Eisner v. Macomber

Supreme Court of the United States · 1920 · Corporations

CorporationsIncome TaxStock DividendsSixteenth Amendmentstock dividendincomeSixteenth Amendmentdirect tax

Facts

Standard Oil Company of California had outstanding capital stock of about $50,000,000 and surplus and undivided profits of about $45,000,000, much of it invested in the business. In January 1916, to readjust capitalization, the company issued a 50% stock dividend and transferred a corresponding amount from surplus account to capital stock account. Macomber, who owned 2,200 shares, received 1,100 additional shares, of which 198.77 shares were treated by the government as representing post-March 1, 1913 surplus, and she was taxed on $19,877 as supposed income. She paid under protest and challenged the tax on the ground that a stock dividend is not income within the Sixteenth Amendment and therefore cannot be taxed without apportionment.

Issue

Whether Congress, by virtue of the Sixteenth Amendment, may tax without apportionment as income of the shareholder a bona fide stock dividend lawfully made out of corporate profits accumulated after March 1, 1913. Also, whether the Revenue Act of 1916 validly imposed such a tax.

Rule

Income within the Sixteenth Amendment is gain derived from capital, labor, or both, including profit from sale or conversion of capital assets, but it must be something of exchangeable value proceeding from property, severed from capital, and received by the taxpayer for separate use, benefit, and disposal. A true stock dividend, lawfully and in good faith made, does not take anything from the corporation's property, does not add anything to the shareholder's proportional interest, and therefore is not income but a capitalization of surplus.

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Red Mesa Milling, a Colorado corporation based in Denver, has substantial earnings retained in new equipment and working capital. To reflect that growth, its board issues one additional common share for every four common shares outstanding and transfers the same amount from surplus to stated capital, with no cash or property leaving the company.

A federal statute declares that any stock dividend is taxable to the shareholder at its cash value. If Nina Patel receives the additional shares, what is the strongest argument against taxing her on receipt of those shares as income?

Explanation. Under the majority opinion, income means gain derived from capital, labor, or both, but it must be something of exchangeable value proceeding from property, severed from capital, and received by the taxpayer for separate use, benefit, and disposal. A bona fide pro rata stock dividend merely capitalizes surplus, changes the evidence of the shareholder's capital interest, leaves the corporation no poorer, and leaves the shareholder's proportional interest unchanged. Congress cannot make it income by definition alone. (Derived from Eisner v. Macomber (n.d.).)