the 3 main printed versions of the tax code 26 USC 1.61-1
has an interesting cross reference "regarding income from sources within the united states "see 26 USCA 861 Without the united states See 26 USCA 862." The indexes of the code also refer to 861 and following regarding determination of sources of income and specifically regarding income within the united states they refer to section 861. The cross references and indexes are not technically the law but they do give us an idea of where to look next. The index of the Code of Federal Regulations does carry some legal weight due to the federal registrar act and contains a similar entry. Under the heading income taxes there is an entry concerning income from nside or outside the US as well as determination of sources of income and refers the reader to 26 CFR 1.861-1
-- 1.864-8T.) Section 861 is the first section in Subchapter N of the statutes. As we saw earlier in 26 CFR 1.1-1
Citizens of the united states are taxed on income FROM SOURCES WITHIN OR WITHOUT THE UNITED STATES. The title of 26 USC 861 Subchapter N is TAX BASED ON INCOME FROM SOURCES WITHIN OR WITHOUT THE UNITED STATES.
Part 1 of Subchapter N includes section 861 and is titled INCOME FROM SOURCES WITHIN THE UNITED STATES We seem to be in the right place to determine what constitutes a source of income. When we examine section 861 itself it is titled INCOME FROM SOURCES WITHIN THE UNITED STATES. We will now review the statutes and regulations relating to this section
26 USC 861 (a)
GROSS INCOME FROM SOURCES WITHIN THE UNITED STATES
Gross income from sources within the United States. The following items of gross income SHALL BE TREATED AS INCOME FROM SOURCES WITHIN THE UNITED STATES. ( a general list is given here that pretty much identifies all types of income as the earlier sections did. See the statute for more information.)
26 USC 861(B)
TAXABLE INCOME FROM SOURCES WITHIN THE UNITED STATES
From the items of gross income specified in subsection(a) as being income from sources within the United States there shall be deducted the expenses losses and other deductions properly. The remainder , if any, shall be included in full as TAXABLE INCOME FROM SOURCES WITHIN THE UNITED STATES..
26 CFR 1.861-1
INCOME FROM SOURCES WITHIN THE UNITED STATES
(a) Categories of income
Part 1 (section 861 and following), subchapter N chapter 1 of the code and the regulations thereunder determine the sources of income for purposes of the income tax. These sections explicitly allocate certain important sources of income to the united states or to areas outside the United States.
Gross income is generally defined as income from whatever source derived 26 CFR 1.61-1, 26 USC 1.61-1
and 26 CFR 1.861-1
through 26 CFR 1.861-14T
determine the sources of income for the purposes of the income tax. Section 61 uses the term source but these sections define what that term legally means. Compared with the exampe of the term fire arms, when the law uses the term "all fire arms" does that mean the reader is to ignore the legal definition of the term fire arms?, of course not. The phrase simply means everything that falls within the range of the legal meaning of ALL FIREARMS. Similarly ALL INCOME FROM WHATEVER SOURCE DERIVED, Depends entirely on the legal meaning of the term SOURCE, and section 861 and following and related regulations determine the sources of income for the purposes of the income tax.
Taxable income as defined in section (26 CFR 1.63-1) means gross income minus deductions. but section 26 USC 861(B) Specifically describes what constitutes taxable income from sources within the united states. The regulations for section ( 26 USC 1.61-1) of the code 26 CFR 1.61-1
will not give you guidance for determining your taxable income, they do not describe how to determine taxable income.
The regulations in section 63 just give a proceedural rule for filing a tax return with itemized deductions, vs using the standard deduction, they do not describe how to determine taxable income. Where as 26 CFR 1.861-1
through26 CFR 1.861-14T
After saying these sections determine the sources of income for the purposes of the income tax The regulations explain that the statutes provide for 3 categories of income. 1. INCOME FROM SOURCES WITHIN THE UNITED STATES, 2. INCOME FROM SOURCES WITHOUT THE UNITED STATES. 3. AND INCOME PARTLY WITHIN AND PARTLY WITHOUT THE UNITED STATES.
