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Income Tax Myths

"Wages are not income."

Some people like to say that wages are not income because wages represent an "equal exchange" of a sum of money for its value in labor, or because income includes only returns to capital, or because the Supreme Court has defined income so as to exclude wages.

This incorrect argument can be addressed several ways.

Statutory Answer

Whatever the attraction of this economic theory of wages, Congress has taken a different view. Section 63 of the tax code, 26 U.S.C. § 63, defines your taxable income to be “gross income minus the deductions allowed” by the tax code. Section 61 of the tax code, 26 U.S.C. § 61 which defines “gross income,” provides:

26 U.S.C. § 61

[G]ross 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; . . .

Thus, the tax statutes specifically provide that your wages (“compensation for services”) are part of your gross income. Since no provision of the code allows you to deduct the value of your services from the compensation you receive, they are also part of your taxable income. So the tax laws do impose a tax on wages, regardless of whether anyone thinks they should.

Theoretical Answer

Moreover, apart from the fact that it's wrong as a matter of the tax statutes, the argument that you should get to deduct the value of your labor is misdirected as a matter of theory. It's based on an incorrect understanding of how to calculate income. When you get income by selling something, you do not calculate your income by taking the sale price and subtracting the value of the thing sold. You calculate your income by taking the sale price and subtracting the cost to you of the thing sold.

Here's a simple example that proves this. If you buy a stock for $100 and sell it later for $120, your income from the transaction is $20—your sale price of $120 minus your cost of $100. If you were allowed to subtract the value of the thing sold, your income would be zero. On the day you sold the stock, its value was $120. So if you could subtract the value, your income would be $120-$120 = 0. But that's obviously wrong, because you made $20 on the sale.

The lesson learned from this simple example is that, in a sales transaction:

Seller's Income = Sale Price - Seller's Cost

It would not be correct to say that Seller's Income = Sale Price - Value. That would be zero in our example, and, indeed, if you could subtract the value of the thing sold, you would almost always get zero. Basically, no one would ever have any income from doing anything! Just about every transaction in a free market society involves an "equal exchange"—the selling of something for an amount equal to its value. If you pay $1 for a newspaper, you get a newspaper worth $1. If you buy a house for $100,000, you get a house worth $100,000. These are all equal exchanges. So if "income" were determined by subtracting the value of the thing sold from the sale price, the result would almost always be zero for every transaction.

So that can't be how it works. Income is generally the difference between the sale price and the cost of the thing sold, not the value of the thing sold.

So getting back to wages, if you could deduct anything from your wages, it would be the cost to you of your labor, not the value of your labor. But you didn't pay anything to own your own labor in the first place. Your cost is zero. So there's nothing to deduct.

This does not mean that your labor is valueless. Your labor is valuable, and you give up that value when you sell it to your employer. But value is not the relevant figure. The relevant figure is cost, which is zero.

Actually, a not-so-bad argument would be that you should get to deduct the costs you do pay to be able to perform labor: the costs of your work clothes, transportation to work, the food you need to eat so that you can stay alive and keep working, etc. And some work expenses are indeed deductible. But the tax laws don't allow deduction of many of these expenses, such as the basic cost of commuting to and from work, and certainly they don't allow the basic cost of food as a deduction, even though you need to eat to stay alive and work. (One reason for this is that it would be too difficult to distinguish the business expense of the food you need to eat for work purposes from the personal expense of the food you would eat whether you worked or not.)

In any event, the main point is that you can't deduct the value of your labor, both because the tax statutes don't allow it and because it would be wrong even in theory.

Case Answer

Protestors sometimes say that Supreme Court cases have defined income narrowly, to include only some specific type of income, such as corporate gain or profit. These arguments invariably rely on taking the Supreme Court's remarks out of context. For example, in the frequently cited case of Eisner v. Macomber, 252 U.S. 189 (1920), the Supreme Court considered the taxability of a "stock dividend" -- that is, a dividend that was not a cash payout, but that simply gave corporate shareholders some additional shares of stock for each share that they already owned. Because such a "stock dividend" has no real effect -- it just divides the same corporate pie up into more slices -- the Supreme Court held that it was not taxable. Naturally, in the course of deciding a case about such a corporate context, the Supreme Court made some remarks that were appropriate to that context, such as noting that, in the corporate context, income would be "a gain, a profit, something of exchangeable value, proceeding from the property, severed from the capital."

