Happy Independence Day! While we’re celebrating America’s birthday this weekend, let’s take a look at the taxes that “make government go” and a select handful of some of the most common frivolous tax arguments used by tax protestors to attempt to avoid paying federal income tax. The federal income tax was created by the Sixteenth Amendment to the U.S. Constitution and was ratified (more on that later) in 1913. In 1913 the top tax rate was 7%. The highest marginal tax rate ever was 94% and was in effect towards the end of World War II (1944 and 1945); at the beginning of the war (1939) it was 75%. During World War I the top rate was 77%. From the 1950s until the early 1960s top rates for individual taxpayers were over 90%. More recently the top rates have bounced back and forth between 35% and close to 40%.* It’s clear that modern taxpayers have it a bit easier than many of their predecessors in terms of top individual income tax rates. Nevertheless, despite the many legal options for reducing individual federal income tax, some tax protestors continue to attempt to avoid paying at all using a plethora of legally repudiated arguments.
Each year the IRS updates The Truth About Frivolous Tax Arguments, which “describes and responds to some of the common frivolous arguments made by individuals and groups who oppose compliance with the federal tax laws.” Often the same arguments continue to turn up year after year, just like bad pennies.
Federal income tax is unconstitutional—There are those who argue that the federal income tax is illegal because the Sixteenth Amendment was not legally ratified. According to the IRS, “This argument is based on the premise that all federal income tax laws are unconstitutional because the Sixteenth Amendment was not officially ratified or because the State of Ohio was not properly a state at the time of ratification. Proponents mistakenly believe that courts have refused to address this issue.” The courts have addressed this and other constitutionally based protest arguments (income tax violates due process prior to illegal search and seizure of property, income tax violates the first amendment, etc.) repeatedly and the IRS summarizes them in Revenue Ruling 2005-19. If an attorney or tax preparer or someone on the internet is promoting one or more of these arguments to you, swim away!
Compliance with federal income tax law is voluntary—Yeah. Not exactly. While the system is based on voluntary compliance in this case voluntary may not mean what you think it means. The IRS states that “The word “voluntary,” as used in Flora and in IRS publications, refers to our system of allowing taxpayers initially to determine the correct amount of tax and complete the appropriate returns, rather than have the government determine tax for them from the outset.” If you don’t file a return the IRS will file a “substitute for return” for you and you may not get all of the credits and deductions to which you are legally entitled. You will get taxed on all income reported to the IRS by third parties.
Voluntary compliance also does not extend to paying tax due. Section 1 of the Internal Revenue Code (IRC) imposes tax on individuals. And the IRC is Title 26 of the Code of Federal Regulations. The law requires individuals to pay their income tax. If an individual owes tax, compliance with the legal obligation to pay is not voluntary.
Fine. I’ll just file a zero return—The IRS notes that these taxpayers “attempt to reduce their federal income tax liability by filing a tax return that reports no income and no tax liability (a ‘zero return’) even though they have taxable income. Many of these taxpayers also request a refund of any taxes withheld by an employer. These individuals typically attach to the zero return a “corrected” Form W-2 or another information return that reports income and income tax withholding…” The IRS goes on to remind taxpayers that, “Courts have repeatedly penalized taxpayers for making the frivolous argument that the filing of a zero return can allow a taxpayer to avoid income tax liability or permit a refund of tax withheld by an employer.” Typically the opinions are based on IRC Section 61, Gross Income Defined, which is the “mom voice” of the IRC. It states that all income from whatever the source is subject to income tax unless a specific exception applies. Section 61 also describes what income can legally be excluded from income.
Courts have also used what is known as “the Beard test” (based on the Supreme Court’s Opinion in Beard v. Commissioner) to invalidate these arguments. The Beard test describes the criteria that make a tax return a tax return. If the “return” doesn’t meet the criteria, it’s not really a tax return. Courts have repeatedly ruled that zero returns “do not evidence an honest and reasonable attempt to satisfy the tax laws or contain sufficient data to calculate the tax liability, which are necessary elements of a valid tax return.” IRS spells out the consequences for taxpayers filing zero returns in Revenue Ruling 2004-34.
But my wages, tips, and other compensation aren’t really income so they aren’t subject to income tax—According to the IRS, taxpayers who use this argument assert that wages, tips, and other compensation received for personal services are not income but rather an “exchange” of labor (or time) for money. This argument brings us back to the definition of income under IRC Section 61, basically income is income unless Section 61 says it isn’t. That means that bartering transactions are subject to federal income tax. If a taxpayer exchanges tax preparation services for a beaver pelt (my mother took one as payment, may she rest in peace), the income received is equal to the fair market value of the services provided. Barter transactions are subject to 1099 reporting rules as well.
Fine. I’ll just relinquish my citizenship—Citizens of the U.S. are subject to income tax on their worldwide income. That’s one of the reasons the IRS has been increasing scrutiny on foreign bank accounts (and the interest they earn). When a U.S. citizen relinquishes their citizenship to become a citizen of another country, their U.S. tax obligations change (but may not be entirely eliminated depending on where their income is sourced). Many tax protesters, however, state that they have rejected their U.S. citizenship and are only citizens of the state in which they reside. The IRS response to this argument is based in the text of the Fourteenth Amendment, which defines the basis for United States citizenship. The amendment states that “[a]ll persons born or naturalized in the United States, and subject to the jurisdiction thereof, are citizens of the United States and of the State wherein they reside.” In other words, federal and state citizenship are simultaneous, not mutually exclusive. The IRS reminds taxpayers that “Claims that individuals are not citizens of the United States but are solely citizens of a sovereign state and not subject to federal taxation have been uniformly rejected by the courts.”
So, toss aside the frivolous arguments, grab some frivolous food, and go outside to enjoy some (non-financial) fireworks this weekend!