In Rob's Case we are only concerned with the first category as he receives all of his income from within the United States. The regulations clearly state that gross income from within the united states consists of the income described in 26 USC 861(a)
and the related regulations. If one has income from partly without or partly within the united states then section 26 USC 863
gives rules about how to divide up such income, some of which will then be treated as income from within the united states. But Rob has no such income so 26 USC 863
does not apply to him. The regulations then go on to say that the taxable income from sources within the united states shall be determined in accordance with section 26 USC 861(B)
and the reader is directed in 26 CFR 1.861-1
to the related regulations 26 CFR 1.861-8
and 26 CFR and 1.863-1
.) If Rob had income from partly without and partly within the united states section 863 could have come into play in determining taxable income from within the United States, but this is not the case. Though its a bit redundant to do so the regulations then make the point again stating that taxable income from sources within the United States shall consist of the taxable income described in paragraph(a)(1) and in some cases (a)(3) for income partly with and partly without the United states. In Rob's case 26 USC 861(a)
and the related regulations 26 CFR 1.861-1
/2/3/4/5/6/7/ and 26 CFR 1.861-8
determine whether he has gross income from sources within the united states. And 26 USC 861(B)
and the related regulations determine whether he has taxable income from sources within the United States.
Tax experts tell most americans that they owe federal income taxes because like most Americans, Tax professionals grew up hearing that almost everyone owes federal income taxes. Rather than starting with no assumptions and examining the statutes and regulations for themselves to determine what is taxable, they got their information from pulications, teachers, and text books all of which echo the conventional wisdom of prior generations. When a tax expert examines the law itself he is likely to simply dismiss any evidence which does not conform to his preconcieved notion (cognitive dissonance), basically boiling down to backwards thinking, most start with the assumption that most income is taxable and when they see that section 861 does not show most income to be taxable the conclude that they are looking in the wrong place and are simply unable to consider the possibility that the evidence means what it says and conventional wisdom is incorrect.
Section 26 CFR 1.861-8
of the regulations is what we were told to use by section 26 CFR 1.861-1
for determining taxable income from sources within the United states, and the first thing those regulations say is that 26 USC 861(B)
and 26 USC 863
state in general terms how to determine taxable income of a taxpayer from sources within the United States, after gross income from sources within the united states has been determined. Then the regulations say that taxable income of a taxpayer from sources outside the united states is determined under section 26 USC 862(b)
and in come cases26 USC 863
as well. Since Rob only has income from within the United States it is clear that he should use section >26 USC 861(B)
and the related regulations to determine his gross income and taxable income. Again the regulations under section 1 the section which imposes the tax 26 USC 1.1-1
told us that the tax is upon taxable income and that us citizens are taxed on their taxable income from sources within or without the United States. And the regulations under section 26 USC 863
specifically say that the tax payer's taxable income from sources within or without the united states will be determined under the rules of secs. 26 CFR 1.861-8
through 26 CFR 1.861-14T
FOR DETERMINING TAXABLE INCOME FROM SOURCES WITHIN THE UNITED STATES. The index of the regulations reinforces the point referring to the regulations under 26 CFR 1.861-1
-- (26 CFR 1.864-8T) and following regarding INCOME FROM SOURCES INSIDE OR OUTSIDE THE U.S. Keep in mind that regardless of these countless citations that tax experts do not use these sections to determine taxable income from sources within the united states. They are either unaware of these citations or misread or ignore them. We now have abundant evidence to show that we are in the right place to determine rob's taxable income it's time to see what those sections show to be taxable income.
