Eisner v. Macomber

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1920 United States Supreme Court case

Eisner v. Macomber, 252 U.S. 189 (1920), was a tax case before the United States Supreme Court that is notable for the following holdings:

• A _pro rata _ stock dividend where a shareholder received no actual cash or other property and retained the same proportionate share of ownership of the corporation as was held prior to the dividend by the shareholder was not income to the shareholder under the Sixteenth Amendment .
• An income tax that was imposed by the Revenue Act of 1916 on such a dividend was unconstitutional even if the dividend indirectly represented accrued earnings of the corporation.

Prior cases

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In 1895, the Supreme Court held in _Pollock v. Farmers' Loan & Trust Co. _ that a tax from income on property, unlike a tax on income from employment or vocations, had to be proportionate to the states' congressional representation. In 1913, the United States ratified the Sixteenth Amendment , which allowed taxation of income without regard to source (income from either property or vocations and employment) and without regard to a state's Congressional representation.

In 1918, the Court, in _Towne v. Eisner _ 245 U.S. 418 (1918), had addressed a nearly-identical situation to one in Eisner v. Macomber. (Eisner was responsible for Internal Revenue Collection in both cases).

However, in the aftermath of Towne v. Eisner, the US Congress passed a revenue collection statute that specifically stated that stock dividends were to be considered as income.

Facts

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Myrtle H. Macomber owned 2,200 shares in Standard Oil , which declared a 50% stock dividend. She received 1,100 additional shares, about $20,000 in par value of which represented earnings accumulated by the company, recapitalized rather than distributed, since the effective date of the original tax law.

The current statute expressly included stock dividends in income, and the government contended that the certificates should be taxed as income to Macomber as if the corporation had distributed money to her. She sued Mark Eisner , the Collector of Internal Revenue, for a refund.

Economic substance of a stock dividend

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The stock dividend in this case was the economic equivalent of a stock split , a transaction in which the corporation multiplies the total number of shares outstanding but gives the new shares to shareholders in proportion to the number that they had held. For example, if a corporation declares a "two for one" stock split and distributes no money or other property to any stockholder, a stockholder who held 100 shares at $4 per share will now hold 200 shares with a value of $2 each, both of which with $400 in value.

Stock dividends vs. cash dividends

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A shareholder's assets do not grow after this sort of stock dividend. Metaphorically, the "pie" is still the same size, but it has been sliced into more pieces, each piece being proportionately smaller. Of course, the same is true of a cash dividend: the shareholder gains cash, but the corporation that is represented by his shares has also lost cash. The shares thus implicitly decline in value by an equal amount.

A shareholder also makes no "sale or other disposition" of stock after this sort of stock dividend. The taxpayer still owns the same proportionate percentage of the corporation that was owned before the stock dividend. Again, that is true of a cash dividend as well.

However, several important factors distinguish a stock and cash dividend. "Overall, the aim of the tax law is to impose a tax on "dividends" when assets representing corporate earnings are transferred to the shareholders. Stock dividends, however, merely give the shareholders additional pieces of paper to represent the same equitable interest; they do not transfer assets or create new priorities among the security-holders. The total value of the common shares, though now spread out over a larger number of units, is left unchanged from its previous level. In effect, nothing of substance has occurred."

The issue in the case was the following:

Essentially, therefore, [i.e. in light of the fact that stock and cash dividends are economically equivalent,] the question in Macomber was not whether the shareholder had gain in an economic sense, but whether in legal or accounting terms the stock dividend was to be regarded as a taxable event.... Stripped of its Constitutional element, the issue in Eisner v. Macomber in the end comes down to a "battle of similarities." Is a stock dividend (as the majority held) "more like" a situation in which a corporation simply accumulates its earnings and makes no distribution at all? Or is it (as Brandeis thought) "more like" the receipt of a cash dividend which is followed by a reinvestment of the cash received in additional shares?

— Marvin Chirelstein , Federal Income Taxation, A Law Student's Guide

Decision

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In the majority opinion, Justice Mahlon Pitney ruled that the stock dividend was not a realization of income by the taxpayer-shareholder for the purposes of the Sixteenth Amendment:

We are clear that not only does a stock dividend really take nothing from the property of the corporation and add nothing to that of the shareholder, but that the antecedent accumulation of profits evidenced thereby, while indicating that the shareholder is richer because of an increase of his capital, at the same time shows he has not realized or received any income in the transaction.

The Court noted that in Towne v. Eisner, it had clearly stated that stock dividends were not income, as nothing of value was received by Towne; the company was not worth any less than it was when the dividend was declared, and the total value of Towne's stock had not changed.

Although the Court acknowledged the power of the Federal Government to tax income under the Sixteenth Amendment, it essentially said that Congress was not given the power to tax as income anything other than income. In others words, Congress did not have the power to redefine "income" as it appeared in the Constitution:

Throughout the argument of the Government, in a variety of forms, runs the fundamental error already mentioned—a failure to appraise correctly the force of the term "income" as used in the Sixteenth Amendment, or at least to give practical effect to it. Thus, the Government contends that the tax "is levied on income derived from corporate earnings," when in truth the stockholder has "derived" nothing except paper certificates which, so far as they have any effect, deny him [or "her" — in this case, Mrs. Macomber] present participation in such earnings. It [the government] contends that the tax may be laid when earnings "are received by the stockholder," whereas [s]he has received none; that the profits are "distributed by means of a stock dividend," although a stock dividend distributes no profits; that under the Act of 1916 "the tax is on the stockholder's share in corporate earnings," when in truth a stockholder has no such share, and receives none in a stock dividend; that "the profits are segregated from his [her] former capital, and [s]he has a separate certificate representing his [her] invested profits or gains," whereas there has been no segregation of profits, nor has [s]he any separate certificate representing a personal gain, since the certificates, new and old, are alike in what they represent—a capital interest in the entire concerns of the corporation.

The Court ordered that Macomber be refunded the tax she overpaid.

Dissents

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In the dissent, Justice Louis Brandeis took issue with the majority's interpretation of income. He argued that the Sixteenth Amendment authorized Congress to tax "incomes, from whatever source derived" and that the authors of the amendment "intended to include thereby everything which by reasonable understanding can fairly be regarded as income." Also, "Congress possesses the power which it exercised to make dividends representing profits, taxable as income, whether the medium in which the dividend is paid be cash or stock, and that it may define, as it has done, what dividends representing profits shall be deemed income."

He noted that in business circles, cash dividends and stock dividends were treated identically. In effect, he argued that a stock dividend is really a cash dividend since it is really two-step affair, with a cash distribution that is then used to purchase additional shares by the exercise of stock subscription rights. Brandeis saw no reason for two essentially-identical transactions to be treated differently for tax purposes:

Justice Brandeis' effort to construct, or read in, a cash distribution was strained and unconvincing. The plain fact is that Mrs. Macomber did not receive, and could not have obtained, a cash payment from Standard Oil. Had she wished to substitute cash in an amount equivalent to the value of the stock dividend, she would have had to sell the dividend shares to other investors. No other cash source was made available.

— [Marvin Chirelstein]

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