But these remarks were not a comprehensive definition of income in all contexts, and, whenever the Court has given such a comprehensive definition, it has been broad enough to include wages. Indeed, in the very same case, the Supreme Court gives a definition: it says that "'Income may be defined as the gain derived from capital, from labor, or from both combined,’ provided it be understood to include profit gained through a sale or conversion of capital assets." This definition clearly includes wages, which are a "gain derived from . . . labor." More recently the Court has stated the matter even more broadly: it said that Congress intended the income tax statute to exercise "the full measure of its taxing power," so that the statute should be read to cover all income that may constitutionally be taxed, and it suggested that "income" would include all "accessions to wealth." Commissioner v. Glenshaw Glass Co., 348 U.S. 246 (1955). Again, that would include wages.

So you can't just look at a stray sentence or sentence fragment from a Supreme Court case that was limited to a particular context. When the Supreme Court has actually defined the term "income," the definition has always been broad enough to include wages.

Moreover, innumerable lower court decisions have addressed the question of whether wages are income, and the courts have said yes every time. Here are just a few samples out of literally hundreds of cases (bolding added):

 
Jones v. Commissioner, 338 F.3d 463 (5th Cir. 2003)
"Income tax laws apply to income earned by individuals. See, e.g., United States v. Burton, 737 F.2d 439, 441 (5th Cir.1984) (“Beyond dispute, wages are income.”)."
 
 
Grimes v. Commissioner, 806 F.2d 1451 (9th Cir. 1986)
"There can be no doubt that the tax on income is constitutional and that, for the purpose of the Sixteenth Amendment, income includes “gain derived from capital, from labor, or from both combined.” Eisner v. Macomber, 252 U.S. 189, 207, 40 S.Ct. 189, 193, 64 L.Ed. 521 (1920). Sections 1 and 61 of the Internal Revenue Code impose a tax on income, and wages are income."
 
 
United States v. Connor, 898 F.2d 942 (3d. Cir. 1990)
"Congress exercised its power to tax income by defining income as, inter alia, “compensation for services, including fees, commissions, fringe benefits and similar items.” 26 U.S.C. § 61(a)(1) (Supp. II 1984). Every court which has ever considered the issue has unequivocally rejected the argument that wages are not income."
 
 
Coleman v. Commissioner, 791 F.2d 68 (7th Cir. 1986)
"Some people believe with great fervor preposterous things that just happen to coincide with their self-interest. . . . Coleman says that wages may not be taxed because they come from his person, a depreciating asset. The personal depreciation offsets the wage, leaving no net income. . . . These are tired arguments. The code imposes a tax on all income. See 26 U.S.C. § 61. Wages are income, and the tax on wages is constitutional. "
 
 
Ledford v. United States, 297 F.3d 1378 (Fed. Cir. 2002)
"Mr. Ledford bases his entitlement to . . . relief on his view that the federal tax code does not tax compensation received for personal labor. Mr. Ledford's view of the tax law is mistaken, as the tax code quite plainly defines income to include amounts received in compensation for services rendered. 26 U.S.C. § 61(a) (2000) (“[G]ross 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....”). Indeed, every court that has considered the matter has found this argument to be wholly without merit—so much so that merely raising it is considered sanctionable."
 
 
Common Sense Answer

If you've read all of the above and you still believe that wages aren't income, here's one more thought:

If wages are not income because they are just an "equal exchange" -- if you really get zero gain or profit from your wages because what you give up is equal in value to what you get -- then why do you work? Why does anybody work?

No one works for the pure fun of it. No one would work for zero gain or profit. If people really believed that they were getting zero from working, they would stop. People work because they get income from working. That income is taxable.