The scenario is that Robert Johnson is a U.S. Citizen and performed a service within the 50 states and was compensated for it. 26 USC 861(a)
states the following items of gross income shall be treated as income from sources within the United States. And on the list is compensation for labor or personal services performed in the United States. There are some unusual exceptions in the statute but none of those apply to Rob. Even here the law seems to include Rob's income. We now drop down to section 26 USC 861(B)
for determining taxable income from sources within the united states. There we are told that from the items of income in 26 USC 861(a)
certain deductions can be taken and the remainder if any SHALL BE INCLUDED IN FULL AS TAXABLE INCOME FROM SOURCES WITHIN THE UNITED STATES. After all this research it seems that Rob's income is taxable after all, or at least it looks that way at the moment. The key to understanding federal income taxes is understanding subchapter N of the code which is entitled TAX BASED ON INCOME FROM SOURCES WITHIN OR WITHOUT THE UNITED STATES. Section 26 USC 1.61-1
lists some common items of income that can be taxable but says nothing about who is receiving the income or where it's coming from. As its title suggests Subchapter N spells out the circumstances under which those items of income are taxable when derived from inside or outside the US. Before studying part one more thouroughly we will look at the other parts of subchapter N.
PART 2 deals with NONRESIDENT ALIENS AND FOREIGN CORPORATIONS. PART 3 deals with INCOME FROM SOURCES OUTSIDE THE US section 911 of PART 3 deals with CITIZENS OR RESIDENTS OF THE UNITED STATES LIVING ABROAD. It also includes rules about those who reside in or recieve income from FEDERAL POSESSIONS (virgin islands, guam, puerto rico)
PART 4 gives special rules about DOMESTIC INTERNATIONAL SALES CORPORATIONS PART 5 deals with INTERNATIONAL BOYCOTT DETERMINATIONS.
Its clear that PARTS 2 through 5 of subchapter N are all about international and foreign commerce. While those parts talk about the domestic income of foreigners and certain foreign income of us citizens they say nothing about citizens that live and work exclusively within the US.
Now we will examine PART 1 and the related regulations in more detail. As we already saw section 26 USC 861
at first glance seems to show most domestic income to be taxable. However the proper scope of this section can only be understood in the context of the rest of subchapter N. Part 1 and its regulations DETERMINE THE SOURCES OF INCOME FOR THE PURPOSES OF THE INCOME TAX. The sections therein give the general rules about determining taxable income 26 USC 861
, from sources within the United States. 26 USC 862
, From without the United states, and 26 USC 863
from sources partly within and partly without the united states. But the regulations 26 CFR 1.861-8
say that 861, 862, and 863 are for determining taxable income from SPECIFIC SOURCES. So we must see if the law somewhere defines what constitutes a SPECIFIC SOURCE of income before we blindly assume we know what the term means in common english, exactly the same way we defined the term fire arms previously.
Rob only has income from within the United States and section 26 CFR 1.861-8
is the section of the regulations we were repeatedly told to use by 26 USC 861
, 26 USC 862
, 26 USC 863
for determining taxable income from SOURCES within the United States. In the first paragraph of 26 CFR 1.861-8
it again mentions SPECIFIC SOURCES saying that the rules of that section apply in determining taxable income of the taxpayer FROM SPECIFIC SOURCES AND ACTIVITIES UNDER OTHER SECTIONS OF THE CODE REFERRED TO IN THIS SECTION AS OPERATIVE SECTIONS. THE OPERATIVE SECTIONS INCLUDE AMONG OTHERS SECTIONS 26 USC 871
AND 26 USC 882
. These are examples of operative sections, and as we see in 26 USC 871
non resident aliens doing business within the united states shall be taxable as provided in section 1. The regulations direct us to 26 CFR 1.861-8(f)(1)
titled MISCELLANEOUS MATTERS for the complete list of operative sections which describe, specific sources and activities, income from which is taxable under section 26 USC 861
, That list includes the Foreign tax Credit rules that are found in 901 and following, and includes the sections earlier discussed with the income of domestic foreigners and foreign corporations, and certain rules relating to federal posessions (puerto rico, virgin islands etc.) to foreign and international sales corporations.
In the first paragraph of Section 26 CFR 1.861-8
of the regulations (the section "for determining taxable income from sources within the United States"), it is again made clear that the section applies only to the listed "items" of income when derived from "specific sources." "The rules contained in this section apply in determining taxable income of the taxpayer from specific sources and activities…" 26 CFR 1.861-8(a)
Again, a few paragraphs later, in defining the term "statutory grouping," these regulations again state that taxable income must come from a specific source. "the term 'statutory grouping' means the gross income from a specific source or activity which must first be determined in order to arrive at 'taxable income' from which specific source or activity" 26 CFR 1.861-8(a)(4)
26 CFR 1.861-8(f)(1)
it is again made clear that Section 26 CFR 1.861-8
(the section "for determining taxable income from sources within the United States") is applicable only to income derived from "specific sources."
26 CFR 1.861-8(f)(1)
"the determination of taxable income of the taxpayer from specific sources or activities and which gives rise to statutory groupings [see previous citation] to which this section is applicable…"
From these it is clear that the term "source" as used in Sections 26 USC 1.61-1
and 26 USC 861
. does not simply mean any activity from which income is derived. (If it did, there would be no need for Section 861 and following, and related regulations, to "determine the sources of income for purposes of the income tax.") The following citations show that Section 26 CFR 1.861-8(f)(1)
"lists the "specific sources" of income subject to the income tax. The definition of "statutory grouping" (mentioned above) also refers to "paragraph (f)(1)" as the list of "specific sources." Again, the first paragraph of 26 CFR 1.861-8
"states the following:
26 CFR 1.861-8(a)(1)
""The rules contained in this section apply in determining taxable income of the taxpayer from specific sources and activities under other sections of the Code, referred to in this section as operative sections. See paragraph (f)(1) of this section for a list and description of operative sections."
26 CFR 1.861-8(a)(4)
""The term 'statutory grouping' means the gross income from a specific source or activity which must first be determined in order to arrive at 'taxable income' from which specific source or activity under an operative section. (See paragraph (f)(1) of this section.)" [26 CFR § 1.861-8(a)(4)]
The regulations twice identify "paragraph (f)(1) of this section" 26 CFR 1.861-8
"as the list of specific sources. Paragraph (f)(1) itself confirms this again, and then lists the "specific sources" subject to the income tax: The operative sections of the Code which require the determination of taxable income of the taxpayer from specific sources or activities and which gives rise to statutory groupings to which this section is applicable include the sections described below.
26 CFR 1.861-8(f)(1)
(i) Overall limitation to the foreign tax credit…
(iii) DISC and FSC taxable income… [international and foreign sales corporations]
(iv) Effectively connected taxable income. Nonresident alien individuals and foreign corporations engaged in trade or business within the United States…
(v) Foreign base company income…
(vi) Other operative sections. The rules provided in this section also apply in determining--
(A) The amount of foreign source items…
(B) The amount of foreign mineral income…
(D) The amount of foreign oil and gas extraction income…
(E) (deals with Puerto Rico tax credits)
(F) (deals with Puerto Rico tax credits)
(G) (deals with Virgin Islands tax credits)
(H) The income derived from Guam by an individual…
(I) (deals with China Trade Act corporations)
(J) (deals with foreign corporations)
(K) (deals with insurance income of foreign corporations)
(L) (deals with countries subject to international boycott)
(M) (deals with the Merchant Marine Act of 1936)"
For example, item "(iv)" on the list in26 CFR 1.861-8(f)(1)
"specifically refers to sections 26 USC 871(b)(1)
and 26 USC 882(a)(1)
of the statutes, which state the following:
26 USC 882(a)(1)
"A nonresident alien individual engaged in trade or business within the United States… shall be taxable as provided in section 1…"
26 USC 871(b)(1)
"A foreign corporation engaged in trade or business within the United States… shall be taxable as provided in section 11[*]…"
Here the statutes state that these specific activities (or "sources") may produce taxable income. If an "item" of income (such as compensation for services) derives from the activity described in this "operative section," that income is subject to the income tax. The "shall be taxable" phrase would be entirely unnecessary if "from whatever source derived" meant " no matter where it comes from". There is no such "shall be taxable" phrase, nor any "operative section" describing an activity in which a United States citizen living and working exclusively within the 50 states receives income from within the 50 states. The regulations under Section 861 make it clear that the "items" of income must derive from a taxable source or activity described in an "operative section" of the statutes in order to be taxable. Domestic income earned by American Citizens from within the 50 States does not legally constitute "income from whatever source derived."
Again Credit for the above section goes to Larkin Rose, Theft by Deception